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Roth IRA: is there a UK Equivalent? Yes! Full explanation!

Franklin Carneiro da Silva| Updated August 9th, 2022

The US and the UK offer tax advantageous investment options that very few people worldwide are lucky enough to put their hands on!

A famous investment option with tax benefits in the US is called the Individual Retirement Account (IRA), which may adopt several subforms. One of them is the Roth IRA funded with after-tax dollars (meaning your contributions are from net-of-tax money and is not tax-deductible). Once you start withdrawing funds, the money is tax-free. Pretty good, huh?

In the UK, the most similar tax-free investment structure available is an Individual Savings Account (ISA). Like the Roth IRA, payments into your account are made from after-tax income, then the account is exempt from income and capital gains taxes on the investment returns, and no tax is payable on money withdrawn! Also, there is no restriction on when or how much money can be withdrawn.

The incentives are enormous to start building your wealth, and the UK government offers you four types of ISA:

  • Cash ISA: Savings account for short-term and/or emergency needs. Besides, it is more indicated for risk-averse investors who mainly prefer to get a lower but safer income. The Achilles’ heel of cash ISA is inflation which will “eat” your savings slowly through time.
  • Stocks & Shares ISA: An investment account used to buy stocks, ETFs, bonds… where you may grow your pie with a more long-term approach and hopefully exceed inflation. The volatility is higher, but the expected returns are higher as well.
  • Innovative finance ISA: Available only since 2016, this account is designed for peer-to-peer (P2P) lending investments, a form of investing where you directly lend money to businesses.
  • Lifetime ISA: With this alternative, your incentive is to save for a first home or retirement. You may invest in cash and/or securities. The government offers a 25% bonus on deposits—the more restricted type of ISA.

From this point, we will give you a clear overview of the essentials of ISAs, which will match all the four types of ISAs in existence.

Do you really understand what an ISA is?

Created in 1999, ISAs were designed as a crucial way to save for the long run (meaning retirement). People need to be incentivized to invest. Otherwise, it would be much harder to direct their focus on growing their capital over time. Whether you are just starting to save or are building up an investment portfolio for retirement, ISAs will play an important role in your overall financial situation.

The key benefit of using an ISA comes in the form of tax-free on the gains you make from interest, dividends, and/or investment returns. Let’s say you decide to invest outside an ISA, any profits made above the annual Capital Gains Tax (CGT) allowance for 2021-22 tax year is £12,300, are subject to tax at 10% or 20% depending on your tax band. On the other hand, investing through an ISA, you won’t have to pay CGT regardless of the amount in capital gains (£1 or £1M). The same applies to interest and dividends.

How do investment ISAs Work?

In addition to the tax advantages, you also do not need to declare any ISA interest, income, or capital gains on it in your tax return. In other words, you may complete a tax return for investments in a non-ISA account and be in doubt whether or not you should include the ISA Accounts – Don’t worry, you don’t need to!

The annual subscription limit per tax year (6 April to the following 5 April) is £20,000 across all ISAs combined. The only exception is in the Lifetime ISA which has a maximum allowance of £4,000. You can split your allowance across the different types of ISA. For example, you may have invested £8,000 in a Cash ISA, £10,000 in a Stocks & Shares ISA, and, finally, £2,000 in a Lifetime ISA.

Also, evaluate the flexibility of your ISA. Some ISAs accounts allow you to take out money without counting towards your annual ISA Allowance on any tax year. Using the previous example, if you withdraw £4,000 from your Stocks & Shares ISA, you would have £16,000 invested in total, meaning you could re-invest £4,000 in the same or another ISA of your choice.

Remember that not all ISAs offer flexibility, so check the terms and conditions of your particular case!

Pros and Cons of ISAs

Pros

  • Interest, dividends, and capital gains are not taxed (whatever the amount)
  • Wide variety of investment options
  • Tax-free withdrawals at any time
  • No obligation to declare ISAs on your tax return
  • Easily transferable to another provider
  • You can keep it by moving abroad but cannot put more money after you leave the UK
  • ISA can be inherited by a spouse
  • You can start with just £1

Cons

  • A maximum annual allowance of £20,000 (combined IRAs)
  • Contributions are not tax-deductible
  • You cannot accumulate your allowance for the next fiscal year if you invest less than £20,000 in a given year
  • You cannot have a joint ISA (or put it in trust)

Am I eligible to open an ISA account?

The requirements are pretty simple to open an ISA account:

  • Be a resident in the UK
  • Be over 16 years old (18 for stocks and shares ISA) – Except for Junior ISAs
  • Have a national insurance number

Keep in mind that it is not possible to have an ISA account with another person. ISAs are personal investment vehicles, so they must be in only one person’s name.

How to open an ISA account?

First, you need to choose the provider (bank, stockbroker, peer-to-peer lending services, credit unions,…), then you will require the usual documentation: Your full name, address, national insurance number, and a signature.

After you open it, you will get access to a passbook, certificate, or an online statement. You can easily manage your ISA account through home banking.

You can only have one Cash ISA, one Stocks and Shares ISA, and one Innovative Finance ISA in each tax year, which means that if you want to have two cash ISA, for instance, you will have to wait for the following tax year.

What’s the minimum to contribute for an ISA?

There is no minimum amount to start your investment journey through an ISA. Actually, you can even transfer just £1 to have an account opened.

Are there any fees involved?

Every investment company offering ISA charges an annual service fee as a percentage based on the total value of your portfolio. In addition to this fee, you will face stock and ETF trading commissions. You must make a simulation to know how much you expect to trade and the instruments used for that purpose.

You may find a provider with a relatively cheap annual service fee, but that fee loss may be compensated by higher commissions (share/ETFs dealing) or by making money off selling you other services.

As a side note, you are most likely to not pay a service fee on junior accounts, on exchange-traded investments held in an Investment Account, or on the cash you hold. Always check this information beforehand with your provider!

Are ISAs protected?

Yes! If the provider goes bankrupt, you are protected under the Financial Services Compensation Scheme (FSCS). This protects your savings up to £85,000 per person, per institution.

Do not forget that the investment risk is not covered… The market may suffer wide fluctuations, which is part of the “rules”. That’s the very nature of investing. You may face upward or downward movements.

Who offers ISAs in the investment universe?

We believe that the Stocks and Shares ISAs are the ones investors will have a harder time figuring out what provider will be the best option for their needs. Given that, we summarise a list of options:

Online brokers:

Interactive Brokers

Founded in 1978, IBKR is one of the world’s most trustworthy brokers worldwide. It offers a Stocks and Shares ISA with a minimum monthly activity fee is £3 (if you generate a £3 in commission per month, no fee is applicable) and no minimum deposit.
💡 Interactive Brokers also launched IBKR GlobalTrader, a modern mobile trading app to trade Stocks and ETFs, ideal for novice investors.

Freetrade

It is one of the most popular UK-based fintech startups. It is the closest you can get to Robinhood in the US. You do not need to pay any commission to transact stocks and ETFs. You only have a flat fee of £3/month. Read our Freetrade review.

Saxo Bank

Founded in 1992, Saxo Bank is a danish online broker with a high reputation among its peers. Through your Stocks and Shares ISA, you can invest in more than 11,000 stocks, ETFs and bonds. It also has a “Managed Portfolios” feature (similar to a Robo-Advisor).

Trading 212

commission-free stocks and ETFs trading (+6500 global stocks and ETFs), no foreign exchange fees, and presents fractional shares. Over 15 million customers. No fees are applied in their ISA Account (commissions, annual service fee, and dividend reinvestment). Read our Trading212 review.
Disclaimer: 76% of retail CFD accounts lose money.

Robo-advisors:

Wealthify

A Robo-Advisor that offers five different investment styles (each with its own level of risk). Wealthify charges 0.60% for its annual service. This fee can go up to around 1.25% for ESG investment portfolios.

Moneyfarm

Another great Robo-advisor to manage your investments in a stress-free wealth management service. The pricing varies according to your investment amount. It goes from 0.35% to 0.75% in case you invest £100.000 or 10.000£, respectively.

All the companies here mentioned are regulated and/or registered in the Financial Conduct Authority (FCA) in the UK.

Final thoughts

If you are looking to grow your money tax-efficiently, ISAs will definitely be a good option. The landscape for ISAs might be quite complex at first due to the number of options available. The reality is that once you start digging a little bit, you will realize that it is quite straightforward.

Always pay attention to the fees charged and the services provided (do you really need a platform that allows you to buy from 5,000 stocks? Are you happy with only ETFs?).

Our digital world has democratized the financial industry to such a degree that almost anyone can start to grow their capital even with little knowledge!

Let’s us know in the comment section if you have any doubt! 🙂

Franklin Carneiro da Silva
Co-Founder & Fintech Analyst

Franklin is a CFA Level III Candidate with 3 years of experience in Wealth Management as a Fund Research Analyst and the Host of the "Edge Over Hedge" YouTube Channel.

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