With the new tax year now upon us, many consumers will be saving money in a Cash ISA. Although living within your means and building up cash is in itself a noble aim, it is unlikely to offer the best means for retiring early.
Cash ISA woes
There are two main reasons for this. First, Cash ISAs offer limited tax advantages versus a bog-standard savings account. Since interest rates are at best around 1.5% on both products and the first £1,000 of interest income generated outside a Cash ISA is tax-free per year, you would need to have around £67,000 in a Cash ISA in order for it to reduce the income tax they pay.
Second, the returns on cash have historically been poor in comparison to the stock market. While the former has often lagged inflation and offered negative real-term returns, the latter has generally been able to deliver much higher returns over the long run.
While investing in the stock market was somewhat challenging in the past, the logistics of doing so today are relatively straightforward. An account with a share-dealing provider can be opened in minutes online, while low charges for regular investing mean that it is possible for a wide range of people to benefit from the long-term growth rate provided by the stock market.
Two products that are easy to open are Stocks and Shares ISAs and SIPPs. The former offers the accessibility of a Cash ISA, in terms of being able to withdraw capital whenever it is required, but also allows an investor to buy a wide variety of shares and funds. A SIPP is more restrictive than a Stocks and Shares ISA, since any amounts paid in cannot be withdrawn until age 55. But it can offer significant tax benefits in the long run, as well as providing access to a variety of stocks and funds.
Contributions to a SIPP are made before tax is paid, while 25% of withdrawals are not subject to tax. This provides it with an advantage over a Stocks and Shares ISA when it comes to tax. However, a Stocks and Shares ISA could be appealing to investors who may require the capital invested before the age of 55.
The returns on both products are not subject to dividend tax or capital gains tax. This could save investors significant sums of money over the long run. It also means that there is a significant tax advantage over a bog-standard share-dealing account. This is in contrast to a Cash ISA, which is only tax efficient for individuals with large sums of cash.
Although saving money each month is always a good idea, investing it in assets that deliver returns that are above inflation is a better idea than obtaining a low rate of interest through a Cash ISA. With SIPPs and Stocks and Shares ISAs being easy to open and highly tax efficient, now could be the right time to focus on them when it comes to retirement savings.
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