Q. What should I do once I’ve used my £20,000 Isa allowance? I earn £160,000 and usually use my full tax-free allowance quite early in the financial year. I am not sure what I should do once my Isa is full.
I think my options include investing outside an Isa and paying tax on the interest, or buying Premium Bonds to avoid tax entirely. Or I could pay off my mortgage, which is £530,000 at 1.22 per cent until September 2026, or put more into my pension. What would you advise?
Rachel Winter, a partner at the wealth management firm Killik & Co, replies
A. The best answer to this will depend on your financial circumstances and goals. Is retirement planning a key priority? If so, your pension should be a key focus. Do you have a short-term goal that will require funding? In that case, you will want a more flexible solution with easy access. Here are some options to consider.
1. Isas
It’s great that you’re able to top up your Isa so early in the tax year — the earlier you invest your money the more time it has to grow. One of the key benefits of an Isa is flexibility. They can be accessed at any point, and any money taken out during one tax year can be replaced within the same tax year.
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The contents of an Isa can be tailored to suit the owner. Cautious individuals may wish to hold cash, while those with a higher appetite for risk can hold investments such as shares or funds. Within the Isa there is no tax on interest, dividends or capital gains.
2. Premium Bonds
Premium Bonds are a popular savings product issued by National Savings & Investments (NS&I), which is backed by the government. Each bond is £1 and you can invest up to £50,000. The bonds are entered into a monthly draw to win cash prizes of between £25 and £1 million, with an average payout rate of 4.4 per cent.
The prizes are tax-free, making them particularly appealing to higher or additional-rate taxpayers. You are not guaranteed a payout, but the slim chance of winning a £1 million jackpot adds a bit of excitement. The initial capital cannot be lost and the Premium Bonds can be cashed in at any time, so they are a good option for those who may need their funds at short notice.
3. Paying down a mortgage
You’re in the strong position of having locked in a low mortgage rate of 1.22 per cent for a long period of time. When considering whether to use your excess cash to pay this off, ask yourself whether you could instead use it to get a guaranteed return of more than 1.22 per cent (after tax) elsewhere. If the answer is yes, then you would be better off doing this rather than paying off your mortgage.
NS&I has an instant access cash account that pays 3.59 per cent a year. As an additional-rate taxpayer, you will pay 45 per cent tax on this interest, which will reduce your net return to just under 2 per cent. So, you are better off doing this, rather than overpaying your mortgage for the time being.
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Your mortgage rate is likely to rise in September 2026 when your cheap deal comes to an end, so it may be worth using the accumulated savings and interest to pay down the mortgage then.
4. Government bonds
Unhelpfully, the word “bond” is used for many different things in financial terms. A savings bond means a fixed-term cash account with a fixed rate of interest, as opposed to a Premium Bond, which is outlined above. Then you have a government bond, also known as a gilt.
Gilts are issued by the government as a sort of IOU for your investment. They are issued for about £1 at an agreed rate of interest for a set time. On the maturity date you get your money back. They can change hands above or below £1 between the issue date and the maturity date. When interest rates rise bonds become less valuable because investors can get a higher yield from newly issued bonds. And when interest rates fall, they become more valuable.
For example, there is a gilt maturing in January 2026 with an interest rate of 0.125 per cent. This low rate is not attractive in the current environment, so the gilt is trading at a low price of 93p. Anyone buying in now will therefore make a gain of 7p on the purchase price, as well as earning interest.
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Gilts are not subject to capital gains tax, so they can be a tax-efficient alternative to cash.
5. Pensions
Pensions offer fantastic tax relief. Let’s imagine that you contribute £8,000 of your earned income into a pension. The pension firm will reclaim the basic rate of tax (20 per cent) for you, leaving you with £10,000 in your pension pot. As a 45 per cent taxpayer, you can reclaim the remaining 25 per cent tax via your tax return.
You’ll end up with £10,000 in your pension and it will have cost you only £5,500. In addition, there’s no tax on interest, dividends or profits inside the pension itself.
There will be some tax to pay when you draw from the pension in later life, but you could benefit from years of tax-free growth before reaching this point. Pensions cannot be accessed before the age of 55 — rising to 57 in 2028 — so they are not a good home for funds that you may need in the short term.
There are limits to how much can be contributed to a pension. The legislation has been changed many times and it is likely to do so again if we have a Labour government after the next election. So I would strongly recommend seeking advice. A financial planner will be able to listen to your objectives and model the impact of the options discussed here, as well as give you advice on pension contributions.
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Rachel Winter is a chartered wealth manager. She joined Killik & Co in 2012 and is a partner in its investment management team.
