This article is all about the best type of investment account that you can use to make the most from your investments.
I want to make a couple things clear from the start.
1) This article is going to be fairly technical.
2) This article is going to be heavily UK focused. So if you’re not based in the UK, this information may not apply.
I’m going to try and make it as straightforward and easy to understand as possible, but the very nature of this subject involves some technical jargon.
I’m not saying this to scare you off, please keep reading!
I’ve mentioned the importance of individual investing a few times now. Personally, once I understood the basic concepts of investing, my next question was “how do I invest?”.
The ability to invest and the mechanics of how to do so varies from country to country and so there’s no one size fits all answer as to the best type of investment account to have.
For the purpose of this article, I’m going to be focusing on the UK because that is where I’m most qualified to talk about this kind of stuff.
I’m going to explain everything in detail, but even if you don’t follow all of it, there will be just a few simple takeaways.
So let’s dive in.
What is the best type of investment account for UK investors?
A stocks & shares ISA.
For the majority of individual investors in the UK, especially towards the lower end of net worth, a stocks and shares ISA is the best type of investment account for people to be using.
I’m not calling you poor by saying you most likely fit into the lower net worth category, I’m right there with you! I mention this only because it’s relevant to the amount that you can invest each year in a stocks & shares ISA (which I’ll discuss later).
What is an “ISA”?
ISA stands for “Individual Savings Account”.
Most people will be familiar with the term “ISA”, or at least heard of it in passing. Most of the time though, the type of ISA that comes to people’s mind is what is known as a “cash ISA”.
The less well-known version of an ISA account is the stocks & shares ISA. It works in a similar way to a cash ISA, the main difference being that you can use it to invest in stocks & shares, rather than just cash.
ISA tax-efficient structure
The reason that ISA’s are so popular, and why I recommend using them, is because they are tax-efficient.
Sometimes accounts like these are referred to as a “tax-efficient wrapper”, another example would be a pension account. I know the term “tax efficient wrapper” sounds more like a dorky educational hip-hop artist, but they’re extremely useful for building wealth.
In some ways, ISA’s actually have a more favourable structure than pensions.
With an ISA you have a yearly allowance, which is currently set to £20,000 per year.
What this means is that within a single UK tax year (April to April), you are allowed to put up to £20,000 into your ISA.
You can split your allowance between a cash ISA or stocks and shares ISA as you see fit. As long as the total saved doesn’t exceed £20,000. Any remaining allowance doesn’t get carried over to the next year either. So if you only managed to put £10,000 into one of your ISA accounts for the whole tax year, your remaining £10,000 allowance does not get rolled over to the next year, it expires.
This £20,000 limit is actually pretty high for most people, which is why I recommend it as the best type of investment account to use. Most people don’t save anywhere near £20,000 a year, which makes it a really useful tool. Even if you save more than that amount, it’s often still worthwhile maxing out your ISA allowance before looking at other less tax efficient options.
The fantastic thing about the tax efficiency of an ISA is that your money is allowed to grow free from any additional taxes like Capital Gains. Even better, when you withdraw from your ISA, the money is not classed as income and subject to income tax (unlike pension withdrawals which are taxed like a salary).
So what this means in simple terms is that you can save and invest up to £20,000 each year, let it grow tax-free (so you keep 100% of your gains). Then once you have reached your investing goals, you can withdraw and use the money from the stocks and shares ISA without paying any additional tax (or have it affect your tax liabilities).
It’s like a legal tax blindspot.
Why use a stocks & shares ISA instead of a cash ISA?
With interest rates at historic lows, you earn bugger all interest in cash savings accounts right now.
Also everyone has a “Personal Savings Allowance”, unaffected and not connected to an ISA. Depending on your tax bracket, this Personal Savings Allowance means that you can earn up to £1,000 interest on cash savings accounts without paying any tax. With some savings accounts offering as little as 0.01% interest, you’d have to have heaps of money saved up to hit your £1,000 tax-free interest allowance.
So you might as well just use a regular savings account for your cash instead of an ISA because there’s no real tax benefit there.
A stocks & shares ISA on the other hand, can grow at much higher interest rates tax-free, depending on where you invest your money.
It makes much more sense to use your ISA allowance for savings that have the potential to grow the most in order to take advantage of the tax wrapping, spitting tax-free pounds instead of bars. Sorry for that awful rap joke.
By concentrating your investments and savings in an account that protects you from tax liabilities, a stocks and shares ISA provides you with the best possible chance of reaching financial freedom as quick as possible.
The benefits of a cash ISA are pretty redundant right now and you’re better of using your allowance for a stocks & shares ISA and then just holding a regular cash savings account.
Where can you open a stocks and shares ISA?
Most UK investing platforms will offer the ability to invest using a stocks & shares ISA. They’re pretty straightforward to set up and open online through the websites.
Vanguard is where I hold my stocks & shares ISA and it’s a really simple user interface for setting up things like direct debits to automate your investments. On top of that, investing through Vanguard is low cost, and their customer service is excellent.
The bottom line
There was a lot to get through in that post, but I hope you learned something useful.
The biggest takeaway is that unless you are saving and investing over £20,000 per year, a stocks and shares ISA is likely to be the best type of investment account for you to be using.
Thanks for reading and happy investing!