Roth IRA vs Stocks & Shares ISA: What’s the Difference?


In the UK, the government allowed us to invest tax free through what is known as an Individual Savings Account or ISA for short. Over in the United States, the closest equivalent is a Roth IRA. Both allow people to invest in the stock market tax free up to a certain amount.

Both accounts were created as an incentive to save, as earnings made from interest are tax free. They are not saving accounts, they are investment accounts, so capital may be at risk. But investing through these vehicles can build wealth quicker than regular bank/retirement accounts.

You might think of a Roth IRA as a retirement account, and you’d be right. But what a lot of people don’t realise, because your contributions are post tax, you can withdraw your earnings made after your initial investment tax free. This is the same for a Stocks & Shares ISA.

So if you invest $10,000 into your Roth IRA and leave it for 5 years. Your balance could become $40,000. You would then be able to withdraw the $10,000 initial capital. Leaving your $30,000 of earnings to start making more money.

Stocks & Shares ISA vs Roth IRA 950x950

Investing in a Stocks & Shares ISA

The UK Government has allowed residence to invest up to £20,000 per year into what is know as an Individual Savings Account. With a stocks and shares ISA, people are putting their money in the hands of the bank, with the hope of beating inflation through strategic investment plans.

You can manage your own ISA if you wish but many of the high street banks offer this service for a minor fee.

With a stocks and share ISA you can invest in these vehicles:

  • Unit Trusts
  • Company Shares
  • Investment Trusts
  • Exchange Traded Funds
  • Mutual Funds
  • REIT’s
  • Index Funds
  • Bonds & Bond Funds

Along with the added protection of the ISA, the earnings you make each year are tax free, and can be withdrawn from your account usually without penalty.

How do Stocks & Shares ISA’s Work?

Like I said, you can let the bank or brokerage do all the work, or you can dive in a give it a go yourself.

The easy way is… You put regular monthly amounts in to your ISA account making sure not to exceed the £20,000 yearly limit, then you sit back and watch the money grow. This will be done through your bank, or an investment app like Wealthify.

The slightly harder way is… Go to somewhere like Trading 212, eToro or Moneybox, open an ISA account, then start to invest on your own.

ISA accounts work in the same way any other investment account does, except, you can only invest a certain amount each year.

Who Should Invest in a Stocks & Shares ISA?

Most people should consider investing in some sort of ISA account, if not a stocks and shares, maybe a cash or lifetime ISA. They are passive and easy to manage, but most importantly, they get people thinking about saving for the future.

I think, the younger you are the more open you should be to risk. Wealthify offer ISA portfolios in these 5 ranges (based on the 2019 figures, Wealthify boasted these returns on stocks and shares ISA accounts):

  • Cautious = 6.43%
  • Tentative = 9.37%
  • Confident = 11.96%
  • Ambitious = 14.75%
  • Adventurous = 17.14%

Now, you can’t expect these returns every year, especially with the current volatility in the 2020 market. However you can see the passive ISA option can yield some high gains.

So a young person may feel more comfortable investing in an Adventurous ISA account, whereas someone looking to save for retirement might look more towards a Tentative approach.

Investing in a Roth IRA

The US equivalent to the stocks and shares ISA is the Roth IRA. Very similar in the way it works, you put your savings into this investment account, and the earnings become tax free income during your retirement.

Retirement accounts you are meant to keep the money safe until you reach a certain age. But when hard times hit you need the money now.

With a Traditional IRA withdrawals made before the age of 59+1/2 come with a tax bill from the IRS and a 10% early withdrawal fee. You can avoid this by investing in a Roth IRA. As long as you do not touch your earnings, and only withdraw your initial capital, you will have no tax to pay, and no early withdrawal penalty.

What separates the Roth IRA from the stocks and shares ISA is eligibility. Unless you can do some fancy footwork with an existing IRA, if your annual income is more than $118,000 you cannot open a Roth IRA directly.

You can see if you’re eligible to open a Roth IRA by seeing which box you fit in on this table:


Filing Status
Modified Annual Gross IncomeYou Can Contribute
Married or Filing Jointly< $196,000Up to $6,000 for people under 50
Married or Filing Jointly$196,000 <…< $206,000A reduced amount calculated upon registration
Married or Filing Jointly$206,000 <You cannot contribute to a Roth IRA
Single, Head of Household, or Married Filing Separately< $124,000Up to the $6,000 limit
Single, Head of Household, or Married Filing Separately$124,000 <…< $139,000A reduced amount
Single, Head of Household, or Married Filing Separately$139,000 <You cannot contribute to a Roth IRA
Figures correct as of 2020

We try to keep this data correct and up to date, but for the latest contribution figures you should consult with a financial advisor or check out the IRS Website.

The one loop hole you can’t get round when it comes to Roth IRA’s is… You need to be a US Citizen with a US address and social security number.

Find out if you should open a Roth IRA account!

How do Roth IRA’s Work?

The best way to understand how a Roth IRA works is to look at the concept of delayed gratification. If you invest in a 401K it is instant gratification because you are able to use this as a tax write off. However you have to pay the tax when you retire.

With a Roth IRA you will get delayed gratification. By investing your savings or post tax income, you will not receive the instant tax write off. But later in life, when you begin to withdraw money from your Roth IRA, it will be tax and penalty free.

Just like a retirement account, you will contribute regular amounts and manage your investment, the easiest way to do this is through an online advisor like M1 Finance or Betterment.

Those contributions will go into your fund and invested across a mix of the following:

  • ETF’s
  • Bond Mutual Funds
  • Individual Stocks
  • Certificate of Deposits
  • REIT’s
  • Precious Metals and other Commodities

Who Should Invest in a Roth IRA?

As I’ve mentioned, Roth IRA’s have certain requirements you must fill to become eligible to open one.

Most people who are eligible should consider opening a Roth IRA simply because of the tax benefit later on in life, as well as the freedom you will have to withdraw earnings when you need them.

Roth IRA’s unlike Traditional IRA’s can be used to build wealth long after you’ve retired. After the age of 70, most retirement accounts will start to automatically drain. But with a Roth IRA, you can still contribute past that age, and any money left in the account can be passed onto your family.

If you are someone who struggles to save money, this might the best option for you. Because your money is always available to you, and once you have started to earning interest, your balance will continue to grow.

On top of that, much like the stocks and shares ISA, the younger you start the better.

Key Differences

There are a few key differences I’d like to point out before you choose which is best for you:

Roth IRAStocks & Shares ISA
Tax Free EarningsYes, you can withdraw you initial investment, but not any earningsYes, completely tax and penalty free income
Yearly Contribution LimitDepending on annual income, maximum of $6,000£20,000 regardless of income
Control Over InvestmentFull control over investment if wantedGenerally banks or brokers will control your investment
RiskRisk level determined by investment strategyLower risk investment, but capital is still at risk
CostM1 Finance offers free accounts, but others may chargeAnnual management fee is usually between 0.1% – 0.3% of capital held

Pro’s & Con’s of a Roth IRA

Pros

  • Tax Free Retirement Income:
    • Because you are investing post tax money, or savings into this account, any withdrawals you make upon retirement as tax free.
  • No Mandatory Withdrawal Scheme:
    • Just because a Roth IRA is sold as a retirement account doesn’t mean you need to retire. For a lot of people, they enjoy working well into their 70s. There are no restrictions and how long you can contribute for, and no one telling you when to take money away. With Traditional IRA’s the IRS will begin taking your money once you hit 70 if you don’t begin withdrawing This is not the case with a Roth IRA.
  • Access to Contributions:
    • With most retirement accounts, if you decide to draw money early you are either hit with a huge tax bill, or penalties. With a Roth IRA, you can withdraw capital with no tax to pay, and zero penalties. You just can’t draw earnings.
  • Estate Planning:
    • As we know, you don’t have to take your Roth IRA savings if you don’t want to. That makes them perfect for estate planning. You can build you wealth and pass it down to family members for education costs, house purchases, or any other future expense.
  • High Income Loop-Hole:
    • Nicknamed the ‘Backdoor Roth IRA’. If you earn above the income limit for opening a Roth IRA, you can contribute to a Traditional IRA, then convert it to a Roth IRA regardless of the account balance or your yearly income. (You may need to consult a tax advisor about this move, as there might be capital gains to pay).
  • Home Purchase:
    • If you are under the age of 60 and looking to buy your first home, you can withdraw up to $10,000 from your account with no tax or penalties. That is for both capital and earnings.
  • High Earnings Potential:
    • With the current bull market we are experiencing, your earning potential is unlimited with this account. Average returns in 2019 were 12%.

Cons

  • You Pay Tax Upfront:
    • People who struggle to save money, or that are living paycheque to paycheque might find it hard to find money to put away into a Roth IRA post tax.
  • Low Maximum Annual Contribution:
    • I know $6,000 will be a lot for people to save, but for people at the top end of the spectrum earning just under the allowance of $139,000. $6,000 is a low amount to save.
  • You Have to Set it up Yourself:
    • Roth IRA’s are not an employer pension scheme, you need to set it up yourself which can be a small inconvenience. But it is not as hard as it sounds.
  • Income Limits:
    • $139,000 annual income is a lot, and most people in the US will never have an annual salary like that. But for those that do, it is terrible you are unable to contribute to this form of retirement. However… There is always a ‘Backdoor’.

Pros & Cons of Stocks & Shares ISA

Pros

  • Tax Free Earnings:
    • Yes, much like the Roth IRA, the earnings from an ISA are tax free.
  • Unlimited Access:
    • Not only can you withdraw your initial investment capital, you can also withdraw earnings you’ve made tax & penalty free. There might be a small admin fee with you broker, but you can still take it.
  • Connected People Transfers:
    • You can transfer the value of you ISA to any connected person ie. Your spouse, child, grandchild with no tax or penalties. This makes it a great investment for lifetime expenses like education or homes.
  • High Allowances:
    • The annual investment allowance into an ISA is £20,000. Much higher than the US equivalent.
  • Anyone Can Open One:
    • The only requirement to open an ISA is to have a bank account and a form of photo ID.
  • Beat Inflation:
    • Even with a passive ISA made by the banks with an average return of 4.8%, you can still outpace inflation. With ISA’s provided by investment groups, returns in 2019 averaged 15.8%.
  • Very Passive:
    • ISA accounts are very passive as someone else is managing your investments. This comes at a cost, but at least you’re spending time researching, buying and selling, or worrying.

Cons

  • High Management Fees:
    • Banks will charge you an annual management fee which can be as much 1% of your account balance, this is cutting into your profit. Investment brokers offer much lower fee accounts.
  • Your Capital is at Risk:
    • With all investments in the stock market, your capital could fall. During times of high market volatility or uncertainty, you could see your investment decline.
  • Not Suitable for Short Term Investors:
    • Realistically if you require the money you are investing in the next 5 years, you don’t want to put it into an ISA. You will not have given enough time to earn any compounding interest.

The Verdict

If you are in the US, open a Roth IRA immediately, go to M1 Finance or Betterment and signup for webinar, consultation, or even an account.

M1 Finance is our first pick for Roth IRA’s for the simple fact, they offer everything Betterment does, but the account is completely free! You can invest 100% passively, 100% free.

If you are thinking about a stocks and shares ISA, Moneybox is your best bet. It’s completely passive, and very cheap. You can enter your desired risk level and what sort of vehicles you want to invest in, and they’ll do the rest of the work.

I think if you are able to, open 1 of each. The Roth IRA is the best retirement account on the market at the minute, and the Stocks and Shares ISA is the best long term savings account.

You don’t need to max out your contributions, but add a little now and then, and you’ll soon see the account balances grow. I would prioritise contributing to your Roth IRA, for retirement income, but you should treat your ISA as a backup.

Chris Race

I am an accountant from the U.K. specialising in Management Accounting, Personal & Business Tax, Financial Analysis, and Wealth Management. My passion for learning is what lead me to creating this blog. Stock market investing has always been a interest of mine, and since I was 18 years old... This interest has become a source of income for me and my family.

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