At Rotherwood Insurance Consultants a common question we get from client is should I maximise my ISA allowance for the tax year or move more money into my Pension. The short question to this answer is generally both, but the actual answer is more complex and depends on numerous factors such as age, Investment time horizon, Employment status and Earned income for the tax year to name a few.
As useful place to start when comparing a Pension contribution to and ISA contribution is to compare the Pro’s and Con’s of a Pensions contribution vs ISA contribution, it’s important to understand the key differences between these two types of savings vehicles:
Pros:
- Tax Relief | Contributions receive tax relief at your marginal rate, making it a tax-efficient way to save for retirement.
- Employer Contributions | Many employers match or contribute towards your pension, significantly boosting your savings.
- Higher Annual Limit | The annual contribution limit is generally higher compared to ISAs.
- Tax-Free Growth | Investments within the pension grow tax-free.
- Inheritance Benefits: Pensions are usually outside of your estate for inheritance tax purposes and can be passed on tax-efficiently.
- Tax Free Element | 25% of a Personal Pension can be taken tax free, proving important tax efficient income in retirement
Cons:
- Limited Access | Funds are not accessible until you are 55 (rising to 57 in 2028), limiting early access to your savings.
- Taxation Upon Withdrawal | While you get tax relief on contributions, you are taxed on pension income when you withdraw during retirement.
- Tax Free Cash Cap | Although the Conservative Government removed the LTA is the spring 2023 the ammount of tax free cash avaliable is capped at 25% of the old LTA £1,073,100 * 0.25 = £268,275
- Complexity | Pensions can be complex, with various rules and limits to understand.
Pros:
- Flexibility | Funds can be withdrawn anytime, offering immediate access to your savings.
- Tax-Efficient | No tax on interest, dividends, or capital gains, and withdrawals are tax-free.
- Simplicity | ISAs are generally simpler and more straightforward than pensions.
- Variety of Options | There are different types of ISAs (Cash, Stocks & Shares, Innovative Finance, etc.) catering to different needs.
- No Age Limit | You can contribute to an ISA at any age.
- Tax Free Withdrawals | The whole value of an ISA can be withdrawn at any point, the money withdrawn can also be replaced within the same tax year.
Cons:
- Lower Annual Limit: The annual ISA allowance is £20,000, lower than the pension annual allowance.
- No Employer Contributions: Unlike pensions, ISAs do not benefit from employer contributions.
- Inheritance Tax: ISAs form part of your estate for inheritance tax purposes.
- No Upfront Tax Relief: Contributions are made from post-tax income, without the tax relief available on pension contributions.
- Impact on Means-Tested Benefits: Although ISAs do not affect state pension entitlement, substantial savings in ISAs may affect eligibility for certain means-tested benefits.
In summary, pensions offer higher contribution limits and tax relief, making them ideal for long-term retirement savings, especially if you can benefit from employer contributions. ISAs, on the other hand, provide more flexibility and accessibility, with tax-free growth and withdrawals, suitable for both short-term and long-term savings goals. Please feel free to contract Rotherwood Insurance Consultants on 01306 742747, email [email protected] or fill in the below information or visit our Get In Touch Page if you wish to discuss the above or any financial planning needs.
The tax information in this article is correct as of 09-01-2024.
