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When saving for retirement is it best to save via a pension or an ISA? Perhaps a mix of the two is the best option? We look at the advantages and disadvantages of each.
There are two main types of pension defined contribution and defined benefit (also known as final salary pension). What follows relates only to defined contribution pensions.
Here, an ISA is the clear winner. A pension fund cannot be accessed until the pension holder is 55 years of age. With an ISA there are no restrictions on when part (or all) of the fund may be withdrawn unless there are special conditions linked to higher interest payments.
Any withdrawals from an ISA are tax free but with a pension, only the 25% of the fund may be withdrawn tax free. It is possible to manage the tax burden by making multiple withdrawals from the pension fund but overall the ISA is a far more flexible solution.
An ISA is simply a savings account from which an individual may make withdrawals tax free. In the 2019/2020 tax year, the maximum contribution to an individual’s ISA is £20,000. It is not possible to bring forward unused allowances from previous years.
The contribution limit for pension is much more generous with an annual allowance of £40,000 or total yearly salary (whichever is lower). Unlike ISA’s unused allowances in previous years can be carried forward. However this annual allowance is significantly reduced for those who have accessed income from their flexi-access drawdown arrangements. You can read all about the rules on pension contributions here
With an ISA there is no tax benefit when paying into the scheme. With pensions, 20% is added to contributions by the pension provider (relief at source). A higher rate taxpayer can claim a further 20% or 25% depending on the level of their earnings via self assessment. Employers can make a contribution to an individual’s pension fund but this is not possible with an ISA. Pension contributions, therefore, have a distinct advantage over ISA contributions.
If we assume the pension and ISA hold the same assets then the growth rate on each should be similar. However, it is difficult to make a direct comparison as a wide range of assets may be held in a pension fund whereas an ISA is more limited.
The overall growth of a fund (be it ISA or pension) is compromised by the level of fees. There remains an ongoing controversy about the level of fees on pensions but fees and charges can be equally high for an equity ISA.
A key issue for many when comparing pension vs ISA is inheritance tax. Here, pensions are the clear winner. In most cases pensions sit outside an estate and are therefore not subject to Inheritance Tax (IHT) . This is not true for funds in an ISA as these form part of the estate although ISA’s that invest in shares listed on the Alternative Investment Market (AIM) can be exempt from IHT .
The winner is? Well, it depends on personal circumstances and aspirations. A combination of pension and ISA is probably best for most people.
All of the above is based on the current tax rules. Changes to tax legislation will involve a complete re-assessment of the pension vs ISA debate.
Should you have any questions then please give us a call and we will be happy to help. Or if you would like to discuss your options complete the form below and we will call you back at a time convenient for you.
This blog is intended to provide a general review of certain topics and its purpose is to inform but NOT to recommend or support any specific investment or course of action. The past is not a guide to future performance. The value of investments can go down as well as up and you may not get back the full amount you invested. Tax and financial regulations can change. Any figures quoted above are correct at the date of publication.
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