Thanks for finding my new site, focusing on FIRE (Financial Independence/Retire Early) for Americans who live in the UK, or want to.
This site grew out of an idea that I had after helping a number of people on both Facebook and Reddit. There is lots of information out there about how to invest for FIRE, and tons of information on both US and UK taxes, although somewhat less on how the two systems interact. It’s really hard to find something that ties it all together, and that’s really important for US citizens in the UK. Investing in a way that isn’t tax efficient can be hugely punitive (55%+ tax rates, massive fines for non-compliance with unexpectedly complicated tax filings, etc.).
I started putting a document together to summarize the basics of what you need to know. Once that document reached 40 pages (!), I realized I needed to either write a book or create a better site for it. That’s this site.
For starters, I’ll be moving the content from that initial document here, organizing and expanding. Those topics include:
Summary of each account option for investing (pensions, ISAs, IRAs, SIPPs, etc.)
High level review of real estate, inheritance tax, things to consider before you move, and the US/UK tax treaty
From there, I’ve got some ideas about other topics I’d like to explore, and will also post on more timely topics as they come up. I’ve started a list on this page – definitely welcome your comments on other topics you’d like to see!
It’s been almost two months since I last posted, so rather than leave it any longer, I wanted to say something. But I’ll keep it quick – my attention has been focused elsewhere, although I hope that to change again in the coming months.
First off, work has been busy. 80% in a good way, 20% in a frenetic way, as I’m about to move into a new position for someone who is retiring, while we’re also in the midst of going live with a project that I’ve been working on for two years (and it isn’t going quite as smoothly as I’d hoped). Nothing existential, just keeping me busy. And of course I still have my family, and two little kids can demand some attention!
The other big draw on my attention has been Ukraine. This isn’t a political, military, or international relations focused blog, so I won’t spend any time on my thoughts on the war. However, international relations and security studies are one of my long-term interests, as much as investing and personal finance, so I’ve been spending a lot of time thinking about Ukraine. Suffice to say, my thoughts go out to the people of Ukraine, some of my dollars/pounds have gone to the Red Cross to help them, and to the Ukrainians fighting, I wish them good hunting.
From an investing perspective, the last few months have been turbulent, but while things are more volatile than they have been for some time, nothing has changed my fundamental approach. Inflation is higher than I’ve really seen (I was a child the last time it was this high), but I’m very fortunate to be somewhat insulated – not driving much, 5 year fix on the mortgage, 2 year fix on the electricity and gas, groceries up a bit but not breaking the bank. The Government is messing around on the margins, but the Spring Statement isn’t even worth a post- tiny tweaks for those of us fortunate enough to be investing for the long term, not enough to make much difference for those less fortunate.
And the markets have been volatile but not that volatile, if you’re generally a total market investor. FTSE 100 almost flat for the year now, after the recent recovery. VT (Vanguard All-World/All-Cap) down 6%, just noise – still a little up from a year ago. Unless you’re in particularly growth-y stocks, or a Russian ETF, none of this is huge.
Bonds are a bit of a conundrum – BNDW (world bonds) down almost 6% for the year (excluding the piddling interest), looks almost like equities. UK gilts looks the same. I’m honestly not quite sure what to think of bonds right now. Rates are still very low, feeling like it’s an asymmetric risk profile (rates can’t fall that much more, but have plenty of room to rise), but I’m also not a proponent of 100% equities. In practice, that means almost all of my fixed income allocation remains in the TSP G fund, EE bonds, and cash (none of which has any risk to principal, although plenty of risk to loss of purchasing power through inflation), with only a small, slowly growing allocation to gilts in my UK pension. Searching out higher risk bonds for a higher yield feels like too much risk for the reward, so I don’t see much in the way of alternatives. Curious to hear how you are all managing your bonds/fixed income allocations these days.
Put that all together, and you get some very hard times for a lot of people, and a great deal of geopolitical uncertainty. But from an investing perspective, it’s the same lesson as usual: stay the course. Trying to respond to world events is a fools errand, and few of us have the foresight to anticipate them. Broad diversification at a low cost remains the best approach for almost all of us, with an eye on how to keep taxes to a minimum.
For me, January to April is the “active” season for investing. My Roth IRAs have been done since January (in Interactive Brokers for the first time). Interactive Brokers turned down my application to be a professional investor, so I’m keeping my ISAs with Hargreaves Lansdown for now – will fully contribute to those with the monthly savings option in early April, with a little cleanup to use up remaining cash after that. And my company pays bonuses in March. This year, I salary sacrificed the vast majority to my pension, rather than paying 62% to HMRC, so I’m waiting for that to show up in the next few days. There’ll be a rebalance in the midst of this, since none of those new investments goes into US equities and I want to keep the overall equities/fixed income allocation broadly stable.
But by the end of April, it’ll be all sorted, and, aside from monthly pension contributions and additional savings, the “busy” period of the year for investing will be done. US and UK taxes will be the next order of business – more to come on that.
Hope you’re all keeping well, and I promise not to keep it quite so long for the next post!
I don’t usually post about my ISA experiment every month (previous updates here), but January has been an interesting month. Obviously not just for my ISAs, but across the market.
Some headline figures, to set the scene for those who haven’t been watching closely (good for you!):
US Large Cap (S&P 500)
US Small Cap (MSCI US Small Cap)
UK Large Cap (FTSE 100)
UK Mid Cap (FTSE 250)
Our ISAs (UK mixed cap)
All figures include dividends
This is the first time our ISAs have diverged from the FTSE 100 in a pretty big way – very visible on the charts:
Not great, but what’s going on under the hood, where is this divergence coming from? Looking at each of our ISAs, there’s a dramatic difference:
My ISA: up 0.06% for the month (not much, but positive!) – within squinting distance of the FTSE 100 at -0.3%
My Wife’s ISA: down 9.7% (!) – not too far off the smaller cap FTSE 250 at -8.3%
So what’s going on here? Two key themes emerged when I dug a bit deeper:
Size makes a difference
Thinking back to when I put our ISAs together, I did mine first, and basically started at the top of the FTSE 100. Skipped some here and there, but 80% of my ISA is from the top third of the FTSE 100 by market cap, and the smallest one is still in the 70s. Average market cap of my ISA is £42 billion.
I assembled my wife’s ISA second, after already picking most of the biggest parts of the FTSE 100. Aside from National Grid up near the top, her ISA is clustered around the middle of the FTSE 100, with a long tail, and 25% of it too small to make the index. Her average market cap is £9 billion – dragged up by National Grid; without that, it’s not much over £7 billion.
All told, that means my ISA represents about 40% of the FTSE market cap – not at the same weights (I’m basically equally weighting stocks, based on cost, not market cap – way too much hassle – plus a rough market cap weighting of sectors), but still a good chunk of the index. However, my wife’s only represents about 8%.
So when smaller cap stocks performed significantly worse this month, it’s no surprise that her much smaller cap ISA performed worse than my much bigger cap one. Before this month, UK large and small caps were close enough that it all averaged out, but not in this pullback.
Now, I’m not saying that large will always outperform small, not at all, just that when they diverge, my pseudo-index doesn’t index that well. I could sell out of some of her smaller cap positions to fill in some of the big cap holes (we don’t have HSBC, Shell, British American Tobacco, etc.), but a) I don’t want to pay the fees and b) none of this volatility is all that scary, especially when each individual stock is only £1,000 or so invested.
Luck (or randomness!) matters, too
Remember that I’m not making high-conviction bets on these stocks – it’s not far off darts against the FTSE 100 with some rudimentary due diligence and my own idiosyncratic ethical screen. BP vs Shell, Vodafone vs BT – not much more than a coin toss. Should average out in the end, right?
And yes, I still believe it will, but this month, the fact that I only hold 40 stocks meant I got a bit unlucky. Of the top 20 performing stocks in the FTSE 100, we only hold 4 (all in my ISA), and even the best weren’t great this month (average just under 8% up for that top 20). But we hold 6 of the 20 worst performing (5 of those in my wife’s ISA), which are down an average of almost 17%.
So again, no surprise that with our winners in my ISA and our losers in my wife’s ISA, and having fewer winners than losers, we underperformed the FTSE 100.
I’m not changing our approach on the basis of a single month – far too small a data set. And there’s no reason to think that it couldn’t have gone the other way, with us beating the index by 5 percentage points.
But it is a useful reality check that a pseudo-indexing approach does have real limits. Hopefully things that average out over time, but we can’t expect to perfectly replicate the index by only holding part of it.
Bigger picture, I’m not saying much about the volatility and pullback this month, because it’s nothing to panic about. This is the stock market being normal, at least so far – if there was no volatility, there’d be no risk premium! My handful of US fun money stock picks show the hazard in stock picking, too – yes, I own a very small amount of Gamestop, down over 50% since I bought. The pullback in these, plus some of the trendy working from home stocks, is pretty impressive, although less trendy stocks aren’t doing too badly, in the US, UK, and elsewhere.
One of my financial experiments for this year was was to use one of the lesser-known options for US citizens abroad to buy index funds – buying a non-US UCITS ETF inside a US IRA. Depending on exchange rates and my employer’s performance, I may also be within touching distance of the Roth IRA income phase out, so I’ll make this a backdoor Roth contribution for the first time.
Normally, non-US ETFs are toxic because they’re PFICs (Passive Foreign Investment Company) – an exotic-sounding instrument that just covers all non-US funds, even the most boring vanilla index funds, and results in punitive taxation and onerous filing requirements. However, within the shelter of an IRA, the main downsides of PFICs don’t apply – there’s no tax anyway, so the punitive tax doesn’t matter, and you also don’t have to deal with the headache of the tax filing typically associated with PFICs. At least, that’s how I interpret it – still not a tax lawyer!
Why bother with this when you could just use a US address to open an IRA and buy US ETFs directly? For one, not everybody has a US address they can use, and even if they do, I don’t want to rely on that forever. My main IRA remains with a big US brokerage using my parents’ address (where I lived for a decade, shows up on my credit report, etc. – strong links there, and it’s a zero income tax state), but it seems prudent to have a backup IRA where I can use my real US address.
And if you are lucky enough to have an existing broker that doesn’t mind you changing your address to the UK, they probably should restrict you from buying US ETFs, as a UK resident. Whether they do or not is a different story…
So one way through this catch-22 is buying UCITS (probably Irish) ETFs – which are perfectly accessible to UK residents – in an IRA – so the fact they’re PFICs doesn’t matter.
Now, just because this is something that’s allowed by US and UK tax and investment rules, doesn’t mean it’s in high demand. In fact, the only broker I know of that will a) allow you to open an IRA with a non-US address and b) allow you to buy UCITS ETFs within the IRA, is Interactive Brokers.1
Interactive Brokers Overview
Interactive Brokers (IBKR) is a huge, long established (since 1978) broker, but isn’t really focused on retail, buy-and-hold investors – more active traders and the like – so you may not have heard of them. But this isn’t some brand new fintech company, they’re an institution. And, they have one key feature for us: a willingness to extend their offerings to the full extent of what is permissible under the law, filling some narrow niches – like buying UCITS ETFs in an IRA.
As mentioned in my post on their ISA offering, what they are not known for is an intuitive interface or good customer service. That doesn’t mean they’re unusable – the interface is confusing but learnable, and I haven’t needed customer service yet – but just to set expectations, you will not get a polished, hand-holding experience. Not even Vanguard level.
There’s a much more detailed writeup of Interactive Brokers here – not from me, but I generally agree with the analysis.
Opening an IRA at IBKR
The account opening process is actually fairly straightforward – no different from most other financial institutions. Just click on the big link on their home page and go through the steps. One additional question will be what permissions you want for the account – margin, options, all kinds of exotic stuff can be traded through IBKR. But all we need is stocks/ETFs.
If you’re doing a backdoor Roth IRA, you’ll need to open both a Traditional and Roth IRA. If just a normal IRA contribution, open the IRA of your chosen flavor. I won’t go into the details here of the differences between Roth and Traditional, nor the pros and (minimal) cons of a backdoor Roth – I trust you know what you want, you’re following all rules on income, prorated Traditional holdings, etc., and are just trying to figure out how to do it as a US citizen living abroad.
Quick health warning – this information is current as of January 2022. Eliminating the Backdoor Roth was included in the draft Build Back Better bill in late 2021. This might still go through, eliminating the backdoor option. Worst case, it might be retroactive and require us to unwind previous backdoor contributions in 2022 – hopefully not!
Funding Your New IRA
Because an IRA is a US-specific account, it can only be funded in dollars. If you already have your IRA contribution in a US bank account, this is straightforward – just do an ACH transfer into IBKR. Easy to set up from IBKR’s Deposit page. Note that ACH deposits have a 4 business day hold time before you can trade with it, or do a Traditional to Roth conversion. There’s a 44(!) day hold before you can withdraw the money to a different account, but that’s not what we’re trying to do.
I’ve also heard of people using bill pay, sometimes being faster and with shorter hold times. However, my US bank sent a literal paper check for bill pay, which isn’t any faster. And when I tried to use our joint checking account to bill pay into my wife’s IRA, the check got rejected as “third party” – presumably because my name was on it too. So I’ll be sticking to ACH and just making sure I plan ahead.
If you don’t already have your deposit in USD, here’s a good writeup on how to use Interactive Brokers for currency conversions – it’s almost always the cheapest around, especially for the $6k you’re looking at for a full IRA contribution. This is a bit of a convoluted process to get to an IRA, since you can’t use the IRA itself for the conversion (you’ll want a separate IBKR brokerage account). High-level, the steps are:
Move GBP from your UK bank account to IBKR
Convert GBP to USD
Wait the day or 3 holding period
Withdraw USD from IBKR to your US bank account using ACH (takes another few days)
Deposit USD from your US bank account to your IBKR IRA (another few days)
Wait 4 day holding period
(convert Traditional to Roth – only if doing a backdoor Roth)
Finally buy your investment
Theoretically, you could skip steps 4 and 5 and just transfer from your IBKR brokerage account to IBKR IRA, but IBKR is notoriously fiddly about internal transfers, especially if the details on the accounts don’t match perfectly.
All told, for money that started in my UK current account until buying an ETF in my IRA, it took 20 calendar days. There were a couple of delays that might be avoided (like the whole paper check bill pay thing), but realistically it’s probably about 2 weeks minimum.
Traditional to Roth Conversion
Step 7 above can be a bit confusing to navigate, so I’ll go into a little more detail here. Nothing difficult, just the fun of the IBKR interface. This only matters for Backdoor Roth – if you’re just doing a plain Roth contribution, or a Traditional that you won’t convert to Roth, you can skip this part.
Write down the account number of the Roth IRA you want to convert into – you have to type this in later, no drop down selection.
Go to Account Settings
3. Find “IRA Conversion” on the right hand side:
4. From there, just follow the prompts. Type/paste in the account number of the Roth IRA that you wrote down earlier, then decide how much to convert (if you’re doing a backdoor, probably you want to convert everything – saves you hassle if you just do the full $6,000 all at once so you don’t repeat these steps multiple times). You shouldn’t need to do any federal withholding on the transfer, because a plain Roth IRA backdoor, without any existing Traditional IRA balance, isn’t taxable.
Investing in UCITS ETFs
Once you’ve jumped through all the hoops above, actually buying the ETF(s) is easy, just like any other trading on IBKR. There’s not a separate ETF trading area, it’s just like trading any stock. I won’t go into the details of market vs limit orders or anything like that – the options are basically the same as any other brokerage.
Picking your ETF(s) is up to you, of course. My personal criteria are below, but you may have different preferences:
I wanted something where the expense ratio wasn’t dramatically different from the US option – not wanting to pay 0.22% for an all world fund where it’s 0.08% in a US version.
Didn’t want US investments inside the ETF – no point paying 15% dividend withholding inside the Irish fund, when there’s no dividend tax actually due because it’s inside an IRA. That’s just a 15% drag on dividends for no purpose.
Traded in USD, just to keep life a little simpler and avoid having to do any currency conversions within my IRA.
Accumulating, so that I don’t have to pay for dividend reinvestment or remember to do it. Since a Roth IRA is tax advantaged in both the US and UK, no worries about reporting on the internal dividends and reinvestment – but if you’re reading this as a US citizen in a non-US country that doesn’t recognize the Roth IRA, you may want distributing to make you life easier.
Ideally a one-for-one replacement for a fund I have elsewhere in my portfolio, just to make balancing easier.
I settled on using EIMI as a substitute for the VWO I hold in my existing IRA. This ticks all the boxes:
Expenses of 0.18% compared to 0.10% – higher, but still low cost and about the smallest delta I could find.
On a $6,000 contribution, that’s $10.80 vs $6 a year, plus the $4 IBKR commission compared to $0 commission at other brokers. An extra $8.80 a year isn’t going to move the needle.
Non-US emerging markets, no worries about paying unnecessary dividend withholding tax.
Traded in USD on the London stock exchange
Very nearly a one-for-one substitute for VWO. The key difference between the two is that VWO does not include South Korea, while EIMI does.
South Korea is on the border between emerging and developed markets. The index VWO tracks (FTSE Emerging Markets All Cap China A Inclusion Index) counts South Korea as developed, the EIMI index (MSCI Emerging Markets Investable Market Index) counts it as emerging.
Since I also hold VWO’s developed ex-US sister VEA which does include South Korea, I wind up with a small Korean overweighting – not enough to stress about.
VWO also has more holdings (5,250 vs 3,001), but this is largely tiny small caps which are unlikely to make much difference. The major holdings of both funds are very similar, except for the Korean companies.
So I’ve bought $6,000 of EIMI in both my and my wife’s IBKR IRAs, and did a small rebalance away from VWO in my other IRA, for negligible net impact on the overall portfolio.
Now that I know how the process works, and know to be patient with all the steps, this is not a terribly difficult way for US citizens abroad to access good ETFs, even without a US address. Yes, it’s limited to $6k per year, assuming you’re eligible, so it hardly fixes the whole problem, but it’s a nice option to have. It also means that if my existing IRA ever decides they don’t want to deal with me, I could transfer to the IBKR one without any forced liquidations.
Personally, I haven’t decided if my 2023 IRA contribution will be with IBKR or my other brokerage, but I’m leaning towards IBKR just to keep some activity on the account.
1Maybe also Schwab International, but their website says you can only trade non-US ETFs over the phone, with a $50 transaction fee, and it’s not clear if you can do it in an IRA. Regardless, $50 transaction fees plus the hassle of calling to do them is not very attractive.
I saw on Reddit yesterday that Interactive Brokers now offers an ISA. Potentially, this could be exciting news, opening up a new ISA option for Americans in the UK. Why? Because IBKR is both a) generally very low cost and b) friendly to US citizens outside the US. I already have Roth IRAs with IBKR (will write up that experience soon), so consolidating my ISAs there could be interesting.
So I thought I’d do a quick comparison with my current broker and usual recommendation for Americans in the UK, Hargreaves Lansdown. Cutting to the chase: it’s not clear to me yet if IBKR is a better option than HL, but at least it’s good to have other options coming – competition can only help. I can’t do anything until the new UK tax year on 06Apr anyway, so will see how things develop over the coming months before making any changes.
Costs & Fees
IBKR and HL take very different approaches to their fee structures:
HL is fairly simple, but can be pretty expensive:
Dealing: £11.95 per trade, but purchases can be brought down to £1.50 using the Monthly Savings feature (also tapers down if you have 10+ trades in the previous month, but you probably want to avoid that kind of active trading)
Dividend Reinvestment: 1%, with £1 minimum and £10 maximum
Platform Fee: 0.45%, capped at £45 per year (assuming you hold individual stocks, which is your only real option as a US taxpayer to avoid PFICs)
Currency Conversion: 1% up to £5,000, tapering down to 0.25% for over £20,000
IBKR generally offers a Tiered and a Fixed fee option – Tiered is almost always cheaper, but it’s not clear to me if Tiered will be an option for ISAs
On Fixed, it’s £3/€3/3 CHF/3 USD for all trades on European exchanges up to £6,000/€6,000/10,000 CHF/$8,000. Trades bigger than that are 0.05%. For US exchanges, it’s at least $1 per trade (or $0.005 per share, if that’s higher, up to a maximum of 1% of trade value).
On Tiered, for European exchanges it’s 0.05% of the trade, minimum of £1/€1.25/1.50 CHF/$1.70. For US exchanges, it’s $0.0035 (~1/3 of 1 cent) per share, minimum $0.35, max 1% of the trade value.
Dividend Reinvestment: charged the same fees as other transactions. Automatic reinvestment is only available for US and Canadian stocks, other stocks would have to do it manually.
Platform Fee: £3 per month minimum activity fee. Either you pay at least £3 in commissions for trades, or you get charged a £3 fee (or the difference, if you have some commissions but less than £3).
Currency Conversion: 0.03% – best on the market that I know of
Withdrawals: One free per month, £7 after that – should never need to pay this if you plan ahead.
A couple of illustrations:
Buy £1,000 of a UK-listed individual stock, like part of a pseudo-indexing portfolio:
HL: £1.50 if you plan ahead using Monthly Savings
IBKR Fixed: £3
IBKR Tiered: £1 (the minimum, since 0.05% of £1,000 is less than £1)
Buy £20,000 of a US-listed stock, like if you decide Berkshire Hathaway is close enough to a diversified mutual fund that you put everything there:
HL: £11.95 dealing fee (I can’t find any US stocks on the list for Monthly Savings) plus currency conversion fee of £137.50 = total £149.45
IBKR Fixed: £20,000 buys you about 85 shares of BRK.B. At $0.005 per share, that’s less than the $1 minimum, so it’s $1. Add 0.03% currency conversion of £6 = total about £6.75
IBKR Tiered: At $0.0035 per share, this is just under the $0.35 minimum, plus the same £6 currency conversion = total about £6.26
One year of my pseudo-indexing approach of 20 UK stocks purchased in one month, assuming 40 dividend payments a year:
Dealing: 19 stocks at £1.50 using Monthly Savings, plus 1 stock at £11.95 to soak up the unused cash = £40.45
Platform: £45 a year
Dividend Reinvestment: 40 dividends x £1 each = £40 (in practice will be a bit less, since not every dividend will be big enough to buy a full share)
When you eventually sell (far in the future!), it’ll be £11.95 per stock, or maybe a bit less if you have enough transactions to move down the dealing fee table. That’s £239 future cost, although could be spread across many years of contributions.
Dealing: 20 stocks at £3 each = £60
Platform: £3 per month, one month this is covered by the dealing fees, so 11 months = £33
Dividend Reinvestment: 40 reinvestments x £3 each = £120 (also going to be less in practice like HL)
Total: = £213
Future selling fees: 20 stocks at £3 each = £60
Dealing: 20 stocks at £1 each = £20
Platform: same as Fixed = £33
Dividend Reinvestment: 40 reinvestments x £1 each = £40 (again, going to be a bit less)
Future selling fees: 20 stocks at £1 each, or maybe a bit more if the value is high enough to exceed the minimums = call it £60 for argument’s sake
In summary, for regular pseudo-indexing in UK stocks, if IBKR Tiered is an option, it’s moderately cheaper than HL (£30ish a year), while Fixed is a bit more due to the higher dealing fees. But if you want non-GBP stocks, IBKR becomes dramatically cheaper, on either Fixed or Tiered, due to the far lower currency conversion fee. Also, if you want to trade actively, instead of using Monthly Savings, the HL dealing fees skyrocket and either IBKR pricing scheme is much cheaper.
It is clear you generally wouldn’t want ISAs at both, or you get stung by both the £45 and £36 platform fees every year, so you need to pick your poison.
IBKR is known for good margin rates and options, but within an ISA they only allow:
Securities issued by Companies
Depository Receipts, American Depository Receipts and American Depository Shares
Due to PFIC and MiFiD/KID rules, that will mean it’s just individual shares for US citizens, same as Hargreaves Lansdown. No difference here that I can see.
This is one I can only describe from other people’s anecdotes, so take with a big grain of salt – I haven’t had to use customer service with either company yet.
HL has a generally good reputation for customer service, being known as a relatively high-fee, high-touch broker. It’s help documentation is generally clear and concise.
IBKR has a generally poor reputation for customer service, as a low-fee broker. They enable some very complicated things (especially outside ISAs), and expect their customers to be knowledgeable about what they’re doing. They have extensive help documentation, but it’s not always that clear. I’ve heard their phone support isn’t all that helpful.
The experience of each aligns with their customer service. HL is a slick-feeling website and app, nicely laid out, generally pretty intuitive. IBKR’s user interface feels about 20 years old, it’s not always easy to find where to go to do what you want to do, but the capabilities are all there somewhere and it’s quite efficient once you learn it.
I would not recommend IBKR for somebody who is brand new to investing, it’s intimidating at best and possibly an error trap. HL makes it easy for new investors, although US citizens need to be careful because they won’t stop you from doing things that are legal but have horrific US tax consequences.
I’ve already used up my 2021-22 ISA allowance, so I can’t do anything right now anyway. But I will be keeping an eye on any user reports on IBKR ISAs, especially to confirm if Tiered pricing is an option. If Tiered is an option, it’s certainly worth thinking about, although whether the hassle of moving existing investments is worth the modest £30 a year savings is an open question – you also buy into a tiny marginal hassle of doing manual dividend reinvestment. There doesn’t appear to be any fee with HL or IBKR for a transfer of stock, but I don’t know how much pain it will involve.
If any of you decide to open an ISA with IBKR, I’d be very interested in your experience!
Now that the London market has closed for the year, it’s time for another update on my S&S ISA experiment – no huge changes since September 2021, but good to look back on 2021 and see how it’s gone.
Very quick background – because of the PFIC limitations in holding index funds in an ISA, I’m trying a mostly “pseudo-indexing” approach in my and my wife’s ISAs, buying 40 individual stocks in the hopes of approximately matching the performance of the FTSE 100. They’re all UK listed stocks, avoiding foreign currency fees from Hargreaves Lansdown and any dividend withholding headaches from US stocks.
A couple small updates since September:
We’d already maxed out our ISA allowances for 2021-22, so no new contributions, just holding the same 40 stocks in our S&S ISAs and seeing how they do.
I changed the source of the monthly account fees (0.45%, capped at £45 a year, so £3.75 a month) from within our ISAs to newly opened taxable brokerage/general investment accounts (GIA, what HL calls a “Fund and Share Account”). This means that we keep £45 more a year within the ISA wrapper. For the moment, I just put £50 cash in the GIA, but am going to purchase £1,000 of two new stocks in each of them in January, in the hopes that the dividends will pay that £45 fee in perpetuity. This is a miniscule optimization, but there’s no downside so why not?
Honestly, aside from adding a few more months to the graphs below, there’s been very little change here since September. We’re still very close to the FTSE 100, so no complaints. Overall, if we’d put our money in a FTSE 100 ETF (CUKX), it would have grown 5.3% since we started our ISAs, which matches our actual performance (within £14, assuming equal fees).
Definitely more noise month to month, although by the end of December they’ve come together closely:
The performance of individual stocks is still all over the place, despite averaging out to something practically identical to the FTSE 100:
Is an ISA worth it?
The big question – after 9 months (a short trial in investing terms!), is an ISA worth it for a US citizen in the UK? Quick rundown of the pros and cons:
UK tax-free dividends: you’ll never pay UK tax on dividends, while in a GIA, you’d pay tax on anything above the £2,000 annual allowance. You “only” need about a £50k ISA balance before this starts to matter.
UK tax-free capital gains: you’ll never pay UK tax on capital gains, while in a GIA, you’d pay tax on anything above the £12,300 annual allowance. In practice, the allowance is generous enough that this is pretty manageable, but it could be a significant benefit for very large balances.
Deeper awareness and understanding of investing: this is a double-edged sword, but I certainly feel like I’ve learned more about investing, the companies I’m invested in, and the broader British business world. It’s also fascinating, to me, to see the vastly disparate performance of individual companies, which averages out to something more modest in an index fund. You could see this without having any skin in the game, but that certainly helps drive interest.
US taxable dividends and capital gains: compared to a GIA this is a wash, but clearly a disadvantage compared to a pension or IRA.
No indexing: this one is difficult to quantify, but there is clearly an increased risk of underperformance (or overperformance!) due to being invested in a smaller number of companies. Even just compared to the relatively small FTSE 100, that’s 2.5x more companies than the 40 in our ISAs. Compared to something like a total world ETF (Vanguard’s VT, for example), that’s 9,289 stocks compared to our 40 – not even close. So far, I feel reasonably comfortable that my performance isn’t going to dramatically diverge from the FTSE 100 in normal circumstances, but if the next Amazon/Apple/Tesla is a UK company that we haven’t bought in our ISA, there could be a much more significant divergence.
Skewed asset allocation: this is a constraint of how I have personally implemented my ISA, picking only UK stocks. This is for what I think is a good reason, avoiding currency conversion fees and dividend withholding headaches on US stocks, but it does mean that I’m overweight UK in my overall portfolio. I’m ok with a modest UK home bias, but not everyone will be. You could buy other country stocks too, but will have an even harder time mimicking a bigger index with only 20 stocks. You could buy more stocks, but the fees add up and each holding winds up tiny.
Higher fees: £45 a year for each account, plus £1.50 for regular investing, £11.95 for on-demand dealing, 1%/min £1 for dividend reinvestment – it all adds up. Managed carefully, I can keep it around £125 a year per account, but that’s a lot more than the 0.08% you might pay for an index fund for an account with a modest balance (£16 on a £20k balance at 0.08%). However, if your account value is north of about £150k, you might actually save money compared to an index fund. If you do any sort of active investing, the fees add up really fast – not recommended.
If you’re curious, that £125ish a year breaks down as:
£45 account fee
19x £1.50 for regular investing (£1,000 for 19 stocks, once a year) = £28.50
1x £11.95 for the 20th stock, using up the “leftover” cash from the other 19 (if you contribute £1,000 but the stock price is £19 a share, you get 52 shares and £12 change – add up all that change and you’ll want to buy something with it rather than sitting there at 0% interest)
40x £1 dividend reinvestment fees (2 dividends per year, per stock) – this is technically a 1% fee, min £1 and capped at £10 per reinvestment, but none of my individual holdings are nearly big enough yet to throw off more than £100 per dividend = £40.
In practice it’s slightly less because a) not all the stocks pay dividends and b) if a single dividend doesn’t reach the £10 threshold for HL to reinvest, it just stays in cash until the next dividend, so only £1 to reinvest 2 dividends.
Bookkeeping: keeping track of the purchases of 40 stocks and their dividends is more work than just buying one index fund with a few dividends a year. It’s not unmanageable, and HL’s records are pretty easy to use plus an Excel sheet, but it is a bit more work. If you were being efficient, you could probably get this down to an hour or so a year. For me, it’s now a part of my normal monthly financial updates, so a few extra minutes a month.
Deeper awareness and understanding of investing: seeing the sausage being made isn’t for everybody! If you’re the kind of person who will be upset by a 50% fall in an individual stock, and especially if you’d then be tempted to sell it, this is a real danger. Could also tempt some into stock picking and active investing – an ISA really isn’t the place for it due to the transaction fees and US tax. If you want to do active investing, a Roth IRA makes a lot more sense.
Quantifying the tax benefits
I did some quick modeling of the tax benefits. For a basic rate taxpayer, with UK dividend tax at 8.75% (from 06Apr22) and a 0% US dividend tax rate, you need to get annual dividends above the £2,000 UK dividend allowance before an ISA makes any difference – otherwise, a GIA is exactly the same from a tax perspective, and slightly lower fee (HL doesn’t charge the 0.45%/£45 account fee for a GIA). Assuming a 4% dividend yield, you have to get to a £50,000 balance before you save a penny. But get to £100,000 balance and you’re saving £175 a year on dividend tax (all UK – assuming you stay in the US 0% qualified dividends/long term capital gains rate).
The math works out similarly for a higher rate taxpayer, with UK dividend tax at 33.75% and US at 15%. Up to £50,000 at a 4% dividend yield, you’re under the UK dividend allowance, and paying US dividend tax at £300 a year – but if the money was in a GIA, you’d be paying the same US dividend tax on that, too. Above £50,000, you’d start paying UK dividend tax in a GIA, but since the UK rate is higher than the US rate, you’d have enough passive category foreign tax credits to offset all of the US tax on the dividends above £2,000 – note that you would still be paying the £300 US tax on the first £2,000 of dividends, since it’s not UK taxable. In an ISA, there’s no UK dividend tax so you’re just paying the US 15% on all the dividends. At £100k, you’re saving £375 a year on dividend tax in an ISA compared to a GIA, and it only goes up from there
Quick math: that’s £4k a year in dividends. For the GIA, first £2k is only US taxed at 15% = £300. Second £2k is UK taxed at 33.75% = £675. US tax on the second £2k is fully offset by FTCs. So total of £975 tax in a GIA. In an ISA, it’s US tax only on the full £4k of dividends at 15%, for £600, £375 less than the GIA).
In summary, if you expect your account balance to get above about £50k, an ISA will probably save you money every year on dividend taxes. Not massive amounts unless you have a big ISA balance (to save £1k a year in tax, you’d need an ISA balance of almost £200k), but if you saved £20k a year for 5 years and then stopped, over 30 years you’d pay about £49k in dividend taxes in an ISA, and £120k in a GIA with the same investments (assumes 4% dividend yield, 3% capital growth, reinvested dividends, higher rate taxpayer). The extra fees in the ISA would add up to a few thousand GBP, but you’re still well ahead of a GIA, less than half the taxes and fees.
Capital gains is tougher to model, and realistically I think most people would be able to stay under the £12,300 annual allowance by careful management with tax-loss and tax-gain harvesting, especially if also supplemented by Roth contributions or other pre-pension investments. But it’s there if you need it, and you might also be able to stay in the 0% US long term capital gains bracket, for a total of 0% on capital gains tax.
All that said, is an ISA worth it? Honestly, it’s probably marginal for most people. There are tax savings to be had, but it has risks due to reduced diversity and it does add complexity. It’s pretty clear an ISA is not worth it in these situations:
A pension/SIPP is far more tax efficient, so all your investment intended for ages after pension access age is better in a pension (at least up to the Lifetime Allowance). ISA only makes sense for money you need before 55/58/whatever.
A Roth IRA is also clearly more tax efficient, since it’s recognized by both the US and UK, and you can withdraw the contributions at any time, helping with the bridge from early retirement to pension age. There will be exceptions, but in general I would recommend maxing out a Roth IRA before touching an ISA.
If you aren’t comfortable with the additional risk and complexity that comes with individual stocks, accept the tax hit and use an index fund in a US brokerage account (assuming you can get/keep one, possibly using a US address).
If you plan on moving back to the US, an ISA probably isn’t worth the faff. You won’t care about the UK tax advantages once you move back, and there are no US advantages.
So who is an ISA good for? Assuming you’re a US citizen in the UK, of course:
You expect to be able to get above £50k-ish in your ISA in fairly short order (e.g. max the ISA for 3 years), where the UK dividend tax advantages start to matter OR
You aren’t able to get non-PFIC index funds in a GIA, so you’re forced into individual stocks anyway (for example, your brokerage enforces the MiFid rules preventing you from buying US funds and you’re unable to open a different one, unable to use a US address, etc.). If you’re going down the individual stocks pseudo-indexing route anyway, the only downside to an ISA vs something like Interactive Brokers is the higher trading fees. If you’re just doing buy-and-hold investing once a year, plus dividend reinvestments and the account fee, you can keep this close to £125 a year, which is offset by the dividend tax savings once you hit a £70k-ish balance OR
You’re an investing nerd and want to optimize every tax efficiency you can, and find watching the sausage being made interesting more than scary.
AND you don’t mind the extra bookkeeping, the pseudo-indexing reduced diversification, and potentially the impact on your asset allocation.
I’m in buckets 1, 3, and 4, so I plan to continue with my ISA investments. I’ll move cash from Premium Bonds to our ISAs in April (and rebalance with G fund bonds in my TSP, to keep overall equities vs cash+bonds allocation in balance) and invest in the same 40 companies again. Keeping to the same 40 companies also means the dividends will double, which increases the efficiency of dividend reinvesting by reducing the number of £1 reinvestment fees I pay compared to having 80 companies. For me, I’m happy with the ISA wrapper as a supplement to my core investments in my UK pension and Roth IRA, plus legacy investments in my TSP, but it’s not for everybody.
I always find the end of the year a good time for reflection, on the past year and the upcoming one. It’s a bit of a transition time for many of us – I certainly had a bit of a mad rush to the end of the year at work (which happens every year, and yet none of us have learnt how to prevent it!), and am feeling a bit of a relaxed “sighhhhh” as I sit here on Christmas Eve. So without further ado, some of my highlights of 2021 and thoughts for 2022:
Another year of not quite normal
I won’t dwell on COVID, but certainly this has not been a normal year for any of us. Starting the year in a prolonged, tapered lockdown with kids not going to school wasn’t anybody’s idea of fun, but we got through it. I started a new position at the same employer that’s permanently 100% working from home aside from (eventually) some travel, so this “temporary normal” really is becoming my “new normal,” at least from a work perspective. I’m very fortunate to have half of a summer house as my office, making it relatively easy to separate work and home, even if my commute is just a few steps out the back door and across the garden. The flexibility and lack of commute is certainly nice, although the dark side, especially in a global role, is that I have done a lot of early mornings and late nights to work with colleagues in Asia and the US. Better than hopping on a 12 hour flight just to spend a week in a conference room, at least.
I did do two quick business trips to the continent before Omicron put a stop to that. It was a strange experience actually seeing colleagues in person, including some people I’ve been working with for years but never physically met. It was nice to get out, and I am looking forward to a bit more travel next year – there’s a happy balance to be struck, I think.
On the family front, having two young kids certainly fills our days! The girls are wonderful, albeit challenging at times. The older one has adapted to COVID school life, and having a full, uninterrupted autumn term has been good for her. COVID pre-school is all the younger one has ever known, which is a bit sad but they have a good system. I wish we saw our extended family a bit more – some of that is hazards of the expat/immigrant lifestyle, but we’ve missed out on trips that would have happened otherwise, and at this point my dad hasn’t seen our younger daughter since she was about a month old, more than 3 years ago. Hopefully in 2022!
I started this blog
Some of you know that I’ve been pretty active on Reddit and Facebook groups related to investing, FIRE, Americans in the UK, and so on, and this blog grew out of an idea for an investing flowchart for Americans in the UK, due to all the special challenges we face. I couldn’t really find a place to host it, so I started with a Google Doc that eventually became the foundation of this blog, the flowchart and all the account descriptions.
I’m enjoying this medium as somewhere I can go more in depth – maybe in ways that are a bit self-indulgent, if I just get interested in something and want to explore it. But it’s my blog and I get to do what I want 🙂 That said, I appreciate all of you reading this, and very much welcome suggestions on what I should explore next, beyond the suggestions some of you already provided. I won’t guarantee I’ll get to all of them – some things I just don’t feel qualified to cover in much detail where I have no direct experience and they’re particularly complex, stuff like buy-to-lets, defined contribution pensions, estate planning beyond the basics, etc. But I’m mostly up for learning!
I did initially include some ads on here, figured I’d at least try to cover the hosting costs. But the ads I saw were all very low quality, and I made a total of 6 cents before I stopped them. I might revisit that in the future, but for the moment I’m happy to count this as an inexpensive hobby, rather than having rubbish ads cluttering up the space.
Next year, I do want to spend some time making the blog look and function a bit better. Nothing too extreme, just make it a nice experience, easy to find things, that sort of stuff. If anybody happens to know a good resource for learning how to do that, I’d appreciate the recommendation, or I’m sure I can figure it out with Google and YouTube.
Staying the course (mostly)
I’ve done LOTS of thinking about investing this year, especially on asset allocations and eventual withdrawal plans. End result is something not all that different from where I started, just with better clarity and a few small tweaks:
Decided that I will consider bonds & cash as a single asset category, starting at 21% and going up 1% a year. Adjusted my asset allocation to match, which meant a slight move into US and UK government bonds (TSP G fund and a gilt fund in my UK pension, plus pre-existing series EE bonds and cash, largely in Premium Bonds).
Within equities, I am essentially purely global market cap with a modest UK home bias. That home bias is largely driven by the ease/cheapness of having only UK stocks in my ISA. So my equity allocation winds up being market cap across all my investments except my ISA, and then some extra UK in the ISA. That feels about right – a little home bias makes some sense, and it’s practically more feasible than trying to match a global index with individual stocks
Aside from asset allocation, I’ve done my usual contributions plus started my ISAs:
Matched the maximum employer match in my UK pension (8% from them, 8% from me). This feels like the right balance for tax efficiency and ability to bridge from early retirement to pension access age. I may bump up those contributions a little next year, depending how year-end bonuses look, to try to stay out of the 63.25% tax rate, which is just horrifying!
Maxed out Roth IRAs for me and my wife
Maxed out ISAs for me and my wife, as part of the ISA experiment. A good chunk of this was a move from cash/mortgage debt, not out of income. I’ll post a separate end of year update on my ISA experiment.
Some small taxable investments, just fleshing out asset allocations to make best use of cash, bonds, & equities. Some of this was in a new Interactive Brokers account, which has also been a small, successful experiment (with more to come with a Roth IRA in UCITS ETFs early in 2022).
I also continue to allow myself up to 5% of fun money, for individual stocks, crypto, whatever. I unashamedly put a small amount into meme stocks like Gamestop and Blackberry – they’ve bounced all over the place, some are up and some down as of today. Takes care of FOMO without risking significant money. I dabble slightly with some biotech stocks too, since I’m in the industry – these have done better than the meme stocks, though nothing life-changing. All together, while I “allow” myself 5%, these add up to just under 1% today, and that’s fine. I haven’t done any crypto yet, but haven’t ruled it out, either, as part of that fun money.
In harder numbers, 2021 was good – topline net worth is up 15%, of which about 10% is new contributions from income and 90% is investment growth, for a 13.5% investment growth. That’s not entirely suitable for investment comparisons, because just under 1/3 of our net worth is tied up in the house, and I’ve only assumed a very conservative 5% increase in our house value since purchase 2.5 years ago. I tend to be conservative with house equity, especially given transaction costs and the challenges in valuing a one-off asset. But given where we are, in the countryside but commutable to London, it’s easy to imagine a much higher appreciation.
So for better comparison, if I exclude home equity and only look at equities and bonds+cash, I get:
All World Equity Tracker (VWRP)
FTSE 100 (CUKX)
S&P 500 (VUSA)
All using accumulation funds to include reinvested dividends
That all sounds pretty consistent – VWRP beat me due to being 100% equities compared to my 79/21 split, but I’m a bit higher than LifeStrategy 80 because I don’t have as large a UK bias as they do, and the UK underperformed the US. Obviously this year would have been a great year to be 100% US large cap growth (up 30%+), but hindsight is 20/20 🙂
I do see a lot of people advocating stuff like that: 100% equities, all in the S&P 500 or Nasdaq, maybe with some margin, options, tilts to tech, and so on. That scares me a bit, and makes me worry we may finally be nearing the top of this long bull market, but I could also see it running for a few more years.
My Boglehead side says “stay the course” and “buy the haystack”
My Buffet/value investing side says “be fearful when others are greedy” and “only when the tide goes out do you discover who’s been swimming naked”
I’m sticking with my mostly market cap based approach, but buying more modestly priced UK equities in my ISA doesn’t feel bad, either, and keeping my strong 40%ish ex-US position is also comforting. And if things do go down and equities fall under their rebalancing thresholds, I’ve got plenty in bonds+cash to rebalance into cheaper equities.
How close is FIRE?
That growth and ongoing contributions puts us at about 64% to our FIRE number – that’s paying off our current house and 25x annual expenses (4% safe withdrawal rate). I do track our spending vs a general budget – there’s not really active work to stay within a specific budget at this point, more to observe and have confidence that our FIRE spending plan is realistic. We’re within £1,000 of our annual expected spending, depending how this last week of the year works out, so that still feels right, but will definitely keep an eye on our spending given the recent inflation numbers.
At the beginning of the year, we were 55% to FI, so 8% improvement is very good! If we could keep up 8% closer every year, we’d hit our FIRE number by 2026, well ahead of plan (more conservative projections show 2032, and my real goal is financially FIRE-ready by 2036 when the younger one turns 18). If we were to actually hit our number a decade earlier, that’d obviously be great and we would need to rethink some things (in a good way!), but I will also be pretty surprised if we don’t have some kind of a bear market in the next 5 years, or even just flat for a while.
Looking back, we were at 45% to our current FI number when we moved to the UK in 2018. I was worried how the significant pay cut would impact our FIRE path, but the pretty tremendous performance by the markets has more than offset that, and a few lucky opportunities at work have pushed our savings rate to be not too far off where it was in the US. And the impact on quality of life has been very positive, so definitely a net win.
I set up the projection below back in August 2020, using a 5% real growth rate along with my then-current pension contribution rate. It’s not showing % to FI, but % to my liquid net worth goal – as if I paid off my mortgage today, how much more would I need to hit my FIRE number. While the pension contribution rate has gone up slightly, the big difference between the plan and the actual has been investment growth:
Net worth isn’t quite so dramatic, since it goes back so much further, but telling the same story:
Goals for 2022
A few things I’d like to do for 2022:
Financially, stay the course. Keep going on pension contributions, max out ISAs and IRAs again, and maybe some small taxable investments. The approach has worked very well so far (the last 14 years or so), and there’s no reason to change. Even knowing how highly valued the stock market is today, especially in the US, I have faith in my diversified allocation over the long term.
Personally, I want to keep working on my work/life balance. This year has been a bit of extremes – when I first started the new role, I had plenty of “life” time. But the second half of the year really ramped up, and “work” took up too much. There’s a happy middle there, and I’d like to spend more time in that middle. I am starting another new position next year, taking over from somebody who is retiring. He’s a bit of a workaholic, so that’s something I want to change for myself and for the people in my new team.
And I’d like to make sure to take time and attention to my own fitness. I’m heavier than I’d like to be and don’t get the exercise I should. It’s just a matter of making time for it and being a bit more attentive – not looking to make a drastic lifestyle change, but nudges in the right direction that work over time – just like in investing.
Aside from cleaning up the design and layout, I don’t have any major goals for this blog. I write because I enjoy it and want to help other people in similar situation. I’m happy to reach as many people as I can, but realistically, there’s something in the neighborhood of 200,000 Americans in the UK, and only some fraction of them are going to be interested in this stuff, plus a chunk more interested in moving here. Optimistically, that’s maybe a few thousand interested readers – I appreciate all of you, but I’m also not going to be turning this into a business, so I’ll do what is fun for me 🙂
How has your 2021 been? Where do you want to focus in 2022?
And of course, thank you for reading this year, and I wish you all a happy Christmas and a brilliant New Year! I hope you all enjoy some time with your families and have a chance for some relaxation and reflection.
Edit 06Dec21: I realized that this is all completely wrong! You can get the same effect, without paying National Insurance, by just putting part of the money to the pension, then taking the 62% hit on the take home cash for an ISA.
For example, for £1,000 of pre-tax income, put £475 in your salary sacrifice pension. Pay 62% tax on the £525 remaining, for a take home of £199.50 – then put that in your ISA. That’s £674.50 invested and £325.50 in tax – 32.55% effective tax rate, better than the 33.5% if you use a SIPP. In retirement, that’s £199.50 you can access anytime and £403.75 (after 15% tax) from your pension, total of £603.25, for a 39.675% effective tax rate.
I’ll leave up the original, because the overall analysis of pension vs ISA is still valid – all the numbers just tilt slightly lower the pension you use because you save NI. But avoid all the hassle of a SIPP and just salary sacrifice. Sorry!
Original Post: This will be a fairly nerdy post that only applies to a small niche – fair warning! But if you’re interested in early retirement, the personal allowance taper, and/or the lifetime allowance, it might be interesting. I’ll also note this applies just as much to non-US citizens, nothing US specific here, it’s all UK rules.
Three common topics come up in UK FIRE circles:
How to “bridge” from early retirement to the age where you can access a workplace pension and/or SIPP (currently 55, changing to 57, may well go up more in the coming decades).
For readers familiar with this discussion in US FIRE circles, the UK situation is complicated by the fact that there is realistically no way of accessing a pension early, barring terminal illness (which kind of defeats the point…). This contrasts with Roth ladders, 72(t) SEPP, etc. for the US. But at least ISAs have no age limit at all!
How to avoid the 62% tax trap between £100k and £125,140
That’s 40% income tax, 2% National Insurance (rising to 3.25% next year, for a 63.25% marginal rate), and the Personal Allowance reduction of £1 for every £2 of adjusted net income over £100k, such that the £12,570 allowance drops to zero at £125,140 income.
In simplified terms, Adjusted Net Income is your total taxable income (wages, interest, dividends, self-employment profits, some benefits, some rental income, etc.), minus pension contributions and gift aid donations.
How to avoid exceeding Lifetime Allowance (LTA) and paying the 25% penalty on a total pension value exceeding £1,073,100.
As a general rule, it is more tax efficient to make pension contributions than ISA contributions, due to the relief of income tax on pension contributions, plus the NI relief if it’s a salary sacrifice pension. Nothing I’m going to say changes that – the best way to keep as much of your money as possible is to salary sacrifice it into a pension – and you should always* take advantage of any employer match. That’s even more true at the 62% marginal rate – you can either put £1 in a pension or take 32p home and stick it in an ISA (or a taxable General Investment Account, GIA).
However, if you’re concerned about building an early retirement “bridge” and/or about exceeding the LTA, you want to think about how to manage both pension and ISA/GIA contributions to meet those objectives – basically, how to reduce pension contributions but not let HMRC take too much of your money.
*Somebody will find an edge case where you are better off without an employer match, but it’s extremely rare.
When you salary sacrifice into a workplace pension, 100% of your sacrifice goes into the pension. £100 sacrificed = £100 in your pension, no tax withheld.
But when you contribute after-tax dollars to a SIPP as a higher or additional rate taxpayer, the situation is a little funky:
Your pension provider provides the first 20% of tax relief to you directly in the SIPP, increasing your contribution by 25% (20% tax on £125 is £100, so if you contribute £100, they’ll top up to £125)
To get the remaining tax relief – which could be another 40% if you’re a higher rate taxpayer in the Personal Allowance phase out – you need to ask HMRC, typically via a Self Assessment (if you’re not otherwise required to file a Self Assessment, you can just contact them for the refund – you’d have to get your net adjusted income completely under £100k, since that’s one of the triggers for filing a Self Assessment).
When you get the tax relief back from HMRC, it’s cash – not deposited to your SIPP, just real money in your current account. You could choose to put that cash in your pension (and then get more tax relief next year, since money is fungible and that cash could effectively come from after-tax income), or you could put it in an ISA or GIA. This cash is the key difference between a SIPP and workplace pension, for our purposes today.
Also worth noting that salary sacrifice saves you NI, while a SIPP doesn’t allow you to claim the NI back. Only 2% (to 3.25%) for higher and additional rate taxpayers, but it’s money that’s gone for good.
Splitting After Tax Cash to SIPP & ISA
Given what we know about getting cash tax relief on a SIPP, this opens an interesting possibility. Let’s compare three scenarios – we’ll assume your adjusted net income is within the Personal Allowance phase out, none of this makes much sense in any other bracket. For a simple example, this is all wage income and your wages minus any existing salary sacrifice pension contributions brings you in the £100k to ~£125k range:
Salary Sacrifice: you sacrifice an additional £1,000 to your pension, resulting in £1,000 pension balance. In retirement, this will be taxed – let’s say a 20% tax on the 75% taxable portion, resulting in a final value of £850 (ignoring investment growth and inflation – we’ll take those as constants for all three scenarios). 15% effective tax rate.
ISA only: your £1,000 of taxable pay becomes £380 of take home cash. You contribute all £380 to an ISA. The ISA is tax free forever, so that’s £380 in retirement – less than half of what that £1,000 would be worth in a pension, but you can access it whenever you want. 62% effective tax rate.
Reminder for US citizens: ISAs are not US tax advantaged and you should not hold PFICs in them! Individual stocks only.
SIPP + ISA: take that £380 take home cash and contribute it to a SIPP. Your pension provider adds 20% tax relief, so you have £475 in your SIPP. When you file your UK taxes, you claim back the remaining 40% of tax relief (20% from your 40% higher rate band, and 20% from the Personal Allowance phase out) – that’s £190 cash. You then contribute that £190 cash to an ISA. In retirement, that’s £190 you can access anytime and £403.75 (after 15% tax) from your SIPP, total of £593.75, for a 40.625% effective tax rate (33.5% at contribution)
33% tax today plus more on pension withdrawals for a total of 40.625% isn’t great, but it’s very nearly the same 42% you pay on income under £100k, without the Personal Allowance taper. So splitting between a SIPP and ISA gets you in the same tax position as using after-tax cash in the 42% bracket completely for an ISA, but with the drawback of locking about 2/3 of it away until pension age.
A Spectrum of Options
Scenario 3 above uses all of your cash for a SIPP and then an ISA, but you don’t have to. If you want more in the ISA, you contribute less than the £380 per £1,000 to the SIPP, and put the balance in your ISA. Equally, you can save more tax by putting more than £380 in your SIPP – you’ll have to effectively borrow from yourself until you get your refund from HMRC.
You can pick any option, from 0% SIPP and 100% ISA, to 100% SIPP and -2% ISA (since you still have to pay NI, you could withdraw cash to do that – although at that point you should just salary sacrifice and save the NI).
I tried a couple ways to visualize this – the first comparing the three places that £1,000 can go: tax, SIPP, and ISA. X-axis is the amount contributed to the SIPP, from £0 (everything to tax and ISA) up to £800 (above £800 and you’re basically just taking cash/ISA to pay income tax – go for salary sacrifice at that point). Y-axis is the value in each account: SIPP, ISA, and tax (so in the Government’s account, not yours!):
There are no kinks or inflection points – the more you put in your SIPP, the less you pay in tax, and the less you can access early.
The other way to look at it is how your total investment changes depending how much you contribute to your SIPP:
Again, no kinks or inflections – the more you put in your SIPP, the more you have invested (because the less you pay in tax).
I’ll paste the same charts at the end, but with 15% tax on the SIPP balance – it doesn’t change the conclusion at all.
I’ll reiterate that the best way to reduce taxes is via salary sacrifice to a pension. That said, hopefully this shows that there is a middle ground blending a SIPP and ISA to reduce taxes to a fairly reasonable level while also making some money accessible early, and reducing the impact of the Lifetime Allowance.
I’m in the very fortunate position that, if my employer’s year-end results are good, my annual bonus will probably just push me into the 62% bracket. I will wait to see how far into the bracket I go, but I’m definitely considering the SIPP + ISA option. What do you think, is this something that might be useful to you?
Assumptions & Clarifications
Didn’t want to clutter up the body of the post, but for the especially nerdy, there are some assumptions above that might matter for specific situations, and a few nuances I deliberately ignored:
I’ve assumed that SIPPs are an appropriate investment for a US citizen in the UK (although everything above would also apply equally to a non-US citizen). That means it’s treated as a “pension” per the treaty and you can effectively invest in it (the “pension” designation protects any PFICs). Whether or not you need to file form 3520/3520A doesn’t affect the analysis, although it’s a pain if you decide it is required.
Employer match is already maxed out and you don’t get any payment for the employer portion of NI. If you haven’t already maxed your employer match, obviously do that first. If your employer contributes some of their NI, that would push the balance towards the salary sacrifice pension.
Real returns are the same in a pension or ISA – given the restrictions on US citizens investing in ISAs, this is a big assumption. The analysis would still hold completely true if you used a Roth IRA (with some restrictions on early access), and mostly true if you used a taxable brokerage account as long as you manage capital gains and dividend taxes (both US and UK taxes involved).
You’ve still got room in your ISA to contribute. If ISA is maxed, then Roth IRA or taxable GIA as above.
20% income tax on SIPP withdrawals is a rough assumption. It assumes no Personal Allowance (it’s all used by State Pension, Social Security, or other income – likely to be roughly true) and that your income doesn’t push you into the 40% bracket.
Assumed you’re still staying under the £40k pension annual allowance, combined for all SIPP and salary sacrifice pension contributions.
Instead of having a refund of the remaining 40% pension relief from HMRC, you could get the refund one year and then adjust your tax code so you get the cash spread through the year, and could do ISA contributions earlier. That’s mathematically better (time in the market and all that), but more complicated if your income isn’t stable, you’ve got significant variability in bonuses, paid on commission, that kind of thing.
Charts & Data
Account balances, assuming 15% tax on the SIPP in retirement:
Total investment, also with 15% SIPP tax
And if anybody wants the spreadsheet data (easier to pick out individual values), I’ve made a copy in this Google Sheet.
Hi everybody – sorry it’s been a while, life gets in the way! Nothing bad, just been busy with family and work and nothing has really drawn me in for a full post. So I thought I’d post a few thoughts on two topics today, and some thoughts on upcoming posts.
Inflation & Investing
Most of the talk on the various finance communities I frequent seems to be some variation on “what to do with such high inflation?!?” Lots of variations on a theme: how to protect my investment from inflation, should I buy bonds with such high inflation and low yields, what should I do about an emergency fund so I don’t lose money to inflation, and so on. My thoughts:
First, calm down, inflation isn’t that high, when you compare to history or to other economies. 4.2% in the UK, 6.2% in the US – yes, these are big numbers when we’re used to 2% or so, but it’s a long, long way from hyperinflation. Nobody is trucking around dollars or sterling in wheelbarrows!
But, interest rates are also extremely low, when usually you can get a risk-free return that matches or beats inflation. The last time inflation was above 5%, in 1990, 10 year treasuries were above 8% yield – today, they’re at 1.375%. Quick graph of 10 year treasuries vs annual US inflation – the UK data I have isn’t as clean, but it’s a similar trend:
So, what to do about it? Realistically, is there anything you can and should do, now that inflation is actually here? A few of the more commonly recommend approaches include:
Inflation-indexed bonds/gilts are designed for to mitigate against inflation, but their yields, aside from the inflation adjustment, are practically (sometimes literally) 0%. And any bonds traded openly are subject to interest rate risk if rates rise from their current very low levels. I don’t have a crystal ball to say when or how much rates will rise, but rising inflation feels like it increases the risk of rises in the near future, and we’re seeing the market price that in with mortgage rates coming off their record lows. Plus, inflation is already here, so the higher inflation linked adjustments are priced in – I don’t see these as especially attractive, except maybe as a portion of your overall bond allocation.
US I bonds take away the interest rate risk, since they aren’t openly traded, only bought and sold to the US government. And the current rates of 7%+ (all of that being inflation adjustment) are clearly attractive, although that’s only guaranteed for 6 months before the inflation adjustment changes, and you’re stuck with the 0% coupon rate. The 1 year lockup, 5 year penalty on interest, and $10k annual limit don’t help, either, and as UK spenders we take on currency risk with USD investments. I think there’s a place for these, but given the limits they’re hardly a panacea for an inflationary environment.
Some people are recommending crypto as a store of value in an inflationary environment. Not sure I buy that crypto won’t be impacted by inflation (no historical data), but I do know the day to day fluctuations in crypto prices make me hesitant to use crypto as a safe store of value even if those fluctuations aren’t linked to inflation. I don’t want my “safe” money bouncing around that much! Crypto as a long-term investment is a topic for a different day…
For me, this is the time to stay the course. If you trust your overall asset allocation and investment policy statement, it’s designed to handle anything life can throw at it, within the foreseeable possibilities. I’m still at my 79% equities, 21% bonds+cash allocation with no intention of changing, except bumping to 78/22 next year as planned. Changing your plans just because people and the media are making a lot of noise is a good way to chase performance and lose out overall.
Within the bonds+cash allocation, it always makes sense to move money to the best combination of yield, access, and risk – leaving all your cash in a 0.01% high street bank account isn’t a good idea in any environment! Same if you have a dedicated emergency fund, at least get the best rate you can (probably the 1% prize rate on Premium Bonds, as of today, unless you can lock some of it up for a fix). If you wanted some of your emergency fund in I bonds, that seems reasonable, too.
S&S ISA Experiment Update
I haven’t done a proper update in a few months, mostly because the experiment is going well. I’m within a percent or so of the FTSE 100 – sometimes ahead, sometimes behind, but close. Individual investments are all over the place, with the best (M&S) up 61% and the worst (IAG, owner of British Airways) down 23%. Not through any investing acumen on my part, just my almost-random approach to a DIY index.
I’ll do a bigger update, probably at the end of the year, but so far I call the experiment a success and plan to continue my ISA contributions next UK tax year.
Upcoming Topics – Suggestions?
I keep a running list of topics I’d like to explore – some of the ones that I expect to come up in the next few months are listed below. But I’m eager to hear from you – what would you like to read? More diving into the details of IRS and HMRC publications, tax treaties, and the like? Modeling and projection? My own financial story and approach?
Some topics I might tackle in the next few months include:
Expanded US Child Tax Credit and what it means for Americans in the UK – they’ve made it a bit complicated this year…
Comparison of US tax filing tools – I’ve used TurboTax previously, just started playing around with TaxAct and I’m impressed so far. Any others you think I should try?
Breakdown of my 2021 taxes – I expect 2021 to be a reasonably typical year, might be a good example of what a US tax return looks like for an American in the UK
2021 year in review – it’s been a good year from a personal finance perspective, at least!
Tools for tracking investments and FIRE in two countries, two currencies – at least the approach that works for me
Impact of Biden’s Build Back Better Bill on Americans in the UK, once/if it’s actually passed…
What else should I take a look at? Thanks for reading!
In my recent post on my approach to bonds and cash, I mentioned that I don’t have any dedicated emergency fund at all. I know this flies in the face of conventional personal finance wisdom, but I think I’ve got a pretty sound justification. My personal approach is not quite so aggressive as somebody like Early Retirement Now, with a 100% equity portfolio and emergencies funded through a combination of credit card float, cashflow, home equity line of credit, and a worst case equity sale. It’s not that I disagree with ERN’s logic, and I fully believe that his approach is mathematically the highest return one, but my risk appetite is a bit lower – that’s just what helps me sleep at night.
Over the years, I’ve gone through three distinct phases of emergency funds – while these might not be for everybody, I think they’re a reasonable framework for thinking about an emergency fund as you mature in your finances.
Phase 0: Crisis Finance
I’m cheating with Phase 0 because I’m in the very fortunate position that I never really went through it myself. This is where you’re living paycheck to paycheck and frequently not having enough at the end of the month, dipping into payday loans, borrowing from friends, racking up credit card debt, and the like.
In this situation, it totally makes sense to me to have a small emergency fund (few hundred £ maybe) just to smooth out the inevitable bumps in life. Clearly the main focus here is getting out of the paycheck to paycheck cycle!
Phase 1 : Dedicated Emergency Fund
This is where I was basically from leaving home through most of my 20s, and lines up with conventional personal finance advice. I was starting to invest, but most of those investments were locked away in my TSP (military 401k), not much I could call on in an emergency. So, I had a dedicated high-yield savings account I considered my “emergency fund.”
You’d want to tailor how much is in this fund to your own situation – I had a very secure job for most of this time (the Navy tends not to fire people on short notice) that also came with very good healthcare, plus relatively low fixed expenses (I was single, renting, no major loans), so this didn’t need to be a ton of money, maybe a few months of expenses. I can’t really recall having to dip into it for anything big, maybe some car repairs, but it gave me piece of mind.
Of course, if you have large fixed expenses, a “flexible” (aka unreliable) job, and/or health issues (for those readers in the US – not as much as concern if you’re in the UK with the NHS), then that argues for a substantially larger pot.
I grew out of this phase from a combination of three factors:
Got out of the military and into a good job, but it wasn’t rock-solid like the Navy
Bought a house, got married, had kids – bigger fixed expenses and less ability to tighten my belt
Steadily growing net worth, including starting to have more money in easily accessible investments through a taxable brokerage account
Phase 2: Discrete Savings Pots
All those things happened around the same time – I don’t think any one of them alone pushed me into this next phase, and it’s kind of a fuzzy line. But I started realizing that my “emergency fund” was doing two very different things:
Insuring us against a major emergency – protracted job loss being the most likely, major health spending the other primary possibility (still in the US at this point, although my insurance was pretty decent).
Smoothing out irregular expenses – some of this was lumpy within a year (oil-fired heating costs a lot in the winter, car insurance paid annually, that kind of thing), and some spread over multiple years (boilers, hot water heaters, roofs, appliances, cars – all eventually need replacing and maybe irregular repairs).
Bucket #2 isn’t really an emergency, since these are things that we know will happen, even if we don’t know exactly when or how much. At this point, I had some guesstimates on what this spending looked like, and set up buckets to build up incrementally every month. For example, $250 a month to utilities, but in the summer it’s more like $100 and winter more like $400 actual spend, so the account grew in summer and shrank in winter, aiming to be just a bit above $0 come the warmth in spring. At the time, these were actual separate bank accounts, although all at my main bank. Eventually they just became lines on a spreadsheet, mostly due to moving to the UK and not wanting to deal with so many actual accounts – you could do the same thing with “pots” in Monzo, Starling, etc.
Bucket #1 was still a “real” emergency fund, but as my investments grew, I started to get comfortable with some of that fund being invested. Given my experience and the Boston area job market, I wasn’t expecting to be out of work for long, even if I was laid off or my company folded, so I was pretty ok having maybe three months of expenses in cash, and the rest accessible from a taxable brokerage account. I was doing a gut feel calculation, not too much math behind it, but figured the expected returns were worth the potential risk of having to sell in a downturn. Everybody will make a different call on this, and that’s ok!
That risk panned out for me – whether that’s luck or just good risk management, I’ll leave to you. But this was around 2015, so with reinvested dividends that money has nearly tripled since then!
I kept this approach for a good 6 years or so, until very recently. There’s no time limit on it, and I think the transition to the next phase is more emotional than quantitative.
Phase 3: Consolidated Cash & Bonds
As part of my recent thinking on asset allocation and the role of cash+bonds in my portfolio, I realized that my dedicated “emergency fund” served no real purpose. I’d actually been slowly reducing that line on the spreadsheet anyway, because my other short-term cash savings were high enough that it seemed silly to keep so much cash, but that wasn’t entirely a deliberate decision, more just gut feel.
Now, I actually have a logical basis:
My cash+bonds allocation, at 21%, is already about 2.5 years of normal budgeted spending, more than any emergency worth planning for. In a real emergency, we’d cut spending back to push that well past 3 years.
There are “black swan” kind of events this won’t cover – if my wife and I both get injured and can never work again, say. But no emergency fund can practically insure against that – you only insure against never working again by fully achieving financial independence, and we aren’t quite there yet.
My cash+bonds allocation is very safe, with extremely limited volatility
Mine is safer than a conventional bonds approach, with it being primarily the TSP G fund, Series EE bonds, and Premium Bonds – issued and guaranteed by the US and UK governments, with no chance of loss of capital.
But even if you were in 100% BND or similar, take a look at the chart and see how big the biggest drops are – absolutely tiny compared to stocks. Something like a 7% drop during the COVID drop in 2020, compared to an almost 50% drop in a US total market fund.
I have good control over the non-emergency lumpy expenses. Practically, they largely come out of cashflow (via credit card float), although I’m still tracking my buckets on a spreadsheet, more for budget measurement than any sort of real concern over emergencies. They’re pretty theoretical buckets within the cash part of the bond+cash allocation, but I find them helpful to see if my budget stays realistic – since my current budget is also my expected retirement budget, it’s important that I know how much I’m spending.
I have ample credit available. I’ve never needed to use it (pay off your credit cards in full every month!), but I’ve got 6+ months of normal budgeted spending available on my credit cards. Sure, not everything can go on a credit card, but combine that with the cash+bonds allocation and tightening our belts and we get to something approaching 4 years of spending before needing to touch equities.
Put that all together, and I don’t see a point in having another pot of cash labelled as an “emergency fund” anymore – that would really just tilt my asset allocation more towards bonds+cash for the purposes of semantics.
Special Considerations for Americans in the UK
Pretty much everything I said above applies whether you live in the US, UK, or almost anywhere else – only caveat being around health care expenses as a very plausible emergency in the US, but a much smaller financial impact in the UK.
A few caveats specific to Americans in the UK, though:
Currency risk is real, so take that into account when deciding where to put your emergency fund, if you have one, or your cash+bonds allocation.
It’s safest if your emergency fund is in the currency where most of your expenses are – probably GBP for most of us in the UK.
For the past few decades, the pound has mostly fallen relative to the dollar, so you’d actually make out to your advantage if, for example, you’d had your emergency fund in USD just before the Brexit vote dropped the value of the pound from about $1.60 to $1.20.
There’s no reason to think that trend has to continue though – you could easily have the pound appreciate just as your emergency happens. If that same situation were reversed and the pound climbed from $1.20 to $1.60, your USD-denominated emergency fund has dropped, in GBP terms, by a quarter. Your 6 month fund now only covers 4.5 months!
Personally, if I was still in the Phase 1 or maybe Phase 2 mode, I would have my dedicated emergency fund in GBP only – it’s entire purpose is to help me sleep at night, and exposing that fund to currency risk just gives you another thing to worry about. In Phase 2, if you’re starting to expose some of your e-fund to market risk, maybe it’s ok to also add some currency risk – just be aware of how much risk you’ve added!
In my current situation, I’m not worried that about a third of my cash+bonds allocation is in USD. Even the remaining two-thirds is still a healthy cushion, if a major currency swing were to coincide with my emergency.
Taxes are still inevitably complicated, although it’s not too bad for most of the kinds of accounts you’ll use for an emergency fund
Big picture, the UK and US both tax interest from savings accounts or bonds as income, so you’ll be taxed at whatever your marginal income tax rate is (20, 40, 60, or 45% in the UK; 10, 12, 22, 24, 32, 35, or 37% in the US). The UK has a pretty generous personal savings allowance, at £1,000 (basic rate), £500 (higher rate), phasing out at the additional 45% tax rate. So if you’re under that UK PSA, you may well owe a bit to the US if you don’t have other passive category foreign tax credits to offset it, or if you’re using the Foreign Earned Income Exclusion (since this isn’t earned income, the FEIE doesn’t help).
Realistically, you’re not going to make that much interest on an emergency fund today. Even a quite big e-fund – say £6,000 monthly spending and you want 12 months of spending, so £72,000 – is making you something like £720 a year at 1%, maybe £1,080 at 1.5%. Even at the highest tax brackets, that’s not a huge impact on your finances, but I know we’d all prefer to pay as little as legally feasible to HMRC & the IRS.
A few ways of cutting back on the tax:
If you’re above the PSA, you can avoid UK tax by using Premium Bonds or an ISA (Cash ISA or hold bonds/fixed income/etc. in a S&S ISA). You’ll still be subject to US tax, though.
You could also hold bonds/fixed income/money market/etc. in an IRA. Most practically this would be a Roth IRA, so that you can withdraw the contributions any time without penalty, although you can also use the “money is fungible” principle and sell equities in a taxable account to generate cash for spending and then sell the bonds/whatever to buy equities in an IRA – you’ve effectively taken the cash out of the IRA, just with a bit more shuffling around.
US Series I and Series EE bonds give you the option of deferring US tax until the bonds mature or you cash them out, or you can pay tax on an annual accrual basis. UK gilts work similarly at first glance, although they’re not one I’ve dug into deeply.
I don’t know for sure how the other country respects the deferment vs accrual option for bonds from the first country. For my Series EE bonds, I use the accrual basis for both my US and UK taxes, because trying to do them differently might make my head explode! (bad enough I do the accrual for two different tax calendars…). That’s one I can’t guarantee I’m doing right, but the interest is small enough I’m not going to sweat it – worst case, I’m paying HMRC slightly more and quite a few years earlier than they’d get paid otherwise.