This article is an excerpt from the Good Guide to Financial Planning, in association with EQ Investors. The guide shows you what to do with your money for the best as you navigate major life stages such as buying your first home, getting married, having children, the ‘peak earning’ years’ and retirement. Download your free copy here.
Traditionally we have thought about pensions as the primary way of funding this chapter of our lives and they remain the cornerstone of good retirement planning. However, with limits on both the size of pension funds and the contributions you can make, as you plan for your retirement you should consider your income as coming from a range of sources.
Drawing from several sources allows you to take an income in a much more tax efficient manner, which can be adapted if your circumstances change.
How to split investments outside your pension
For investments outside your pension, we would recommend you split this out into short-term, medium-term, and long-term pots.
Your short-term pot should contain three to six months’ worth of expenditure – your ‘emergency fund’ and any ad hoc expenses due within the next 24 months. This should be easily accessible and not locked up for a fixed period.
One option to consider is NS&I Premium Bonds. Instead of interest there is a monthly prize draw for tax-free prizes, with a one per cent annual prize fund rate and they are 100 percent protected by the UK Government.
Although cash savings offer protection, interest rates are historically low, and many accounts aren’t keeping pace with inflation. In real terms, this means your cash retirement savings could be decreasing in value.
It is therefore important that your medium-long term pots are being invested to target inflation.
Stocks and Shares ISAs
Outside your pension a Stocks and Shares ISA offers a tax efficient way to invest for the future. Each year you can save up to £20,000 in your Stock and Shares ISA, invested in a wide range of investments including funds and shares. Any gains are exempt from UK Capital Gains Tax. You don’t pay UK tax on any income you receive from your ISA. And you don’t need to declare any of this on your tax return.
As an ISA has a limit on how much you can contribute – where to next?
When your ISA is full
A General Investment Account (GIA) is a way to invest more money once you’ve used up your ISA limit for the tax year. Much like the Stocks and Shares ISA, the GIA can be invested in a wide range of investments including funds and shares. A GIA has no limits on how much you can invest each year and you don’t need to lock your funds away until a certain age.
However, investment accounts do not offer the same tax benefits as pensions or ISAs, meaning that any interest/dividends you receive from your investments may be subject to income tax and any gains that you make when selling your investments may be subject to capital gains tax.
Although these accounts are taxable, your dividend and capital gains tax allowances can be utilised before any tax becomes payable.
Take note of investment risk
It’s important to note with both GIA and ISA investments, there is investment risk and it’s likely the value of your savings will fluctuate, falling as well as rising over the short term. As a result, it’s usually only advisable to invest if you have a time frame of at least five years, allowing you to ride out short-term dips.
Remember, Stocks and Shares ISAs and GIAs typically come with several different investment options with various levels of risk. It’s important to pick a profile that suits your attitude to risk and future goals.