The UK and the US both offer tax-advantaged investment accounts to encourage people to save for retirement. If you’ve been looking into your options, you may have come across the Individual Retirement Account (IRA). In the US, a Roth IRA allows an individual to save for retirement with tax-free investment growth.
While there are various types of IRA accounts, the most popular is the Roth IRA. Investors can contribute up to an annual allowance of $6,000 with after-tax income and there is no minimum investment amount, making it easy to get started. Roth IRAs allow early withdrawal of contributions (not capital gains) without penalty and your money grows completely tax-free.
If you’re thinking that’s a pretty sweet deal for our American friends across the pond, you’ll be happy to hear that there’s a Roth IRA UK equivalent.
What is the UK equivalent of the Roth IRA?
The closest UK equivalent of the Roth IRA is a Stocks and Shares ISA, sometimes referred to as an Investment ISA. Similar to the Roth IRA, contributions are made with after-tax income and your money grows free of capital gains tax.
However, unlike the Roth IRA which is primarily used to save for retirement, the Stocks and Shares ISA is more flexible. UK investors can withdraw their contributions and investment returns at any time with no penalties.
How does an ISA work?
Each tax year, you’ll have the option to invest up to £20,000 across your ISA accounts. If you do not use the full £20,000 ISA allowance, you lose it and it does not roll over to the following tax year. You have up until the 5th of April to secure this year’s ISA allowance.
Currently, there are four different types of ISA wrappers available for UK investors which allow for tax-free capital growth. These include:
- Cash ISA: Similar to a traditional savings account, you can receive interest on money saved in the account.
- Stocks and Shares ISA (Investment ISA): A tax-free investment account where you can invest in assets such as company shares, bonds, investment trusts, index funds, REITs and ETFs.
- Lifetime ISA: An ISA that incentivizes you to save for your first home or retirement. You can contribute up to £4,000 each tax year and receive a 25% bonus from the government. There are strict withdrawal restrictions.
- Innovate Finance ISA: Using an online peer-to-peer lending platform, you can lend your capital to individuals and businesses, in return for interest over a fixed term.
You can choose to split your allowance across ISAs or invest in one account. For instance, you could invest £15,000 into a Stocks and Shares ISA, £4,000 into a Lifetime ISA and £1,000 into a Cash ISA. Alternatively, you can choose to invest the full £20,000 into a Stocks and Shares ISA.
Keep in mind that each tax year, you can only contribute to one Stocks and Shares ISA account. An account from a previous tax year can be kept open but you cannot contribute to it until the following tax year.
Any investment growth or income received from dividends is free of capital gains tax, making the Stocks and Shares ISA an attractive option for long term investors.
How do you open a Stocks and Shares ISA account?
To open a Stocks and Shares ISA account, you will need to be a UK resident, have a national insurance number and be over 18 years old.
The first step is to decide on how much of the £20,000 allowance you want to invest. Keep in mind that your capital is at risk and investments can go up and down. You should make sure you have an emergency fund, and avoid using cash that you need access to in the near future.
Next, open a new Stocks and Shares ISA account with an investment platform that allows you to buy and hold a range of investments in one place. Popular investment platforms include Freetrade, Trading 212, Moneyfarm, Vanguard and Nutmeg.
When choosing a platform, you should pay close attention to any fees including the cost of buying and selling investments. High fees erode your investment gains over time, therefore it can be a good idea to choose a low-cost approach.
Before you start to invest, consider your investment strategy. Having a plan before you invest can put your investment goals into perspective and determine your risk tolerance. Investing is a unique kind of casino, and a plan will help you remove the likelihood of emotions affecting your investment decisions.
The final step is to choose your investments and contribute to your account. If you prefer a passive investment approach, you can set up a direct debit to drip feed your money regularly. More confident investors might prefer to make lump sum contributions based on investment research and market events. You can weigh up the pros and cons of each in my post lump sum vs drip-feeding investing which is better?.
Roth IRA UK Equivalent
While there is no direct equivalent of a Roth IRA in the UK, the key is to grow your money tax efficiently and that makes an ISA the best option for UK investors.
However, with different types of ISAs available, it can be hard to choose the best option. Investing in a Stocks and Shares ISA is the most flexible and tax-efficient way to grow wealth. And in most cases will deliver better returns than cash savings.
Be mindful of fees and the investment services provided when you choose your investment platform. Use your investment objectives, risk tolerance and time horizon to make an informed decision on the best asset allocation for your financial needs.
Register today for a Stocks and Shares ISA. With my Freetrade referral link, you could receive a free share worth up to £200 when you open an investment account.
Should I invest with a Stocks and Shares ISA?
Stocks and Shares ISAs are best suited for mid-term or long-term goals. As investments can go up and down in value, it’s important that you give your money enough time to grow and recover from market downturns or crashes. You should feel comfortable about putting your money away for several years without touching it.
Can I open a Stocks and Shares ISA for my children?
Yes, you can open a Junior Stocks and Shares ISA (JISA) which currently has a tax-free allowance of £9,000.