What is the Best Thing to do With a Lump Sum of Money?

1. ISAs offer tax-efficient returns

ISAs are a type of account that allow you to save or invest your money tax-efficiently.

Each tax year, you have a maximum allowance for how much you can save and invest across any ISAs you have. In the 2022/23 tax year, the ISA allowance is £20,000.

So, if your lump sum is larger than this, you may want to spread it across different types of investment.

Make sure you choose an ISA provider that’s covered by the Financial Services Compensation Scheme (FSCS), so you can sleep easy at night knowing your money is protected.

Stocks and Shares ISAs let you invest your savings

Stocks and Shares ISAs allow you to build a portfolio of investments with your money.

The magic of a Stocks and Shares ISA is its tax “wrapper”, meaning your investments are protected from Income Tax, Dividend Tax, and Capital Gains Tax (CGT).

These types of ISA are ideal if you want to achieve potentially higher returns with your lump sum savings over the medium to long term.

You should remember that investments can go down as well as up, so if you’re unsure of how to invest then you should contact a financial adviser. They’ll be able to design an investment strategy for you that’s suited to your risk tolerance and personal financial situation.

Cash ISAs allow you to save your money tax-efficiently

A Cash ISA is similar to a savings account in that you deposit your money and receive interest on your savings. The difference is that Cash ISAs are tax-efficient, so your money is free from CGT and Income Tax.

The rate of interest your provider offers usually depends on the type of Cash ISA you decide to open. Fixed-rate Cash ISAs, for example, typically offer better rates, though they require you to commit your money to the account for a certain period of time.

Meanwhile, instant access Cash ISAs allow you to withdraw your savings whenever you need them.

Lifetime ISAs (LISAs) are great for saving towards a house deposit or retirement

If you’re aged between 18 and 39, a Lifetime ISA (LISA) is ideal if you’re saving towards the deposit for your first home or to boost your retirement pot.

You can invest up to £4,000 each tax year in your LISA and, better yet, you’ll receive a 25% government bonus on deposits. This means you could get a total of £1,000 in government bonus each tax year.

As with other ISAs, your money is protected from Income Tax and CGT in a LISA.

Since the £20,000 ISA allowance applies to all different types of ISA, you could invest £4,000 of your lump sum into your LISA, then contribute an additional £16,000 in your Stocks and Shares ISA, Cash ISA, or a mix of the two.

Please keep in mind that you could face a 25% withdrawal fee if you take money out of a LISA for anything other than the deposit for your first home, or before you reach age 60.

2. Personal pensions can be great for saving toward retirement

If you’re a long way from retirement, you may not have given your pension pot much thought. Even so, if you’ve just come into a lump sum of money, there may be no better place to invest it than in a personal pension such as a self-invested personal pension (SIPP).

SIPPs are a type of personal pension that give you greater control over how your money is invested. If investing isn’t your forte, however, many SIPP providers offer a financial advice service to help you invest your savings, usually for an additional fee.

SIPPs may be quite useful if you’ve just received a large lump sum – the maximum gross contribution you can make to your pension tax-efficiently each year is usually £40,000 (or 100% of your earnings).

Also consider: The most important pros and cons of investing in SIPPs

Much like an ISA, money invested in a SIPP is protected from Income Tax and CGT.

Better yet, contributions also qualify for tax relief. This means a £100 contribution only “costs” you £80 if you pay basic-rate Income Tax. For higher- and additional-rate taxpayers, this falls to £60 and £55 respectively.

Bear in mind that you’ll typically face higher costs compared to standard pensions. These may include:

• Yearly admin fees
• Charges for transferring money in or out
• Fees for trading in funds or shares
• Fund manager fees (also known as an annual management charge).

Continue reading to discover the two types of SIPP typically available.

Low-cost SIPPs are straightforward and easy to manage

As the name suggests, you will typically pay lower fees with a low-cost SIPP. While you may still be charged for dealing in shares, you could avoid paying annual management charges or other fees.

If you’re more confident making your own investments, a low-cost SIPP may be more suited to you. Of course, this means that you may not receive any advice from your provider.

Higher-cost, or “full” SIPPs offer a wide range of features

Higher-cost, or “full” SIPPs, typically offer a much wider range of investment choices compared to their low-cost counterpart.

You’ll typically pay more money with a higher-cost SIPP. These costs may come in the form of annual management charges as well as trading fees, and any other costs your provider may levy.

These higher costs usually come with additional benefits. For example, you may receive investment advice or admin support from your provider.

3. General Investment Accounts enable you to invest a lump sum

Most of the accounts we have discussed so far have had limits or allowances that restrict the amount of money you can deposit. Meanwhile, General Investment Accounts (GIAs) have no such limitations.

GIAs enable you to invest your money and allow you to trade a wide range of assets, including stocks and shares, trusts, and exchange-traded funds (ETFs).

As mentioned, there is no limit to the amount of money you can deposit in a GIA, and there are no restrictions on the period of time you have to hold your money. This could make them a great choice for making a single lump-sum investment.

Remember that, unlike an ISA, you will typically be subject to CGT if you make profits using a GIA above your annual CGT allowance. As of 2022/23, this allowance is £12,300. You may have to pay tax on any gains you make above this amount.

The CGT tax rate is 10% if you pay basic-rate Income Tax, and 20% if you’re a higher- or additional-rate taxpayer.

You may also be subject to Dividend Tax if you earn any dividends through your GIA. While the first £2,000 earned through dividends does fall within your Dividend Allowance and is tax-free, any dividends you receive above this amount are taxable in the year you receive them.

From April 2022 the Dividend Tax rates are:

• 8.75% rate for basic-rate taxpayers
• 33.75% for higher-rate taxpayers
• 39.35% for additional-rate taxpayers.

While not as tax-efficient as an ISA, a GIA can be a useful option if your lump sum is especially large and you’ve reached your limits and allowances on your other accounts.

4. Buying cryptocurrencies could diversify your portfolio

Cryptocurrency is a relatively new craze that has swept the world recently. Crypto is a type of digital currency that can be used to make purchases, although few companies currently accept it in return for goods and services.

The main reason people buy crypto is to trade with it. Similarly to stocks and shares, people tend to buy crypto when its price is low and sell when it’s high to turn a profit.

There are many different cryptocurrencies out there, two of the most popular being ethereum and bitcoin.

You can trade these on marketplaces known as crypto exchanges, such as Coinbase or Gemini. Many of these platforms come with a digital crypto “wallet”, which allows you to store your purchased currencies.

Ready my guide to trading cryptocurrency to find out more about these investments.

Bear in mind that cryptocurrency is highly volatile, and as of April 2022, is currently unregulated in the UK.

5. Hold it in a savings account in the short term

If you want to save your money away without thinking about it too much, or you want somewhere to hold your money while you make some longer-term decisions, you can always just hold it in a savings account.

Depending on what you plan to do with your lump sum, you should think carefully about the best savings account for your needs.

If you’re saving a large amount for a long time, for example, you may want to think about finding a savings account with a competitive interest rate so you can ensure your savings continue to grow. Easy-access savings accounts, for example, may not be the best choice to hold your money for a long period of time since they typically offer lower interest rates.

Also consider: Will interest and savings rates rise in 2022?

When using a savings account, your Personal Savings Allowance protects you from Income Tax on the interest your money accrues.

The first £1,000 of annual interest for basic-rate taxpayers is tax-free, falling to £500 for higher-rate taxpayers. and £0 for additional-rate taxpayers.

After this, your interest may be subject to Income Tax. This could be a concern if you hold a particularly large sum in your account.

Fixed-rate savings accounts offer typically better rates

If you don’t think you’ll need to access your money, a fixed-rate savings account may be a good choice for you. You’re typically required to hold your money in a fixed-rate savings account for a set period of time.

These types of accounts tend to offer slightly better interest rates than easy-access accounts. According to Moneyfacts, the best five-year fixed-rate savings account as of 24 March 2022, for example, offers an interest rate of 2.40%.

You may be able to withdraw cash before the account matures, but you could face a charge for doing so.

Variable-rate savings accounts allow you to access your money anytime

Variable-rate savings accounts instead offer a rate of interest that can move up or down, depending on the Bank of England’s base rate.

You aren’t restricted to holding your money for a set period of time with a variable-rate savings account, so you’re normally free to withdraw money whenever you need it. This means you could also decide to move to another financial institution altogether if you find an account that offers a better rate.

An easy-access savings account can be particularly useful for holding an emergency fund. With this, you will be able to get immediate access to your money should you need to in a pinch.