If you’re in the position where you have maxed out your ISA allowance of £20,000 per year, it’s fair to say you’re in a pretty strong financial situation. However, this does raise the question, where should you invest your money for optimal returns and tax savings once your ISA limit is reached?
Once you have maxed out your ISA’s £20k per annum limit, you can invest more in your employer or personal pension plan (SIPP), invest in a LISA or invest in a general investment account. The optimum choice should consider expected returns, liquidity and tax implications.
So given there are a number of options to invest in once your ISA limit is used up and the optimum choice comes down to your personal circumstances, what factors should you be thinking about when it comes to deciding where to invest your money?
Where should you invest your money once you have used up your ISA limit?
After using up your ISA limit and assuming you have an emergency fund saved, the first port of call should be investing money into your pension (whether that be your employer pension scheme or a personal plan (SIPP)). These investment accounts have the significant advantage of being tax-advantaged.
As I laid out in my guide on how much to contribute to your pension each month – it’s crucial you take full advantage of your employer’s pension match.
Every employer in the UK is legally obliged to contribute a minimum of 3% if the employee contributes 5%. Many employers will offer a better ‘match’ than this. For example, if you contribute 5%, your employer may match it and also contribute 5%.
For example, if you earn £100,000 per year and contribute 5% that is £5,000 and your employer would match that by contributing a further £5,000 which can be considered “free money” as it is money you wouldn’t have received had you not contributed to your pension.
It’s worth noting that your contributions come from your gross salary which means you do not pay tax on your pension contributions when you make them (you will pay tax on withdrawal but 25% can be withdrawn tax-free and the remainder may be at a lower tax rate than what you have now).
Similarly, you can invest in a personal pension (known in the UK as a SIPP) and benefit from the same tax advantages.
Of course, the big downside of investing your money into a pension is the ease of access. Once contributions are made, it’s very difficult to withdraw your money prior to retirement age without incurring heavy penalties.
Other options for investing include the LISA (which is a good option, but your investments must be for either a first home or for retirement), investing in a cash savings account for a large purchase like a house deposit or investing via a general investment account.
What different options are available to me to invest my money?
As well as there being different asset classes and individual assets to invest into, there are also numerous different investment wrappers to invest via. These include ISAs, LISAs, workplace pensions, personal pensions, general investment accounts and cash savings accounts amongst others.
Taking these in turn …
An ISA is an individual savings account which is a tax-advantaged investment wrapper available in the United Kingdom. For 2020/2021, the annual ISA contribution limit is £20,000. There are different types of ISA including cash ISAs and stocks & shares ISAs depending on what the money held is invested in.
Lifetime ISAs (LISAs) are a form of ISA which allows people to save for retirement or their first home. Each year, the government will contribute 25% of whatever you contribute up to a maximum of £4,000, meaning the government could give you £1,000 per year in the best-case scenario.
A workplace pension scheme is a pension account offered by your employer to allow you to save for retirement via a deduction of your wages. Your employer is legally obliged to contribute 3% or more to your pension provided you contribute the minimum 5%. The funds are typically invested in assets like stocks and bonds.
A self-invested personal pension (SIPP) is a government-approved personal pension wrapper available to citizens in the UK which enables individuals to save and invest for retirement. The pension funds can be invested in a wide variety of options and are tax-relieved meaning the government top-ups your contributions by 20%, 40% or 45% depending on your tax rate.
A high-interest cash savings account is a type of savings account available to UK citizens to allow them to save money and earn interest over time. These accounts typically offer higher rates of interest than standard current accounts and often involve deposit/withdrawal stipulations.
A general investment account (GIA) is an investment account that is not in a tax-advantaged wrapper like ISAs or SIPPs are. These accounts do not offer tax relief which means if individuals investments grew beyond the annual capital gains tax allowance, they would be liable to pay tax on their investment gains in this account.
Further options include saving in a cash account for an emergency fund or in advance of a big purchase such as a house deposit. Generally speaking, it makes sense to take advantage of your employer pension match if applicable, save up a reasonable emergency fund (3-6 months depending on your circumstances) and then begin to look into these other investment types, starting with the ISA.
Why is an ISA the best choice for investing your money?
An ISA is a tax-efficient method of investing whilst allowing you to turn your investments into cash very quickly and cheaply (unlike a pension). Utilising your £20k annual ISA contribution limit and taking advantage of your employer pension match are both fundamental to investing success.
The two big advantages of the ISA in the UK are that it’s tax-advantaged and highly liquid.
Investments not held in an ISA are subject to capital gains tax. This means any investment gains over and above the annual capital gains tax-free allowance are taxed at the prevailing capital gains tax rate. These taxes can eat away at your investment gains and so are best avoided where possible.
An ISA (individual savings account) protects any investment gains from being taxed. The drawback is that only £20,000 per annum can be invested into this account type, meaning any additional money must be invested into a different account (whether that be a general investment account subject to tax, or a pension account).
The second big benefit of an ISA is liquidity. In a pension, your money is effectively locked away until retirement age as you can not access it without incurring early withdrawal penalties.
In an ideal world, our investments are as liquid as possible meaning that if we ever needed cash quickly, we could sell our investments fast and without incurring any tax or penalties.
The ISA makes this possible. Whilst selling investments within an ISA will curtail the compounding process, it will not incur penalties or tax. The process of selling investments within an ISA and withdrawing the cash is typically a very fast process taking no more than a few days to complete.
How do I take advantage of my employers pension contribution match?
To take advantage of your employer’s pension contribution match, login to your employer’s HR portal or speak to an HR representative to find out what contribution match is offered. The legal minimum in the UK is 8%, being 5% from the employee and 3% from the employer.
Many companies will offer better contribution matches than the legal minimum, for example, many employers will offer a 1:1 match up to a certain level. For example, for every 1% you contribute up to 5%, they will match.
For most people, the goal will be to contribute as much to your pension as you can afford so you are able to take as much of the “free money” your employer is offering as possible.
For example, if your employer says they will match employees pension contributions up to 7%, it makes sense to contribute that full amount to ensure you receive as much of a contribution from your employer as possible.
Let’s say you had a salary of £50,000 per year and your employer matches your pension contributions up to 7%. If you contributed 5% (£2,500) your employer would match that with another 5% (£2,500) meaning you have received £2,500 from your employer you would not have got if you opted out of contributing to your pension at all.
Now let’s say you started to contribute the full 7% (£3,500). Again, your employer would be obliged to match this and contribute £3,500 themselves. So simply by contributing an extra £1,000 to your pension, you have drawn out an extra £1,000 of total compensation from your employer.
The only downside to this is that this money is locked away until retirement age unless you are willing to incur heavy early withdrawal penalties.
So continuing the example from above, does it make sense to contribute 10% (£5,000) to your pension?
Well, it depends. Going from 7% contributions to 10% contributions won’t increase the amount your employer contributes because they are only committed to matching up to 7%. Despite this, it’s never a bad idea to save as much as possible for retirement and benefit from the tax deferral explained above.
The downside is obvious, the extra money you lock away in your pension by contributing a higher percentage will be inaccessible for many years.
What is a General Investment Account (GIA) in the UK?
A general investment account (GIA) is an investment account that is not in a tax-advantaged wrapper like an ISA. These accounts do not offer tax relief which means if investments grew beyond the annual capital gains tax allowance, they would be liable to pay tax on their investment gains.
When it comes to investing in asset classes like stocks, the general investment account should be the final port of call after tax-advantaged accounts like ISAs and SIPPs are maxed out.
As a GIA doesn’t prevent your investment returns from being taxed, any gains you make beyond the capital-gains tax personal allowance will be taxed at the prevailing tax rate.
Let’s say you have £100,000 of investments sitting in a general investment account and over the tax year, these investments grew to £140,000 without any further contributions made. To realise these gains, you decide to sell the whole portfolio.
You would have a £40,000 capital gain which will be subject to tax. In the 20/21 tax year, the capital gains tax free allowance was £12,300 meaning you have a further £27,700 which you are liable to pay tax on.
This remaining gain will be taxed at 20% meaning you will have a tax bill due of £5,540 (£27,700 * 20%) assuming you have no prior year losses to offset this gain against.
This is why investing in tax-advantaged accounts like ISAs and SIPPs is so crucial.
Am I making a mistake by investing in a General Investment Account (GIA)?
If you are investing your money in a General Investment Account (GIA) without first making full use of tax-advantaged investment accounts like an employer pension, ISA or SIPP, you are making a financial mistake that could have significant negative financial implications in the future.
If the goal of investing is to maximise wealth, it follows that you want to avoid paying tax where it can be legally avoided. Using ISAs and other similar tax-relieved accounts is an effective, legal way of doing this.
In what order should I invest my money into the different account types?
Whilst it varies by individual, investing in the following order is logical: 1. Pay into your employee pension to maximise the employer match 2. Invest in an ISA / LISA up to the annual £20k limit 3. Invest in your SIPP up to the £40,000 annual limit. 4. Invest via a general investment account.
You will not go too far wrong by investing in the order laid out above but clearly, this may not be appropriate for every individual.
Prior to any of these investing steps, it makes sense to pay down high-interest debt and save up an emergency fund of 3 months of salary.
Beyond that, each individual needs to weigh up the importance of liquidity (how easy it is to convert investments to cash) and tax relief to their financial situation.
If having a lot of liquid investments that you can cash out at a moments notice is important to you, the ISA is the most flexible investment choice whilst still protecting any tax burden from emerging on investment gains.
If you are solely focused on investing as much as possible, using your pensions (both personal and workplace) is the way to go as you can defer the paying of tax on your pension contributions until withdrawal.
Should I pay off my debt before beginning to invest?
You should pay off your debt before beginning to invest provided the debt is at a higher interest rate than you can realistically expect to earn from investing. Some commentators suggest paying off all debt regardless of interest rate (outside of your mortgage) prior to investing.
There are two key schools of thought when it comes to paying off debt before investing.
Some commentators suggest paying off all of your debt (outside of your mortgage) before beginning to invest as the psychological benefit to freeing yourself from debt and establishing the positive habit of avoiding consumer debt is the most important thing.
Others take a more mathematical approach and suggest paying off any high-interest debt only (e.g. anything over 6% or so) as paying off this debt is earning you “returns” of the interest payments you will avoid in the future.
Lower level debt, say at 2%, is not worth prioritising above investing as instead of using your money to pay off these debts, you could be investing and earning more than this in returns which would outstrip the rate of accrued interest.
I can see merit in both of these arguments and leave it to readers with debt to make the best decision for themselves.
Should I invest in my employer’s pension scheme or a personal pension (SIPP)?
You should prioritise investing in your workplace pension scheme ahead of investing in your personal pension or SIPP to make sure you are taking full advantage of your employer’s pension contribution match. This means you can earn a greater total compensation from your employer than would otherwise be possible.
Both workplace pensions and personal pensions are tax-advantaged in that workplace contributions are paid from your gross salary so don’t incur tax and SIPP contributions are topped up by the government to “pay back” the tax you would have paid on earning the money to contribute.
In both cases, tax is only paid on withdrawal with 25% of the total pension pot available to be withdrawn tax-free.
The difference between the two is workplace pensions will involve an employer contribution of at least 3% as dictated by law and typically more. Many employers offer great pension contribution matches such as for every 1% you contribute, we will contribute 2% up to a maximum of 10% which is an impressive 1:2 ratio.
For this reason, it makes sense to prioritise workplace pension contributions over private pension contributions if you are formally employed.
At what stage should I invest in a Junior ISA (JISA) for my children?
It is possible to invest on behalf of your children using a junior ISA for up to £9k per annum per child which is in addition to your individual £20,000 ISA contribution limit. This money will be owned by your child but is an effective way for a household to invest more in a tax-advantaged wrapper.
There are advantages and disadvantages to investing in a Junior ISA which are covered in detail in this post by LazyFIDad / Fiology. But it is worth noting that for those looking to invest more of their money in tax-advantaged accounts, this can be one loophole worth exploring. The obvious caveat is that this money will become your child’s at age 18 to do with as he or she pleases!
As always, please remember I am an Accountant, but not your Accountant. In this post (and all of my others) I share information and oftentimes give anecdotes about what has worked well for me. However, I do not know your personal financial situation and so do not offer individual financial advice. If you are unsure of a particular financial subject, please hire a qualified financial advisor to guide you.
This article has been written by Luke Girling, ACA – a qualified Accountant and personal finance enthusiast in the UK. Please visit my ‘About‘ page for more information. To verify my ACA credentials – please search for my name at the ICAEW member finder. Please comment below or contact me here to get in touch with questions or ideas for future posts.