When learning about investing, most of the videos and books out there talk about investing from the perspective of someone who lives in the United States. This can cause confusion for investors in the UK.
You may have heard people talking about a retirement account called a Roth IRA. This account allows you to contribute after-tax dollars and grow your investment tax-free. This is of course a huge benefit when investing. As a UK investor, you may be wondering if there is an equivalent version of this account in the UK. Let’s find out.
Quick Overview
In the UK we have two accounts that have similar benefits to a Roth IRA. We have an ISA account that allows you to invest or save your post-tax income and grow your investment tax-free as well as make tax-free withdrawals. We also have a SIPP which allows you to invest and grow your money tax-free however when it’s time to withdraw you will have to pay income tax on that money.
What Is A Roth IRA?
A Roth IRA is a retirement savings account in the USA that allows you to grow your money tax free.
Main Benefits:
- Tax-Free Growth: Investments grow tax-free, meaning you won’t owe taxes on the earnings as they accrue.
- Tax-Free Withdrawals: You can withdraw your contributions (but not your earnings) at any time without penalty. After age 59½, you can also withdraw the earnings tax-free, provided the account has been open for at least 5 years.
- No Age Limit: There’s no age limit for contributions as long as you have earned income.
- No Required Minimum Distributions (RMDs): Unlike traditional IRAs, you aren’t required to start withdrawing money at a certain age.
Main Rules:
- Income Limits: To contribute to a Roth IRA, your income must be below certain limits, which vary based on tax-filing status.
- Contribution Limits: You can contribute up to $6,000 per year (or $7,000 if you’re age 50 or older). This limit may change, so always check for the current year’s limit.
- Qualifying for Tax-Free Withdrawals: To withdraw earnings tax-free, the account must be open for at least 5 years, and you must be at least 59½ years old. Exceptions apply for certain life events like buying a first home or facing a disability.
- Early Withdrawal Penalties: If you withdraw earnings before age 59½ and don’t qualify for an exception, you may face a 10% penalty and owe taxes on the earnings.
Many people will try to maximise their contributions to their Roth IRA before investing in a general investment account. The ability to grow your money tax-free is a huge benefit.
Is There A Roth IRA Equivalent In The UK?
While there isn’t an exact equivalent to the Roth IRA, we do have similar accounts in the UK. The closest is an ISA which also allows you to grow your money tax-free and have tax-free withdrawals. We also have SIPPs (Self-Invested Personal Pensions) which also allow you to grow your money tax-free, however, you do have to pay tax when you withdraw from your account.
Let’s take a look at each of these accounts in more detail.
What Is An ISA?
An ISA is a type of savings or investment account available in the UK. Any interest or gains made in an ISA are tax-free. You also do not pay any tax when withdrawing from your ISA.
Main Benefits:
- Tax-Free Interest: Any interest earned on cash or investments within an ISA is free from UK income tax.
- Tax-Free Gains: Profits from investments in an ISA are exempt from capital gains tax.
- Flexibility: Depending on the type of ISA, you can choose to save in cash, stocks and shares, or other qualifying investments.
Main Rules:
- Annual Limit: There’s an annual limit to how much you can invest in ISAs. As of my last update, the limit is £20,000, but it’s subject to change.
- Types of ISAs: There are various types of ISAs, including Cash ISAs, Stocks & Shares ISAs, Lifetime ISAs, and Innovative Finance ISAs. Each has its own rules and benefits.
- Age Restrictions: For example, to open a Cash ISA, you must be 16 or older, but for a Stocks & Shares ISA, you must be 18 or older.
As you can see this is very similar to the Roth IRA in the United States however it actually has more benefits. For a start, you can invest up to £20,000 per year whereas a Roth IRA only allows you to invest $6,000 per year. You can also withdraw your money tax-free at any time from an ISA without any penalties, including your gains, unlike a Roth IRA where you need to be over 59.
There are multiple variations of ISA accounts that provide some different benefits. Let’s take a look at the options.
Stocks And Shares ISA
This account allows you to invest up to £20,000 per year without paying any tax on your profits, even when you withdraw. You pay no tax on capital gains, income, or dividends. Remember you can only have £20,000 spread across multiple ISAs in a single year. You can start investing in an ISA with as little as £1.
Lifetime ISA
A lifetime ISA allows you to invest up to £4,000 per year and get a 25% bonus from the government. You are required to use this money to buy your first home or withdraw at 60+ or else you will incur penalties on withdrawal.
Cash ISA
A cash ISA is essentially a high-interest savings account that allows you to save without having to pay tax on the interest you earn. This account allows you to save up to £20,000 per year.
Junior ISA
A junior ISA allows you to invest up to £9,000 for your child and let it grow tax-free. Once they turn 18 they can access this money. It’s a great way to put money away for their first car, house deposit, or university.
How To Open An ISA
If you want to start investing and taking advantage of a Stocks and Shares ISA you can open an account at any time. Most popular investment platforms offer an ISA account to their customers. The platform I like best is Trading 212, especially if you’re just getting started with investing.
If you sign up through the link below, you will also get a free share worth up to £100 when you sign up.
Trading212 is a zero-commission trading platform offering general investment accounts, ISAs and CFD accounts. They are a trusted broker who has been around for almost 2 decades now. They have a range of features such as pies and multi-currency accounts which aren't offered by other brokerages.
- Commission Free Trading
- Access to over 12,000 Stocks and Funds
- Impressive features such as Pies and Multi-currency
- No phone support
What Is A SIPP
A SIPP is a type of personal pension scheme available in the UK. It offers greater flexibility in terms of investment choices compared to traditional pensions.
- Investment Flexibility: You have the freedom to choose and manage your own investments, including stocks, shares, funds, property, and more.
- Tax Relief: Contributions to a SIPP benefit from tax relief. This means if you’re a basic-rate taxpayer and you contribute £80, the government adds £20, totaling £100 in your SIPP.
- Tax-free Growth: Your investments can grow tax-free inside your SIPP. You will only pay income tax when you start to withdraw from your SIPP. You can take 25% as a lump sum tax free and withdraw up to your personal allowance each year before paying income tax.
- Control Over Retirement Income: You decide when and how to draw your pension, offering more control over your retirement income.
Main Rules:
- Annual Allowance: There’s a limit to how much you can contribute to a SIPP each year and still receive tax relief. The general allowance is up to £40,000 or 100% of your earnings, whichever is lower.
- Age Restrictions: You cannot access the money in your SIPP until you are at least 55.
- Lifetime Allowance: There’s a maximum total amount you can hold across all your pension schemes without incurring additional tax charges. This is currently set at just over £1 million, but it’s subject to change.
A SIPP is similar to a Roth IRA as it allows you to grow your income tax-free however, with a SIPP you will be charged income tax on your withdrawals, unlike an ISA or Roth IRA.
How To Open A SIPP
You can open a SIPP on many popular brokerages in the UK. There are also some SIPP providers that specialize in SIPPs only. I would recommend checking out our article on the best pension providers in the UK for more details.
Here’s a few of the best options:
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Best Pension Provider 2023
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Best Self Managed Pension Provider
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5.0
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4.5
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4.5
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4.0
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4.0
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Minimum Deposit:
£1
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Minimum Deposit:
£100
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Minimum Deposit:
£1
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Minimum Deposit:
£500
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Minimum Deposit:
£1
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Subscription Fees:
Zero
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Subscription Fees:
Zero
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Subscription Fees:
Zero
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Subscription Fees:
Zero
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Subscription Fees:
Zero
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Platform Fees:
0.5%
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Platform Fees:
0.45%
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Platform Fees:
0.75%
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Platform Fees:
0.75%
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Platform Fees:
0.6%
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Old Pension Transfer?:
✅
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Old Pension Transfer?:
✅
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Old Pension Transfer?:
✅
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Old Pension Transfer?:
✅
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Old Pension Transfer?:
✅
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SIPP vs ISA For UK Investors
The account type you choose will depend on your personal circumstances and goals. For example, if you plan on needing to use any of the money you invest before you reach the age of 55 an ISA is a much better option as you can withdraw money at any time without penalties.
However, if you want to benefit from the tax relief on a SIPP (The government provides 20% tax relief on all contributions) and don’t plan on using the money until after retirement a SIPP could be a better choice.
When deciding between both it can be a good idea to talk to a suitably qualified financial advisor who can look at your personal financial situation and advise you accordingly.
Remember, in all of these investment accounts the value of your investments can go up and down. Your focus should be on the long term so if the market does go down, you have time to recover.
Final Thoughts
So, if you want the equivalent of a Roth IRA in the UK, the closest you can get is a Stocks and Shares ISA with a SIPP coming in at a close second. Both allow you to invest and grow your money tax-free.
When it comes to withdrawing, you can withdraw from your ISA without paying any tax whereas in a SIPP you can take a 25% lump sum tax-free and the remaining withdrawals will be subject to income tax.
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