If you want your money to start working for you over and above inflation, then to make real gains you have to look at taking some risks. I’m not talking about putting your money on the 3.15 at Doncaster. You are almost certainly already taking some risk with the money in your pension, so why wouldn’t you do it with the money outside of your pension?
There is no universal answer; instead you need to look at how much risk you can afford to take and what meets your needs.
The most obvious way to do this is to use your ISA allowance. Your ISA is not just for cash savings; it can also hold investments. These can be low-risk and high-risk investments. We’ll look more how to attack that problem later on, but for now, know that ISAs may give you a higher yield than cash and inflation, but doing so can take a little more time. You need to put this money aside for at least three years, and ideally for at least five years—hence the need for the buffer account. This doesn’t mean you can’t draw an income during this time, but when you use investments that can go up as well as down, you need to give them time to average themselves out before you can see the benefits.
The ISA allowance goes up most years (£20,000 each at the point of writing), and it’s important that you utilise as much of this allowance as you can each year. The ideal scenario is that you reach retirement with a lump of money in pensions and another lump of money outside of pensions. The advantage of pensions is that you get tax relief on the money at the outset. The problem is that this simply defers the tax, as you then pay tax on the income as you draw it. The advantage of ISAs is that whilst there is no tax relief at outset, when you come to draw the money out, it is tax-free. Therefore, a blend of ISAs and pensions allows you to minimise the tax you pay in retirement. You can draw up to a certain tax threshold from the pensions, e.g., up to the higher-rate tax threshold, and then take the additional income you need from the ISAs, ensuring you are not taxed at a higher rate.
This blend also gives you flexibility. If you need capital for that once in a lifetime trip or want to stop work a couple of years before you can access your pensions, ISAs allow for this. You can access the capital held here when you need it, without restriction.
If you want to save more than the allowance, do not be alarmed. You can use the same investments as you would have put into the ISA, just unwrapped. By holding these funds unwrapped you will pay some tax on the growth, but as most of this growth will be capital growth, it is taxed through the Capital Gains Tax regime. Few people use up their Capital Gains Tax allowance each year, so most of this growth will also be tax-free. The other advantage of this strategy compared to other investment types, like Investment Bonds, is that if you have years where you cannot save the full ISA allowance, you can transfer the money from unwrapped into the ISA wrapper to avoid losing the allowance. These types of investments can generate you a flexible income when you need it. The amount of risk you take usually determines the level of returns. The level of returns determines the amount of income you can draw without eating into the capital, though after retirement eating into the capital may be acceptable, as long as it’s managed in a sensible way. Later in life (during retirement) some other tax wrappers like Investment Bonds can be useful, but for most people this just adds unwanted cost and tax.
You should also be aware of two other kinds of investment groups.
The EIS And Friends
Once you’ve built up a good foundation in ISAs, cash, pensions and possibly some unwrapped investments, some of the wealthier amongst you may be looking for other options. Particularly if you are fully funding your pension (£40,000 in 2015/16), then you may be looking for long-term saving alternatives. This is where the EIS, SEIS and VCT might come into play.
The Enterprise Investment Scheme (EIS) and the Seed Enterprise Investment Scheme (SEIS) are investments in unlisted companies. Venture Capital Trusts (VCTs) are funds that invest in a portfolio of unlisted companies. These all offer very attractive tax breaks, both in ways that are similar to pensions and ISAs, but also in that VCTs can offer some additional savings in the areas of deferring or reducing Capital Gains liabilities, while also reducing Inheritance Tax. These products are generally very high risk and highly specialised. Not many financial advisers have much experience in them either, so if you think this area might be of interest, make sure to get experienced, specialised advice before you proceed, or you might find you’ve saved a load of tax but have lost the original capital.
In recent years, some ‘advisers’ have increasingly pushed unregulated investments on prospective retirees. As enthusiasm for pensions wanes, more people are willing to risk their pension in risky unregulated investments. These tend to take the form of more obscure investments into ‘teak forests’, ‘foreign property’, ‘second-hand endowments’, ‘land banks’ or ‘foreign exchange’.
I am not saying that all investments in this area are rubbish, but what I will say is that many so far have cost their investors their shirts. When regulated, if mainstream investments go wrong they might fall by no more than 10%; even in a financial disaster, high-risk funds might fall 50%, but at least you can get that back 50% back through a compensation scheme. When unregulated investments go wrong, it usually means you lose everything. Even when it hasn’t gone wrong, these investments often prevent you from accessing your funds, only to go wrong further down the line.
Most concerning are the people pushing these products. Many of these pushers have approached me asking for help in moving their clients into environments where they can then invest in their solutions. I refuse point blank, even though it could be quite profitable, because I believe that these clients don’t genuinely understand the risks involved. People at networking meetings approach me to see if I would recommend these products to my clients. These are the sort of people who last week were promoting ‘Utilities Warehouse’ and are now apparently now investment experts.
I met a client once who had been advised to put all of the life insurance pay out from her husband’s death into these types of investments. Nearly every one of them tanked, costing her all of the money she needed to support the rest of her life. Because these investments are unregulated, you cannot make a complaint to the Financial Ombudsman, so if a problem arises, you have to go through the courts, which is a much more complicated and costly process. Avoid these investments like the plague.
One final, but vital, point worth making: Never buy shares off anyone who approaches you on the phone! There are still a lot of share scams going on, and the older and more vulnerable are duped into buying worthless shares for a fortune on the promise of future riches. It is a very slippery slope; once you have made a purchase, you will be targeted time and again.
We had a client come to us who, over a three-year period, gradually sank a total of over £300,000 into these scams. He will never get a penny back from any of them. The scammers are amazing on the phone, and so it is easy to be convinced. You have to be strong and tell them that you never buy any investments over the phone. Just say no and put the phone down. It will save you a fortune!