With the end of the tax year almost upon us, you should be thinking about whether you've made the most out of your long-term savings. These are 5 things you should consider before the 5th April 2021:
1. Use your ISA and pension annual allowances
ISAs and pensions are a great way to save for the future because any income and capital gains made on investments held in both products are free from income tax and capital gains tax.
All adults can save a total of £20,000 each year to the various types of ISA available. The Lifetime ISA has its own maximum of £4,000 that sits within the total allowance. You can only pay into one ISA of each type (Cash, Stocks & Shares, Lifetime ISA) during a tax year. Importantly, if you don’t use all the allowance, it can’t be carried forward, so you lose it for good.
So if you have an unused ISA allowance for this year, you should consider using it if you can before the 5 April deadline. If you use up your annual ISA allowance, you won't be able to pay back money you've previously taken out.
The pension annual allowance for 2020/21 is £40,000 - this includes both contributions made by you and your employer. The annual allowance can be carried forward for up to three years, so you should consider whether you have made as much use of your pension annual allowance as possible ahead of the end of the tax year. If investors are planning on carrying forward their annual allowance, it’s worth remembering that they must have been a member of a registered pension scheme in the tax year concerned to benefit.
Those with very high incomes or those who have started to take taxable income from drawdown will have a restricted annual allowance.
If you are looking to make use of carry forward, note that personal contributions in any year are also limited for tax relief to 100% of your earnings. People with no earnings (including children) can still save up to £3,600 a year in a pension (including basic rate tax relief).
2. Invest Regularly
Whilst it is understandable that people are worried about the uncertainty that Covid-19 is creating in the world and for stock markets, it is important to remember that after you pay into an ISA you don’t have to make an immediate investment decision. The annual ISA allowance is a use it or lose it tax break, you can’t roll it over to other years like you can with the pension annual allowance.
So if you have money you want to invest for the long term, make sure you get it into your ISA account before the end of the tax year. Whilst you shouldn’t leave it in cash within a stocks and shares ISA for too long, you can pause whilst you make your investment decisions and you haven’t lost your annual ISA allowance, which can be very valuable over the long term.
An option to consider if you are worried about the short-term picture is to feed money into the markets at regular intervals, say monthly. You can set this up to happen automatically on most investment platforms and it should help smooth out any short-term volatility. If stock prices fall, you are investing at that lower price and could benefit even more over the long term if prices rise.
3. Consider if your money is working hard enough for you
Over three quarters (76%)* of money subscribed to ISAs is cash. The average interest rate on Cash ISAs according to the Bank of England is 0.35%**, which is below the Government’s preferred measure of CPIH inflation of 0.8%, so at that level the purchasing power of your savings is going backwards. This may be OK if the money is to meet short-term spending needs or is your emergency pot and hence you want a low-risk investment. But if you’re willing to dip your toe into the investment markets you could make your money work harder over the long term.
If you invest £250 a month into a Cash ISA paying the average interest rate, after 20 years you would have a tax-free savings pot of just over £62,000. However, the same amount invested into a Stocks and Shares ISA with an annual investment return of 4.5% after charges would be worth just over £98,000.
4. Ensure you benefit from free Government cash (where possible)
A significant benefit of pensions and Lifetime ISAs is that the money you pay into them will benefit from a top up from the Government.
This is most generous in pensions, where personal contributions are automatically topped up by 20% pension tax relief from the Government. That means that every 80p you pay into your pension is automatically topped up to £1. Higher rate and additional rate tax payers can reclaim an additional 20% or 25% tax relief respectively via their tax return. So, for a higher rate tax payer, every £1 that ends up in their pension only costs them 60p. Even with just basic rate tax relief, if you contribute £100 a month to a pension and assume 5% investment growth each year, the Government contribution to your pension would be worth £38,000 after 40 years of saving.***
With the Lifetime ISA you can get up to £1,000 a year in the form of a Government bonus, up until the age of 50. If you opened a Lifetime ISA at age 18, that is a maximum Government bonus of £33,000 (or £32,000 if you’re unlucky enough to have your birthday on 6 April). The Lifetime ISA can be opened by those aged 18 up to the day before your 40th birthday, and you can save up to £4,000 each year – either in one or more lump sums or as a regular monthly saving. You can withdraw Lifetime ISA money once you’ve reached age 60 or earlier to buy your first property, but be warned that if you take the money for any other reason (apart from severe ill health) you’ll pay an exit penalty which is currently 20% but is due to increase to 25% on 5 April.
5. Use your annual Capital Gains tax-free allowance
For investments held outside an ISA or pension, the annual Capital Gains tax-free allowance is very valuable. Investors can make investment gains of up to £12,300 in 2020/21 without paying any tax. Gains over that amount are added to income and if they fall in the basic rate tax band are taxed at 10% and if they fall in the higher rate tax band are taxed at 20%. An additional 8% is added to the tax rate if the gains are from a second property.
The annual Capital Gains tax-free allowance cannot be carried forward into future years so if you don’t use it, you lose it. You can also transfer investments to your spouse, in order to use their annual CGT allowance.
* Source: HMRC ISA statistics
** Source: Bank of England
*** Pension tax relief rates quoted apply in England, Wales and Northern Ireland, different rates apply in Scotland
The value of investments can go down as well as up and you may not get back the full amount you invested. The past is not a guide to future performance and past performance may not necessarily be repeated. How you're taxed will depend on your circumstances, and tax rules can change. ISA rules apply. A Lifetime ISA isn't for everyone. If you withdraw money before age 60, unless it's to buy your first home, you'll pay a government withdrawal charge of 20%. And if you choose to save in a Lifetime ISA instead of enrolling in, or contributing to, your workplace pension scheme, you'll miss out on your employer’s contributions.
This article is for information purposes only and are not a personal recommendation or advice.