Investor Essentials: What is a tax wrapper?

nutmegonomics


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If you’ve been following our Investing Essentials series, at this point you should have an appreciation of how your investment portfolio can be left to enjoy the power of compounding, and how a diversified portfolio can help you reach your investment goal and potentially set-up a better financial future for you and your family.

image representing porfolio options

However, before you sit back and leave it to the expert Nutmeg investment team to look after your funds, are you familiar with the tax-wrapper options for your savings and investments?

What is a tax wrapper?

When we talk about ISAs and pensions, we will often use the phrase ‘tax wrapper’. This simply means your money is in an account that ‘wraps’ around your investments or savings to offer some protection from tax, as long as the money stays within these wrappers. There are different types of tax wrappers – ISAs and pensions are among the most common – and different wrappers will offer different tax status and different flexibility.

What’s the difference between an ISA and a pension?

In very simple terms, with ISAs your money is taxed on the way in and with pensions it’s taxed on the way out. With an ISA you are contributing money that you have already paid income tax on and you are sheltering any growth and dividends from capital gains tax or further income tax. With a pension, you receive tax relief – or the tax back – on contributions.  So, when you put money into a pension the basic rate of tax you have paid on the amount contributed is added back (and there is further tax relief for higher and additional rate taxpayers, which can be claimed via self-assessment).  When you withdraw from an ISA there is no income tax to pay, but for a pension withdrawal you pay income tax at your marginal rate on all but the first 25%.

And if you want to withdraw money, then with an ISA you can take out your funds

If you were considering your retirement funds and were only to have either an ISA or a pension, a pension would usually come out on top. However, for goals besides retirement, or if you think you might need the money before you retire, then an ISA could be the way to go (though of course for the really well-organised financial individual, a combination of pension and ISAs is a strong plan).

ISAs in more detail

ISA

  • The ISA allowance for the 2021/22 tax year is £20,000. The tax year runs from the 6th April to the 5th April the following year, at which point the allowance resets (and you cannot carry forward any unused allowance from the previous tax year).
  • You will not pay any income tax on money saved in an ISA, as long as you do not pay in more than your allowance each tax year. This applies to not only basic rate taxpayers, but higher rate and additional rate taxpayers too.
  • To open an ISA, you need to be 16 or older (18 for a stocks and shares ISA), and be a resident in the UK.
  • You can only pay into one cash ISA, one stocks and shares ISA and one Innovative Finance ISA in each tax year. However, as long as you remain under your allowance, you can open and hold a mix of these ISA types every tax year.
  • You are able to transfer your ISAs to a new provider, but must not withdraw the funds while doing so or you will lose the tax protection.
  • Nutmeg offers an ISA as a stocks and shares ISA – cash ISAs are available elsewhere.

Lifetime ISA

  • The Lifetime ISA is a government savings initiative to encourage younger people to save for their first home or retirement.
  • You can save up to £4,000 each tax year in a Lifetime ISA and will receive a 25% government bonus on contributions. Any UK resident aged 18–39 can open and save into a Lifetime ISA. Your first contribution must be made before your 40th birthday and you can contribute up to the day before your 50th
  • The government will give you a 25% bonus on every contribution you make until you reach the age of 50. So, for every £4 you invest you receive a £1 top-up. That’s a potential bonus of £1,000 each year to put towards your first home or retirement.
  • You can choose to use these savings to buy your first home worth up to £450,000 or keep it until you turn 60. For both options, you can withdraw your money (including the 25% government bonus) tax free.
  • If you need to withdraw your funds for any reason other than an eligible house purchase, turning 60 or due to critical illness you’ll pay a penalty. The government will charge you a 25% penalty on the total value of the withdrawal, so you may get back less than you put in.
  • Nutmeg offers the Lifetime ISA as a stocks and shares LISA – cash LISAs are available elsewhere.

Junior ISA

  • A Junior ISA (JISA or child ISA) is a tax-free account set up by a parent or guardian for children below 18 (at Nutmeg we can only open a JISA for a child under the age of 16). Anyone can contribute to the account but only the child can access the money – and only after they turn 18. Friends and relatives are increasingly turning to JISA contributions as a way to give children a financial head start in life – you can find out about ways to do this in our
  • As of the 2021/22 tax year, the annual tax allowance or limit for a JISA is £9,000, and as with all ISA allowances this resets every 6th April with the new tax year. The money in a JISA belongs to the child in all but exceptional circumstances. When the child turns 16, they may apply to become the registered contact and manage the JISA themselves. However, they cannot withdraw the money until they’re 18.
  • Any contributions to a child’s JISA are not factored into your annual ISA allowance. Nor do they count towards your Lifetime ISA limit.
  • Nutmeg offers the Junior ISA as a stocks and shares JISA – cash JISAs are available elsewhere.

 

Personal Pensions – the basic facts

What are the different types of pension?

  • Provided you have the qualifying national insurance record, most people in the UK can claim a state pension.
  • If you’re employed, you’ve likely been auto-enrolled into your employer’s workplace pension scheme.

If you’re self-employed, or even if you already have a workplace pension, you can also have a personal pension.  

Pension allowance and tax relief

  • Most people in the UK can get tax relief on pension contributions up to 100% of their earnings or up to the government-set annual allowance.
  • The annual allowance is the amount of money you can contribute to your pensions without incurring any tax charges. For most people, the annual allowance is £40,000 for the 2021/22 tax year.
  • Tax relief is paid on your pension contributions at the highest rate of income tax you pay. So:
    • Basic-rate taxpayers get 20% pension tax relief.
    • Higher-rate taxpayers can claim 40% pension tax relief.
    • Additional-rate taxpayers can claim 45% pension tax relief.

Pension Carry forward and lifetime allowance

  • By using pension carry forward, you can use any unused annual allowance from the previous three tax years to make pension contributions in the current tax year.  You can find out more about this in one of our ‘Nutmeg nuggets’  that  covers how the carry forward option can be used.
  • The lifetime allowance is a set limit on the amount that you can take from all of your pensions without having to pay any extra tax charges. The lifetime allowance is £1,073,100 for the 2021/22 tax year, and includes all contributions and any investment growth.

This should give an overview of pensions, ISA types and the basic rules relating to them. However, this is not intended to be a comprehensive guide, and there are more detailed rules that can apply to all the ISA types, as well as rules relating to pension tax relief and allowances. There are some further details in the FAQ section on our ISA and and more information about the different ISA types on our ‘what is an ISA’ page. If you are unsure whether a personal pension or  ISA is the right choice for you, please seek financial advice. Nutmeg does offer regulated, restricted financial advice

Nutmeg offers stocks and shares ISAs, Lifetime ISAs, Junior ISAs and personal pensions.


ISA

Risk warning

As with all investing, your capital is at risk. The value of your portfolio with Nutmeg can go down as well as up and you may get back less than you invest. Tax treatment depends on your individual circumstances and may be subject to change in the future.

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