If you wish to invest for the future, should you choose aor Individual savings Account (ISA)? There is plenty of advice available for investors, but with so much information out there, it’s hardly surprising that many people struggle to make sense of what is available.
Thoughgenerally have good press, this has not been the case as of late. One only must look at the recent collapse of BHS and Carillion amongst others and the scandals surrounding them, to understand why pension saving has been getting an increasingly bad reputation. The problem for pension saving has also been compounded by the raft of changes to pension regulation, which were designed to encourage more investors to open pensions, whilst at the same time making them less attractive to higher-rate taxpayers.
Though ISAs have become increasingly popular forsavings, the question still remains: should investors opt for an ISA rather than a pension? Martin Bamford, managing director of Informed Choice, understands why pensions have been getting a bad reputation lately, and why ISAs are becoming the new priority, but still believes it is important for investors to not put all their eggs in one basket. He argues that the best way of ensuring a financially secure future is to have a mix of income sources.
Of course, a fortunate few can use up both their ISA and pension allowances each year. For the majority, however, cash-flow represents the biggest concern when they begin to invest and save “in case life throws you a curveball,” as Adrien Lowcock,director at Architas puts it.
“Having a pension early on is important, but for most of us it is difficult; the key is to do something to begin saving towards retirement, even if it is something small,” he says.
Making smart decisions
Lowcock also adds that choosing an ISA over a pension is common for investors and that foregoing pension tax benefits upfront means missing out on long-term growth.
“It wouldn’t be wise to focus only on ISAs. In pensions, all the tax relief is upfront. In ISAs it is at the end, so you get a tax-free income. However, pensions also give out 25% tax free cash. From a tax perspective, if you are a higher-rate taxpayer then a pension makes absolute sense.”
After tax relief, a higher-rate taxpayers contribution of £10,000 would only cost £6,000 on retirement and for those who are on the additional rate of tax the net cost will be £5,500. In addition to this, you will receive tax-free cash on up to 25% of the funds available. For the majority of savers, the annual savings limit is £40,000 – double the ISA limit of £20,000.
Head ofat Tilney, Andy James, agrees that pensions represent the most tax-efficient way of saving. As an example, he cites an example of a person saving £10,000 with a 6% interest rate over 20 years. An ISA saver would end up with £33,102. A higher-rate taxpayer putting the same amount into a pension would see it topped up by basic-rate tax to £12,500. They would also receive a £2,500 tax credit. After 20 years, a higher-rate pension saver would end up with £41,378 with a lower net entry cost of £7,500.
Are pensions a better long-termthan ISAs?
Not necessarily. ISAs are generally agreed to be the most efficient and flexible vehicle for saving. Income from an ISA and capital gains are both tax-free, whereas pension income is taxable. ISAs give you instant access as opposed to waiting until the age of 55 and there is no upper limit on the accumulated amount, unlike a pensions lifetime allowance.
Rob Morgan, pension andanalyst at Charles Stanley Direct, says that those who are thinking solely about investing for retirement should prioritise pensions due to the tax relief that is offered. In his eyes, a “mix and match” strategy is recommended for optimising tax advantages and flexibility at various stages in life.
“ISAs for pre-retirement needs, or for a pot that can be drawn upon at any time when needed, and pensions for retirement,” he says. “The decision between a pension and an ISA will ultimately depend on your individual circumstances, and in many case a combination of ISAs and pensions should be used together as part of a financial plan.”
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