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By Gill Philpott, Tax and Trust Specialist
It’s that time of year again when ISA top ups come to the fore with the looming tax year-end deadline of 5th April 2021. Clients often ask us – ‘What is the difference between saving into a pension versus an ISA?’. The answer can be a difficult one to determine without the support of an expert in these fields. It’s this complexity that sometimes leads to people missing out on the full benefits of each of these savings mechanisms in any given tax year.
This year more than most, you may find that you have more time to look at your savings options, or you may find your financial circumstances have changed and you have more cash available and want to put it into a pension or ISA. You have time now to work with your financial adviser to do what is best for you. In this podcast and supporting article, our Tax expert Gill Philpott explains the differences and the benefits between a pension and ISA.
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Both ISAs and personal pensions can offer you tax benefits, but how do you know what the best fit for your individual needs and circumstances might be?
In this article, we look at some of the advantages and disadvantages of both savings options, in order to provide you with a better understanding of these investments.
Firstly, we look at the tax position of ISAs and pensions in our comparative table below:
Annual contribution limit
No lifetime allowance applies.
£40,000 for all pension contributions, but subject to restrictions for high earners and low earners and those that have flexibly accessed their pension funds.
A lifetime allowance applies.
Tax relief on contribution
No tax relief is given on payments into an ISA
Tax relief is given on payments at your marginal rate of tax.
The payment to the personal pension is topped up by a 20% tax reclaim by the pension provider.
Income received on the underlying investments within the fund
Tax on gains generated within the fund
Restriction on withdrawals
No access to the funds until age 55, and the age restriction is due to be raised.
Tax on accessing funds
No tax to pay on accessing funds
25% of the fund can be taken tax-free and the remaining withdrawals will be taxed at your marginal rate of income tax.
No; included in estate value for inheritance tax purposes
Yes, funds remaining in the pension pot at death do not form part of your estate for inheritance tax purposes.
While contributions to personal pension schemes benefit from tax relief and boost the value of the contribution paid, accessing income from the fund does have tax consequences. In contrast, ISAs do not have the upfront tax benefits that contributing to a pension scheme has, however the funds built up into an ISA can be accessed entirely tax-free.
It is likely however, that the tax benefits associated with contributing to a personal pension scheme and the ability to take a 25% tax-free lump sum from the scheme will, if comparable returns are achieved across both investments, favour the pension route for tax purposes.
So, if a tax advantage lies with the pension arrangement, what advantage does an ISA have? The ISA does provide tax efficiencies, but its distinct advantage over the pension fund is its flexibility in accessing funds. All the funds in an ISA can be accessed tax-free without having to wait until the age of 55. This can lend the ISA to being useful in funding life goals before the age of retirement; repaying the mortgage to enable early retirement, taking a dream holiday for that significant birthday, helping the children onto the property ladder, or contributing to the grandchildren’s first car etc.
Another advantage is that over a working lifetime an annual contribution of £20,000 to a pension will see the pension fund grow to the extent it is more than likely to exceed the pension lifetime allowance. This restricts the amount that can be put into a pension without incurring a tax charge. An ISA however has no such lifetime allowance limit.
ISAs can be a useful option if pension contributions are limited due to high earnings, or a restricted pension contribution allowance of £4,000 when pensions have been flexibly accessed.
There are a range of ISA accounts available to suit different circumstances and saving goals, these include the Lifetime ISA, the Junior ISA, Cash ISAs, Stocks and Shares ISAs.
The decision between contributing to a personal pension or an ISA will ultimately depend on your individual circumstances. In many cases, a combination of investment into both ISAs and pensions may be used together as part of a financial plan.
Ultimately, the best option will depend on individual financial circumstances, objectives and personal preferences. Your Ascot Lloyd financial adviser will always be happy to help navigate the best options for you.
Please contact your financial adviser directly or request a call back to discuss any requirements you may have – we would love to help.
There so many options available when it comes to ISAs, it can be complex. Here you will find the answers to some of the most common questions asked about them.
If you have any further questions, your experienced and knowledgeable Ascot Lloyd Financial Adviser would be happy to discuss your plans in more detail with you.
ISA stands for Individual Savings Accounts (ISAs)
They were first introduced in the UK in April 1999, as a tax efficient personal saving scheme.
There are 4 main types of ISA:
For example, savings in bank and building society accounts.
For example, shares in companies, unit trusts and investment funds, corporate bonds and government bonds.
Remove Innovative finance (IFISA) please
You can use a lifetime ISA to buy your first home or save for later life. You must be 18 or over but under 40 to open a Lifetime ISA
You can put in up to £4,000 each year, until you're 50. The government will add a 25% bonus to your savings, up to a maximum of £1,000 per year.
A Junior ISA is a long-term savings account set up by a parent or guardian with a Junior ISA provider, specifically for their child's future. Only the child can access the money, and only once they turn 18. You can contribute up to £9,000 per child this tax year (2020/21).
For the 2021/22 tax year, the maximum ISA allowance will remain at £20,000. You can choose to invest your money in one type of ISA account, or you can split the allowance across some or all of the other types available. The tax year runs from 6 April to 5 April and your allowance re-sets at the start of each year. You can only pay £4,000 into your Lifetime ISA in a tax year.
You can take your money out of an Individual Savings Account (ISA) at any time, without losing any tax benefits. Check the terms of your ISA to see if there are any rules or charges for making withdrawals.
There are different rules for taking your money out of a Lifetime ISA.
If your ISA is ‘flexible’, you can take out cash then put it back in during the same tax year without reducing your current year’s allowance. Your provider can tell you if your ISA is flexible.
Your ISA personal allowance is £20,000 and you invest £10,000 into an ISA during the 2020 to 2021 tax year. You then take out £3,000.
The amount you can now put in during the same tax year is:
When you die, your ISA will end when your executor closes the account. Otherwise, your ISA provider will close your ISA 3 years and 1 day after you die.
There will be no Income Tax or Capital Gains Tax to pay up to that date, but ISA investments will form part of your estate for Inheritance Tax purposes.
For married couples and civil partners, the survivor can inherit the deceased spouse’s or civil partner's ISA savings and maintain their tax-efficient status, under the Additional Permitted Subscription (ASP) rules.
Many cash ISAs can be opened with a minimum investment of just £1.
With a stocks and shares ISA, most fund will accept contributions starting from either £25 or £50.
You pay no Income Tax on the interest or dividends you receive from an ISA and any profits from investments are free of Capital Gains Tax.
There are a number of advantages associated with an ISA:
*Pension contributions are dependent on your personal circumstances, please speak to your financial adviser.
Our Financial Advisers are available on the phone so please contact us if you have any questions.
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This communication is for information purposes only. Nothing in this communication constitutes financial, professional or investment advice or a personal recommendation. This communication should not be construed as a solicitation or an offer to buy or sell any securities or related financial instruments in any jurisdiction. No representation or warranty, either expressed or implied, is provided in relation to the accuracy, completeness or reliability of the information contained herein, nor is it intended to be a complete statement or summary of the securities, markets or developments referred to in the document. Any opinions expressed in this document are subject to change without notice and may differ or be contrary to opinions expressed by other business areas or companies within the same group as Ascot Lloyd as a result of using different assumptions and criteria.