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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?
The most obvious way to do this is to use your NISA allowance. Your NISA 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 NISAs 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 NISA allowance goes up most years (£15,240 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 NISAs 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 NISAs 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 NISAs, 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, NISAs 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 NISA, 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 NISA allowance, you can transfer the money from unwrapped into the NISA 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.
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Planning Your Retirement: Not Just Pensions