So you've reached a point in your life where you are starting to think about your retirement. But how can you really make the most of your savings and ensure you can enjoy your golden years comfortably?
The three most dominant savings products on the market right now are ISAs, LISAs, and standard pensions. Here we look at what each of these schemes are and (hopefully) helping you work out which option is best for you.
Individual Savings Accounts (ISAs)
An ISA is often a very popular method for putting away your hard-earned money away safe from tax on any interest or capital appreciation you earn.
An ISA account allows you to save or invest money tax-free. That means you can make a profit in interest or returns on your investments without paying income tax on them up to a savings limit of £20,000 per year.
The financial year for your ISA runs the same as in the real world; from the 6th of April to the 5th of April the following year. At the end of each financial year, your new allowance takes effect. Tax rules are always changing so try to always make sure that you know exactly what your allowance limit is to stay tax efficient.
You will not be able to carry your ISA allowance over to the next financial year so, wherever possible, try to make the most of your tax-free savings.
One way to increase the amount you can save for your retirement without increasing your tax bill is by investing up to £20,000 in a combination of the different types of ISA. These are:
- Cash ISAs
These are the ISAs offered to you by banks and building societies. They are essentially just standard savings accounts that allow you to accrue interest on your balance completely tax-free.
- Investment ISAs
You may know this type of ISA better as a stocks and shares ISA. They tend to be provided by fund supermarkets and stockbrokers.
They work by allowing you to place company shares, unit trusts, investment trusts, both government and corporate bonds, and open ended investment companies into your savings account.
It is important to note that if your investments should reduce in value then your savings will too. That means you could be at higher risk of losing money on your investment if you were to choose an investment ISA over the cash alternative.
Bear in mind that, as of April 2018, you are able to claim the first £2,000 in dividends on your investments completely tax-free – whether it is in an ISA or not.
All dividends over the £2,000 threshold not held in an ISA account will be charged interest at a rate based on your tax band. This currently stands at 7.5% for basic rate payers, 32.5% for higher rate payers, and 38.1% for additional rate tax payers.
If the total value of your investments is more than £2,000 then an investment ISA will save you more money.
- Innovative Finance ISAs
With these ISAs, you invest in peer-to-peer lending. You may have heard of popular peer-to-peer lending marketplaces such as Funding Circle, Ratesetter, and Zopa.
Companies like these allow investors to lend money to individuals and businesses looking for a loan. When your borrower comes to the end of their loan term you’ll receive all the money you gave them plus interest as your profit.
At the time of writing, any interest you earn on a peer-to-peer lending platform falls under the Personal Savings Allowance. As a basic rate tax payer you can earn up to £1,000 a year in interest tax-free. If you’re a higher rate tax payer this drops to £500.
One thing to note about innovative finance ISAs is that they carry a lot more risk than other forms of savings as they rely on your borrower paying back their debt. On top of this, should the company you invest in go bust you may not be able to recover some or all of your original investment.
Lifetime Individual Savings Accounts (LISAs)
A LISA is a Lifetime Savings Account. While many use a LISA to purchase their home they also provide a great way to save for retirement. Currently, you can choose between either a cash LISA or an investment LISA but innovative investment LISAs are not yet available.
LISAs can only be opened by those aged between eighteen and forty years old which makes them ideal for those that want to start their retirement planning early.
This allows you to allocate as much as £4,000 of your £20,000 ISA limit into your lifetime ISA. That means that over the course of your lifetime you will be able to contribute a maximum of £128,000 to your LISA yourself.
This is where the LISA offers something a bit different from ISAs. For every £1 you place in your LISA, the government will add a further 25p. Let’s say that you invest £4,000 this year. The government top-up would mean that you have £5,000 in savings by the end of the year.
Once you reach fifty years old, you won’t be able to pay into your LISA anymore and the 25% government bonus will also stop. You will then only be able to withdraw the money without a penalty once you are over the age of sixty but this withdrawal will be completely tax-free.
This is the most common method people are aware of when it comes to saving for your retirement years. Anyone over the age of eighteen is able to start their own pension and contribute up to £40,000 a year towards it. Pensions carry a lifetime limit of £1 million.
For every contribution you make you’ll also receive a tax relief based on your tax band. This is 20% for basic rate taxpayers which works out the same as a LISA. Higher rate payers will receive a 40% tax relief and there is a 45% relief for additional rate taxpayers. Contributions and growth are both tax free.
Even if you have not started your own pension you may already be involved in a scheme. The new auto enrolment pension rules mean your employer is required to sign you up to a pension plan and contribute the value of 3% of your salary a year starting next year. The only caveat is that you will be required to make a contribution of 5% a year too unless you opt out altogether.
Saving for retirement? Let us help
Here at the Financial Management Centre we help our customers to effectively organise their finances on both a personal and business level so that they can really make the most out of their money. The best way to save for your future is by choosing the most tax efficient and profitable savings scheme to suit your needs that allows you access to the cash that you’ve saved as you think you’ll need it.
If you would like our professional advice on guidance out which of these schemes might work best for you, speak to our expert team today. Please call us on 0800 470 4820 or email us at email@example.com.