Types of Trading Accounts

Stockbrokers in the United Kingdom offer a number of different trading account options. By choosing the best type of investment account for your own personal financial situation, you can save 20% or more in taxes on thousands of pounds each year. On top of that, by planning for the future now, you will have more of your own money to spend at retirement. Each account type has advantages and disadvantages over the others. We will look at several of the best and most common options including Individual Savings Accounts (ISA), Self Invested Personal Pensions (SIPP) and standard trading accounts.

Standard Trading Accounts

A standard trading account is, as the name implies, the most basic of the trading accounts, often simply called a trading account, share trading account, or share dealing account. It allows for basic investment purchases including UK and often foreign equities (stocks), bonds, funds (mutual funds), exchange traded funds (ETFs), along with many other types of investments. Depending on the stockbroker you deal with, trading accounts can often be upgraded to allow for options trading and other derivatives, foreign exchange (FX or ForEx), commodities, trusts and other more advanced investment vehicles. Standard share dealing accounts offer nothing in the way of tax benefits or shelter and are best only for those who have exhausted all other tax advantaged options or for short term investors who will not use the money for retirement.

Self-Invested Personal Pensions (SIPP)

This brings us to our first tax advantaged investment option, Self Invested Personal Pensions, also called a SIPP. A SIPP is a self-directed retirement plan of sorts. Any UK resident may own and contribute to a SIPP. Those under 18 must have theirs set up by a legal guardian.

Breaking down the name, we have Self Invested as the first part. This implies, and rightly so, that the investments within the SIPP are made by the investor, not an account manager or broker. Because of this, SIPPs are not recommended for individuals who do not feel comfortable making decisions on where to invest their funds. Investment options range from cash savings to equity shares, bonds, funds, ETFs, REITs and many others. There are virtually no limits to the investing options in a Self Invested Personal Pension.

The last part of the name is Personal Pension, meaning that payments will be made to you from the investment at the time of your retirement. Everyone with a SIPP has the option to take a partial lump sum payment of 25% of the value of your SIPP at age 55 or greater. This 25% payment is paid interest free and allows for several options with the remaining balance in your account. You may choose to transfer the remainder to an insurance company for purchase of an annuity. An annuity guarantees payments from your account, either over a set period of time or at a set amount per payment. The specifics will depend on your age, the amount in your account and any other options you will need to discuss with the annuity provider.

Alternatively, you may decide to keep the funds in your SIPP and take income withdrawals from the account. The funds in the account remain in your care, so you are responsible for managing the account, unlike an annuity. There is no minimum withdrawal amount, so you may choose to not take a payment until later. There is, however, a maximum payable benefit, set forth by HMRC. The income benefits are otherwise flexible, which makes this a great option if you have other income during retirement, such as employee pensions or income from a job.

Tax Advantages of a SIPP

Tax relief is one of the benefits of a SIPP and is available at your standard tax rate at the time of contribution. Contributions made are net of basic rate tax. This means if you wanted to invest £1000, you would contribute £800. An additional £200 is reclaimed automatically from HMRC and credited to your account for a total contribution of £1000. If you are a high rate tax payer, you may be able to collect an additional 20% in relief on a portion of your contribution (or all of it, depending on your income), which can be claimed through your personal tax return. You may contribute up to your entire salary per annum into a SIPP.

An example may be the easiest way to understand how the contributions work. If Investor A, who earns £30,000, wants to contribute £1,000 at one time, he would make a net payment of £800. His investment broker would then claim £200 from HMRC, making a total investment of £1,000. Let’s say instead that he earns £75,000 per year and still wants to make a £1,000 investment. He would still contribute £800 to receive the tax relief of £200. He would then be able to claim another £200 on his self-assessment, since he is a higher rate tax payer.

Individual Savings Account (ISA)

While SIPP owners get tax relief on their contributions, cash coming out of the pension are taxed at the standard UK tax bands. This is one of the disadvantages to a SIPP, since retired investors are usually on a fixed income. Having a significant portion of your hard earned savings eaten up by the tax man can be difficult to overcome.

That leads us to another great option for savings and investing. Perhaps the best option for many investors is an Individual Savings Account or ISA. There are two types of ISAs available, a Cash ISA and a Stocks and Shares ISA. Currently (2011/2012), investors may contribute up to £10,680 into an ISA per annum, half of which may be invested in a Cash ISA. In other words, you may contribute up to £10,680 into a Stocks and Shares ISA alone, or up to £5,340 into a Cash ISA with the remainder going into a Stocks and Shares ISA, up to a total of £10,680. Contributions must be made by 5th April each year for the prior year’s contribution. You may not carry over any leftover amount, so you should try to maximize your contribution each year.

Capital appreciation is tax free inside an ISA and there is no limit on when or how much you may withdraw. Keep in mind, though, once withdrawn, money may not be replaced. For instance, if you contribute £5,000 and later withdraw £2,000, you would have a balance of £3,000. You may still contribute £5,680 more but not £7,680 more, so your total for the year could only be £8,680, since you invested and withdrew. There is no Capital Gains Tax on investments in an ISA and you may not reduce Capital Gains Tax on losses from within the account. Dividend paying investments are also not taxed, however, you may also not claim the 10% tax credit on dividend payments inside an ISA, so in the end, it is still the best option. Unlike SIPPs, withdrawals from an ISA are not taxed either.

Stocks and Shares ISAs offer a wide variety of investment options including UK and international equities, bonds, trusts, funds and ETFs, among others.

Just about anyone who is saving money for any reason should utilize the advantages of an Individual Savings Account. Beyond that, a Self Invested Personal Pension is available for further tax advantaged savings. Individuals with a need or desire to save even more than is allowed with these plans may do so with a regular trading account. Each of type of investment account is available through a number of quality service providers either locally or on the internet. Account fees may vary from one provider to another, so be sure to shop around for the best deals. Our chapter on UK Stockbrokers and Brokerage Firms is a great resource along with friends, family and internet searches.