Posted on: 30th Nov 2015
As it stands, at least on a temporary basis,savers may be able to benefit from welcome tax advantages, compare to those saving using ISAs. Much of it comes down to personal circumstances and the level of savings under consideration, but by better understanding the way in which the available options are taxed, it becomes easier to make the right choice…which often isn’t necessarily the most obvious choice.
There are basically three levels/stages of taxation that are applied to these kinds of savings – tax at the time of funding, taxation while the funds are invested and the tax applied when the funds are accessed or withdrawn. In the case of the pension regime, savings are exempt from the first two of these taxation stages and liable for the final (withdrawal) taxation. In the case of the ISA, these kinds of savings are exempt from the second two types of taxation, though liable for initial funding tax. Best taxation must also be considered as an additional taxation treatment.
In terms of taxation mile invested, there’s currently no difference between the two as both the ISA and the pension allow savings to mature and grow without the application of any tax. However, the two differ quite significantly when it comes to funding and taking benefits. With an ISA for example, no taxation is applied to withdrawals but these kinds of savings do not receive any tax relief on contributions. By contrast, pension contributions do receive income tax relief, but the savings are then taxed at the appropriate income tax level upon being accessed.
Which often leads to the obvious question – does this essentially mean that both options are identical and that the benefits/drawbacks of each effectively cancel one another out?
The answer however is a resounding no, asas they stand today present distinct advantages. For one thing, it’s important to remember that 25% on an available pension pot can be accessed 100% tax free, meaning that it is only the other 75% that is subject to income tax. So by being able to access 25% without paying any tax at all, this represents an obvious advantage over the ISA. If the 25% tax free amount was to be taken away, the two would essentially be equal.
As for the second main benefit of pension savings, it’s generally the case that tax relief tends to significantly exceed the amount of tax paid when the pension pot is withdrawn/accessed. The reason being that while the highest marginal rate of income tax will apply by way of tax relief, a much lower rate of tax is usually payable when the funds are withdrawn. In many instances, workers who are paying tax at higher rates will find themselves once again back in the basic income tax band upon. Which once again means that opting for pension savings as opposed to an ISA can result in enormous comparative income tax savings.
The benefits of pensions also extend beyond death, with new pension flexibility opening up a variety of options for passing on any remaining pension funds. And if the pension holder dies under the age of 75, the pension pot is not subject to any income taxation at all.
For more information on the potential benefits of both pensions and ISAs, get in touch with theteam today for an obligation-free discussion.