Why is tax year end not a beloved season? Well, because they’re taxes. Because there’s math involved, and deadlines, and sometimes forms that often seem designed by counter-intelligence experts to induce panic attacks. And all the rules: can I have multiple ISAs or pensions or will I accidentally end up with a hefty bill from HMRC that will erase all my savings and possibly land me in tax jail (note to self: find out if there is tax jail)?
We can’t alleviate all your fears (there will still be numbers involved) but we can give you some solid advice that’ll make the really crucial stuff feel easy.
Should I contribute to an ISA or a Pension?
A pension, naturally. Unless of course, the answer is the ISA.
Of all the questions we get, this one’s the toughest to provide a one-size-fits all answer. Which type of account you should prioritise depends on four factors: How much you earn; How much you’ll likely earn in the future; How much tax you pay; And whether you’ll need access to the money before you retire.
In a perfect world, you would max out both your pension and ISA. Pension contributions will provide you with tax relief, a kind of instant tax return from the UK government that is dependent on your annual earnings, and is meant to encourage you to save more. At retirement, on the other hand, you’ll be able to withdraw from your ISA without being taxed on your decades of gains, which is also pretty nice. But the world is not perfect - so you’re going to need to prioritise filling up one first.
Here are some rules of thumb that can help you make the choice:
If you think you need the money before retirement (for buying a home, starting a business, having a child), ISAs are a more flexible option. With pensions you have to be sure you don’t need access to the funds until 55, shortly to be 57.
If you make over £50,000 your tax rate goes up to 40% and pension contributions become very attractive. For instance, a pension contribution of £10k would only cost you £6k with the rest coming from tax relief.
If you have a pension through your employer that offers matching funds, make sure to prioritise it. Otherwise you're throwing away salary.
If you make between £100,000 and £125,000, you are effectively taxed at 60% as you lose your personal allowance at this level of income. Pension contributions are a great way of avoiding this tax trap.
Can I have more than one ISA? And Should I?
ISAs are one of the most flexible and personalised ways to put your money to work in the UK. The money you deposit can be used in any number of ways, from a more conservative cash ISA to a stocks & shares ISA that can help you take advantage of gains in the market. Or, you can even opt for a mixture of both.
A little reminder: you can contribute to both a cash ISA and stocks & shares ISA, in the same tax year, as long as you don’t cumulatively contribute over £20,000 - the annual contribution amount for the 2019/20 tax year.
What’s the difference between a cash or stocks and shares ISA? A cash ISA is a fairly risk-free place to park your money for the short term and typically provides an annual interest rate ranging from 0.5% to 1.3%. Here’s the catch. With inflation rates at 1.8% in the UK, you may end up merely treading water (or even losing ground) by keeping savings in a cash ISA.
A stocks and shares ISA, on the other hand, allows you to participate in the stock market and gives you the opportunity to let your money grow in the long run.
Should I use up my allowances at the beginning or the end of the tax year?
This is really a question about a concept called pound-cost averaging. That's a term for investing your money over time, at regular intervals, with the idea that by buying into the market at many moments you'll decrease the risk that you'll buy whatever it is you're buying at a particularly high price.
But is pound-cost averaging a better strategy than putting your £20,000 annual ISA contribution limit into the market all at once? An oft-quoted study by Vanguard found that investing your money all at once gave investors better results than pound-cost averaging 66 percent of the time. And the longer the time frame, the greater the chance that investing all at once was a better strategy. Why? Because while you're waiting to invest your money over time, it's sitting on the sideline, not earning much in the way of returns.
The same holds true for the tax year. When you wait until the end of the tax season to drip money into your investment account you miss out on the other eleven months of potential growth gained from having your money in the market, instead of sitting on the sidelines.
The bottom line: If you are worried about putting all of your money into the market at once, it’s OK to listen to that worry. A lot of our clients drip money into the market through Direct Debits, which is an incredibly smart way to invest as it removes the emotion from the decision and makes sure you aren’t reacting out of fear (or elation).
What is the smartest way to take advantage of tax relief this year?
There is one no-brainer thing you can do to take advantage of tax relief. And that’s contribute to your pension(s) by 5th April.
Your annual contribution room depends on how much you take home in earnings annually (including your salary, pension and other income you may receive) and for the majority of people will be £40,000. Or, if you make under £40,000, the equivalent of your earnings before tax. The rules are complicated, and a little bit complex, so feel free to check out our handy Pension Guide or book a call with one of our investment advisers.
Pensions, as you may be aware, are pretty much the best government-sponsored investment deal out there. When you contribute to any Pension (like a workplace pension or a SIPP) you lower your net income, which means you usually pay less in taxes. Meanwhile, you get to keep that money and earn even more by investing it. When you’ve retired and you take the money out, your tax rate will probably be lower.
In the street slang of Investment Advisers, that’s a “win-win-win.”
How much can I put in each account this tax year?
Every tax year there is an annual contribution limit for your ISA, JISA or Pension accounts.
For ISAs, the annual contribution limit is £20,000. This amount doesn’t get rolled over to the next tax year which means if you don’t use it up by 5th April you lose it. The same goes for a JISA account. This year’s contribution limit is £4,368 but next tax year the amount will re-set to £9,000 after being bumped up in the last Budget update.
For Pensions, the rules get a little bit trickier. Annual contribution limits are based on your annual earnings (including your salary, pension and other income you may receive). Below is a guideline of what you can expect when it comes to contributing to your pension:
£40,000 or under: you can contribute the same amount as your annual salary (pre-tax) to your pension(s)
£40,000 - £110,000: the majority of people can contribute £40,000 to their pension(s) annually
£110,000 and over (which will change to £200,000 and over for 2020/21): the rules become a little more complex, as they are based on your specific circumstances, so best to contact us at firstname.lastname@example.org if you are a client or with your financial provider.
That’s it! Happy tax-ing.
All investing should be considered long-term. While stock markets have typically trended upwards over the long term, your investments can go up and down, and you may get back less than you invest.
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