Where to Invest Your Money in the UKNovember 26, 2021 November 26, 2021 /
Most in the Financial Independence Community located in the US are well-versed on where to invest and in what types of retirement accounts. However, there is a growing number of FI enthusiasts overseas. In my basic Google research, I was unable to find much information catered to the UK retail investor that resembled what we consider in the US an investing order of operations.
I wanted to learn more so I asked Lazy FI Dad to shore up my understanding of how UK residents prioritized their retirement account options.
This post is about 5k words and is an unofficial guide for how UK residents can optimize available retirement accounts available to them to expedite early retirement.
As the audience that will benefit most from this information are from the UK, the currency used is the British Pound (£).
At the time of publishing, 1£ = 1.33 USD.
Where to invest your money in the UK
All the tax wrappers can be confusing. You have ISAs, you have pensions and isn’t LISA Homer and Marge Simpson’s daughter? Lazy FI Dad is here to help simplify some terms, explain the differences and help you decide where to invest your money.
First, let me start by saying I am not going to tell or advise you what to invest in. I’m here to help you understand and choose the right tax wrapper once you’ve decided what to invest in.
Second, it is important to distinguish between saving and investing. I will not discuss savings in this post besides these few words: If you have short-term goals, it is probably not worth the risk to invest that money. You are probably better off saving it and earning a bit of interest. Short-term goals usually mean that you need the money in the next 5-10 years.
Third, the tax rates below are correct as of November 2021, please check for updated rates.
Fourth and most important- This content is not tax or financial advice, it does not and should not replace advice from a tax professional. Please do your own research or use the services of a professional.
Where to invest your money- The 4 types of investment accounts
In the UK, there are 4 main types of investment accounts to choose from when deciding where to invest your money:
- Personal pension
- LISA (Lifetime Individual savings account)
- ISA (Individual savings account)
- GIA (General investment account)
I will explain each one separately, go through the differences, and list some pros and cons. Then, you can have a list of steps to take when you have some money to invest.
The first investment account type is the personal pension.
I touched on the topic of personal pensions briefly in a post about maximising your child benefit entitlement with pension contributions. However, I think it’s important to explain it again and in more depth.
A personal pension is an account in which you invest money that will be available at retirement age. Currently, that age is 55 and will increase to 57 by 2028. There are 2 HUGE advantages and 1 major disadvantage to personal pensions
Advantages of investing your money in a pension
1. Employer match (some employers offer that)
Some employers will match your contributions. An employer match means that for every 1% you contribute towards your pension, your employer will match (and sometimes even double) the amount you contribute, up to a limit. This is simple- free money, take it. In the UK an employer is currently obligated to pay at least 3% if you contribute a minimum of 5%.
As long as you can afford the lower net salary, it’s usually a good idea to max the employer match. The reason you’ll have a lower net salary is that you contribute money from your salary towards your pension. Of course, that means, you’ll have less salary left now, which means less money coming into your bank account each month. On the other hand, you will have more money in your personal pension account.
2. Tax benefit
Your contributions come from your gross salary. That means that you pay no tax on your contributions when you make them.
2.1 Tax rates
If you are a basic rate tax-payer (earn £12,570-£50,270), your marginal tax rate is 32% (20% income tax and 12% national insurance). For example, If you contribute £100 to your personal pension, you are only “giving up” £68 of your net salary. That’s because if you didn’t contribute, those £100 would have incurred a tax of £32 (32%*100) and you were left with £68.
If you are a higher rate tax-payer (earn £50,270-£150,000**), your marginal tax rate is 42% (40% income tax and 2% national insurance). For example, If you contribute £100 to your personal pension, you are only “giving up” £58 of your net salary, using the same logic as above.
If you are an additional rate tax-payer (earn over £150,000), your marginal tax rate is 47% (45% income tax and 2% national insurance). For example, If you contribute £100 to your personal pension, you are only “giving up” £53 of your net salary, using the same logic as above.
“So I pay no tax on pensions at all?”
It’s not that simple, you will pay tax on your pension when you withdraw it, but (probably) less:
- You can withdraw 25% of your balance completely tax-free once you reach a certain age.
- The remaining 75% will be taxed as normal income from an income tax perspective. That means that if you plan to withdraw less (a lower tax-bracket) than you earned, you will pay less income tax on that money.
- You will not have to pay national insurance on perosnal pension withdrawals. Woohoo!
I dedicated a whole post to why I treat my personal pension as money that will be withdrawn with no tax at all.
“OK, so I’ll throw all my money into my personal pension, thanks Lazy FI Dad.”
Woah, not so fast.
First of all, you can “only” contribute £40,000*** a year (you can actually contribute more if you didn’t reach that limit in previous years). You can read more about this on this GOV.UK page. I wish you all to reach this limit every year.
Second, if your pension pots (all combined) are worth more than a specific amount, you will pay a higher tax when you withdraw the money. That amount is called the “Lifetime allowance” and is currently set at £1,073,100.
Disadvantages of investing your money in a pension
There is one major disadvantage to personal pensions. Money in personal pension is the least liquid out of the 4 types of investments account.
Currently, you can not take the money out before the age of 55 (will increase to 57 by 2028). You can only take it out before 55 if you have less than a year to leave AND are younger than 75 AND have less than £1,073,100 in your pension pots. I wish you all to not have to deal with that horrible situation.
Any unauthorised payments from your personal pension will incur a tax of up to 55% based on this GOV.UK page. I hope the 55% rate scares you, it should.
In essence, the money in your personal pension is “locked” until you’re 55/57.
The second investment account type is the LISA.
LISA stands for Lifetime ISA. A LISA is a specific type of ISA (will be explained shortly) with some unique characteristics.
Advantages of investing your money in a LISA
1. No tax on gains, dividends, and interest
This is an advantage that all types of ISAs share. For example, let’s say you invest £1,000. Let’s assume you’re the world’s best-ever investor and you were able to grow the £1,000 to £2,000,000. If you wish to withdraw this amount (subject to the limits in the disadvantages section), you will not pay any capital gains tax on the £1,999,000 of gains you made. This is a huge advantage, especially considering that most of my readers are long-term investors and will probably have very large gains.
If you decide to save your money in a LISA (for a fixed interest rate) or invest in bonds, the interest will also be tax-free. However, if this is a long-term investment, you are probably better off with an S&S (stocks and shares) LISA.
2. Free money from the government!
The government will add 25% of what you contributed, up to £1,000 a year. This means that if you contribute £1,000 to an ISA in one year, the government will add £250 to it (1,000 * 25%). Theoretically, if you contribute more than £4,000 a year, the government will add £1,000 (£4,000 * 25%), which is the maximum you can get from them. However, the LISA rules state you are not allowed to contribute more than £4,000 a year anyway. Any free money from the government is important to at least consider.
- As mentioned above, you can only contribute up to £4,000 a year per person.
- You can only open a LISA if you’re aged between 18 and 40.
- Assuming you met limit number 2, you can only contribute to your LISA until you’re 50.
Disadvantages of investing your money in a LISA
1. Contributions from net salary
You contribute to your LISA from your net (after-tax) salary, which means the money was already taxed.
Although more liquid than a personal pension, LISAs are not very liquid. They are less liquid than “normal” ISAs. You can only withdraw money without paying a fine if you are in one of 3 scenarios
a. You are planning to buy your first home (which costs less than £450,000) AND withdraw the money at least a year after opening your LISA.
b. You are over 60. That’s why I treat my LISA as retirement money.
c. You are terminally ill, with less than 12 months to live. God forbid, I hope you never get to this scenario.
2.1 The 25% fine
If you withdraw money outside these 3 scenarios you’ll incur a fine.
The fine is 25%, which is actually more than the “bonus” you got from the government, let me explain:
Let’s assume you contributed £4,000 and got the £1,000 “bonus” from the government. That “bonus” was 25% of £4,000. However, if you withdraw the £5,000, you’ll have to pay a 25% fine on the whole £5,000. That means you’ll pay a fine of £1,250 (5,000*25%) and will only be able to withdraw £3,750 (5,000-1,250), which is less than you contributed.
This means that using the LISA money for a reason that’s not listed in the 3 scenarios above should really be a last resort.
Money -> LISA (my worst dad joke to date)
In essence, I think the LISA is a “compromise” between the tax benefits of a pension and liquidity if used for retirement. If used for buying a home, it’s a brilliant scheme with very few downsides in my opinion.
ISA (except Junior ISAs)
The third investment account type is the ISA.
ISA stands for Individual Savings Account. If you have investments and don’t know what an ISA is, this post might save you a ridiculous amount of money.
There are 5 types of ISAs:
- Cash ISA
- S&S ISA (Stocks & Shares ISA)
- LISA (explained above)
- Innovative finance ISA
- Junior ISA
I will discuss Junior ISAs in a separate section later in this post.
The only kind of ISA I don’t really go into in this post is the innovative finance ISA. It essentially allows you to become a lender. With an innovative finance ISA, you put money in a peer-to-peer lending platform online and they lend it to other people. The interest you receive from these loans will be tax-free if done through an Innovative Finance ISA.
Let’s move to the advantages of an ISA.
Advantages of investing your money in an ISA
1. Huge allowance (high limit)
You are allowed to put up to £20,000 each tax year in different ISAs. For example, if you put £4,000 in your LISA to maximise the government 25% “bonus”, you will only be able to put another £16,000 in your other ISAs. You can put all the £20,000 in one ISA (except LISA which has a limit). Just to clarify, that’s £20,000 per person!
2. No tax on gains, dividends, or interest
As mentioned in the LISA advantages, this is an advantage that all types of ISAs share. Any gains made within your ISA will be completely exempt from capital gains tax. The dividends your stocks will pay will also be tax-free.
If you decide to save your money in a Cash ISA (for a fixed interest rate) or invest in bonds, the interest will also be tax-free. However, if this is a long-term investment, you are probably better off with an S&S (stocks and shares) ISA.
Both the cash ISA and S&S ISA are completely liquid. Nothing is stopping you from selling it all and moving the money to your current account. There is no law against it (like in pensions) or a huge fine (like in the LISA).
This makes ISAs an amazing tool for investing if the money is not meant for retirement or buying your first home.
As mentioned above, you have £20,000 per person to invest in ISAs, that’s £40,000 per couple and is one of the most generous limits in the world. For comparison, in Israel, the limit is around £4,000 per adult AND you have to wait 6 years before the money becomes tax-free.
Disadvantages of investing your money in an ISA
1. Contributions from net salary
Just like in the LISA, the contributions are made from your net salary. This means that if you’re a higher tax rate payer, you pay 42% marginal tax on your gross salary and contribute to your ISA from your remaining 58%.
2. No “bonus”
We saw that the LISA is also paid from the gross salary but at least gets up to £1,000 of free money. S&S ISAs and cash ISAs don’t even get that. That’s the price you pay for liquidity.
Another type of ISA is the Junior ISA.
A junior ISA is an ISA (just like what we went through in the previous section). However, it has 2 major differences.
The first difference is the limit, it’s £9,000 a year per child.
The second (more important) difference is that the Junior ISA is owned by your child and not you. They can access the money when they turn 18.
Advantages of investing your money in a Junior ISA
1. An additional ISA allowance for the family
Let’s assume a couple of very high earners maxed out both their ISA and pension contribution allowances. Will any additional investment they make during the tax year be taxable for gains/interest/dividends? Not necessarily.
That’s where the Junior ISA comes in. The parents can decide to contribute to their children’s Junior ISAs up to £9,000 a year per child. They might decide that they’d rather give the money to their kids, for when they’re 18, rather than paying tax on gains/interest/dividends.
2. The Junior ISA is owned by the child
This can be viewed as an advantage and a disadvantage.
The advantage is that it will teach the child to manage money once he/she turns 18. If the child is responsible, they can use it for university, starting a business or even a big trip. The (now no longer a) child can also decide to leave the money invested for future needs. Once the child turns 18, the Junior ISA turns into an adult ISA, just like any other Cash/S&S ISA.
Even if the child just wastes this money, I would hope they would at least learn the lesson and be better with money next time. If that happens, I think I’d be happy for this money to be treated as “life tuition”- the price you pay to learn a lesson.
3. Not liquid
While we listed liquidity as an advantage in the other investment account types, here I think illiquidity is an advantage.
If a child is too young to handle an alcoholic beverage, they are definitely too young to handle a big amount of money. That’s why it’s a good thing the child can’t access the money until he/she turns 18.
4. No tax on gains, dividends, or interest
Just like the adults’ ISA, there is no tax on gains/dividends/interest made within the Junior ISA. Assuming you open a Junior ISA for your junior at birth, that money has 18 years (at least) to compound completely tax-free.
Each child can have up to £9,000 contributed towards their Junior ISA per tax year. This, again, is one of the most generous limits in the world.
Disadvantages of investing your money in a Junior ISA
1. The Junior ISA is owned by the child
Investing in a Junior ISA is essentially gifting the money to your child. Yes, they will have to wait until they turn 18 to access it, but the money’s not yours anymore. This part made me consider not including Junior ISAs as an answer to “Where to invest your money” as it will no longer be “your money”.
Also, do you trust your child to manage a big amount of money once they turn 18? I’ll share with you my and Lazy FI Mum’s thoughts as we discussed this in length.
Lazy FI Family’s approach to Junior ISAs
We love our daughter and will do our best to raise her and her future siblings to be responsible adults. However, we are aware of environmental (friends) influence. We can’t know for a fact that our daughter and her future siblings will be able to handle a large sum of money at that age. A few of my 30-year-old friends can’t! It might push her to spend (or even gamble or drink) it away. This is too much pressure, in our opinion, to put on an 18-year-old.
These considerations, together with the fact that we don’t max our ISA allowances any way, made us decide to earmark some money for our daughter in our own ISAs. That way, we still get to control the money if anything happens.
However, our daughter does have a Junior ISA. We opened her Junior ISA to invest any gifts she gets. In my eyes, any gifts she gets belongs to her and not to us.
I know some people (like Lazy FI Mum) think that as they pay for the child’s expenses, they can take the gift to themselves as it’s used for the child anyway. I see the logic in that approach too. There’s no right or wrong but that’s not my approach.
To summarise, Lazy FI Family kids do/will have junior ISAs but we won’t be contributing to them over an amount I and Lazy FI Mum agreed on. It’s where we invest the money that they will control once they turn 18.
General investment account (GIA)
Lastly, after you’ve exhausted the other options listed above, you have the GIA which stands for a General Investment Account. This can be any trading account with any broker or bank.
Advantages of investing your money in a GIA
There are no real advantages for a GIA over an ISA, it’s just another place to invest your money after you’ve used up your ISA allowance, in case you wanted to invest more. Let me repeat that- unless you’ve used up your ISA allowance, there’s no reason (that I can think of) to invest in a GIA, we don’t have one.
However, there are some tax allowances you can use if you are in a situation where you do invest in a GIA.
Capital gains tax allowance
Each person currently has an annual capital gains tax allowance of £12,300. This does not mean you can sell £12,300 worth of investments each year tax-free, it’s even better than that.
For example, let’s say you invested £40,000 which grew to £70,000 and you want to sell the investment. Your gain is £30,000 (70,000-40,000). As you have a £12,300 allowance, you will only pay capital gains tax on the remaining £17,700 (30,000-12,300).
In addition, the allowance is per person so if this investment was a rental property owned by you and your partner, each person would only have half the gain, which is £15,000. However, you each have a £12,300 allowance which means you’ll each pay capital gains tax only on £2,700 (15,000-12,700) each.
Each person has a £2,000 per year dividend allowance.
If you own shares in a company that pays dividends and you hold those shares in a GIA, they may pay dividends. The first £2,000 of dividends paid per tax year will be tax-free. You will be taxed for anything over that amount.
Personal savings allowance
This allowance is a bit more complex. It means you can earn tax-free interest from your savings but your allowance depends on your tax rate.
Basic tax rate payers get £1,000 of tax-free interest a year.
Additional tax rate payers get £500 of tax-free interest per year
Higher tax rate payers get no tax free interest
Just to clarify, you are not entitled to a free £1,000 from the government if you are a basic tax rate payer. It means that if you earn up to £1,000 in interest in a tax year, you won’t have to pay tax on that interest. If you earn more than £1,000, you will only pay tax on the part above the £1,000.
There are no limits to how much you can invest in a GIA, it can be millions.
However, there are limits to how much you can take out tax-free, as mentioned above:
- Capital gains tax allowance- £12,300 of gains per person per tax year.
- Dividend allowance- £2,000 of dividends per person per tax year.
- Personal savings account- for basic tax rate payers, £1,000 of interest per person per tax year.
For additional tax rate payers, £500 of interest per person per tax year.
Disadvantages of investing your money in a GIA
There is no bonus from the government like in a LISA. You can not leave it to grow tax-free like the other ISAs. You can’t invest in a GIA from your gross salary as you do with pensions.
It’s essentially full of disadvantages, that’s why a GIA will be the last place in which you should invest your money.
Where to invest your money- the plan/steps
OK, now that you know what each account is, its advantages, disadvantages and limits, we can look at which one is best for you when deciding where to invest your money.
It all depends on your timeline (short term goals vs. long term goals) and how comfortable you are locking money up.
In a nutshell, the less liquid the money is, the bigger the tax advantage you get. That’s the trade-off and it’s your call. Want more tax savings? give up some liquidity, and vice versa.
The UK personal finance flowchart
I saw an amazing flowchart on Reddit. You can access it here. I tend to agree with the steps it suggests.
Step 1: Fill up your emergency fund
This can be a minimum amount you always keep in your current account or it can be in a separate account. It’s usually recommended to have 3-6 months worth of expenses.
We have about 1.5 months of expenses as our jobs are pretty stable and we can always sell shares from our ISAs.
Later, the flowchart suggests topping up your emergency fund some more, I don’t see the benefit but that’s just my view. The flowchart suggests 1-3 of expenses as the first step and 3-6 months as the later step. It corresponds to Dave Ramsey’s baby steps. Dave Ramsey has 1,000 US dollars as the first step and then, at a later stage, 3-6 months worth of expenses. I guess if you have high-interest debt (see step 3 below), you want to start attacking those ASAP and not wait until you have 6 months worth of expenses saved up.
Step 2: Contribute enough to your pension to at least maximise your employer match.
I explained what an employer match is in the “Personal pension” section above. I also explained why you have to have a pretty good excuse not to max it.
Step 3: Pay off high interest debts
If you have high-interest debts- pay them off ASAP! This comes before any other investment. I’d call any interest rate >5% as high interest but that’s my personal view.
Step 4- Funding short term goals (less than 5 years)
The flowchart suggests saving for those in a cash ISA (or a LISA if buying a home <£450k). I tend to agree that if your investment horizon is less than 5 years, it might be better to just save cash, especially if it’s not money you can afford to lose in a market crash.
Step 5- Paying off other debts
If you have other debts like a mortgage or student loan debt, do your maths. It could be a good idea to pay them off instead of investing the money. However, if the interest rate is very low, this may not be the best idea. It’s your call and as I said- do your maths 🙂
A good rule of thumb that comes from JL Collin’s amazing book “The simple path to wealth” is that if the interest rate is:
- Below 3%- pay off slowly (make minimum payments, don’t overpay.
- Between 3% and 5%- your call, do whatever you want
- Above 5%- pay it off ASAP.
If you follow this rule of thumb, this stage is for interest rates between 3% and 5%.
However, if you prefer investing the money instead of paying off debt (when the rate is below 5%), that’s fine, skip this step.
If you are struggling with debt, check out how to get out of debt in order to build wealth.
Step 6- Define your timeline
Now you need to decide if you need the money before or after the age when you can access your personal pension and your LISA.
If you can lock them up in a LISA or personal pension, do that. Top up your pension as much as you can (I listed the limits above).
However, if you need the money before that, top up your ISA.
As mentioned above, if you’re a first-time buyer, buying a property for less than £450,000- go with the LISA.
Where to invest your money- Lazy FI Family’s plan/steps
First, I contribute enough to my personal pension to get my gross salary minus pension contribution to £50,000. That way I avoid paying the higher tax rate (42% going up to 43.5% from the next tax year). This also ensures we get the full child benefit as I explained in a separate post.
As Lazy FI mum doesn’t want to lock up all our money for 20+ years, any excess money goes to our S&S ISAs, which we don’t max. As I mentioned several times, it’s a trade-off between tax benefits and liquidity.
We don’t have any other debt except our mortgage and the rate is lower than 3% so we don’t overpay that.
Where to invest your money- Summary
Wow, that was a long post!
We went through the advantages, disadvantages, and limits of each type of investment account. We saw that, in general, there is a trade-off between liquidity and tax benefits. Later, we introduced the UK personal finance flowchart to give us an action plan/ steps. Finally, I shared with you how we do things in our family.
I hope you’re still with me and have a better understanding of where to invest your money.
*In this section I talked about a pension type called “defined contribution” which is the common pension nowadays. However, some of you (usually public sector, very senior roles or people on old contracts) might have something called a “defined benefit” pension (also known as “final salary” pensions). If you’re on that, you are very fortunate, ensure you contribute as much as you can as the benefits are huge! You can usually only contribute a set % of your salary, so not a lot of wiggle room but ensure you do it.
The biggest advantage of defined benefit is the certainty you get from it. A defined benefit pension ensures you get a set £ amount each year/month regardless of market returns. This means your employer bears all the risk of market performance and not you.
**There is a ridiculously high tax if you earn between £100,000 and £125,140.
As per the GOV.UK website:
“Your Personal Allowance goes down by £1 for every £2 that your is above £100,000. This means your allowance is zero if your income is £125,140 or above.”
In simple terms, in this specific range, your effective marginal tax rate is 62%! That’s because you are already at 42% plus, every £1 you earn also loses £0.50 of personal allowance which will now be taxed at 40%.
You have your “regular” 42% plus 20% (0.5*40%) from your loss of personal allowance, which brings you to 62%.
If you earn within this range, seriously consider increasing your pension contributions as it can save you a lot of money.
***If you or your spouse (separately) earn more than £200,000 a year, you may be allowed to contribute less than £40,000 a year, please look into “tapered annual allowance.”
By Lazy FI Dad
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