-- Pension or an ISA - The decision is yours? --


Protect your money from the recent Budget tax cuts
Protect your money from the recent Budget tax cuts

DWP tackles state pensions for civil partners
DWP tackles state pensions for civil partners

Maximising Pension Contributions with PIPs
Maximising Pension Contributions with PIPs

One year annuity deferral could take 24 years to recover
One year annuity deferral could take 24 years to recover

I am always asked which investment vehicle is better, an Individual Savings Account (ISA)  or a pension? 

We all have our opinion so lets decide.

ISA's dominante the savings world for several particularly good reasons.

You can save your money, get instant access to your cash, and you do not have to pay tax.

With the amount you can save each year raised to £10,200, a maximum of £5,100 in cash, investors have quickly come to regard ISA's as long-term homes for their nest eggs.

But what about pensions? Are they still worthwhile?

A few years ago, the final salary  pension was a mainstay of the British workplace. And that certainly was worthwhile. Millions of workers knew they would retire in comfort, which often meant two-thirds of their final income.

Unfortunately in the main these have suffered a demise so we are left with defined contribution schemes, also known as money purchase schemes where retirement income depends on how much you save and how fast this grows.

So what are the benefits?

You will soon be able to convert up to 100% of pots into cash once you hit 55 and leave any unused money to your loved ones on death. You will however have to prove that you have sufficient income from other areas in retirement.

But you've been able to do that with ISA's for ages.

PENSIONS

Pension pros:

- Tax relief

When you pay money into a pension the Government refunds the income tax you paid on it. Effectively, basic rate taxpayers only need to put in £80 to see £100 go into their pot; 40% taxpayers only need to put in £60 to see £100 added. When you draw on your pension you are taxed at income levels again. But in all probability you are going to have a smaller income and usually this means basic rate tax. This could mean you're 33% better off than with an ISA.

- High contribution limits

Work bonus: Many employers contribute to their workers' pensions

Pensions have high annual contribution limits of 100% of earnings, subject to an overall cap of £255,000.

- Employee benefits

Many companies have a staff pension scheme. Lots of these used to be generous final salary arrangements. But now most depend on you sacrificing chunks of your salary and watching a pot grow (slowly).

However, most employers will at least match your pension contributions - some even put in more. So if you contribute, say, 6% your employer might put in another 6% or even 8%. Look at this as a pay rise - it'd be madness to say no.

With a pension you can also elect for a salary sacrifice, which will allow you to avoid National Insurance of 11%, so a basic rate tax payer could have tax relief at 20% on the contribution plus 11% national insurance saving. An ISA does not have any of these tax savings.

- Tax-free growth

Virtually tax free growth within the fund. That should mean your money's safely stored away from the Government. Pension funds did used to get dividend  tax credits. But Gordon Brown axed this bonus in 1997. The move is said to have cost pension funds around £5bn a year. So much for 'safely stored', then.

Pension cons

- Not accessible until 55

This is where a pension falls down; you do not have immediate access to your cash in a time of crisis. Any money in a pension cannot be accessed until you reach 55. And even then, you will need to purchase an annuity  – an insurance product that pays a set income for the rest of your life.

- They're complicated

Pensions are difficult to understand and are run in complex ways. This can be very off-putting for ordinary savers who just want to know how much they need to put aside and what they'll get back in old age.

- Government meddling

Every Government has made changes to pensions which has made it difficult for savers to feel that their nest eggs are secure.

And this could keep happening, - You can't access your pension fund until the Government says you can – this used to be 50, has recently been increased to 55 but could rise again. At present, you are allowed to take 25% of the pension fund as a tax free lump sum, but again, it is possible that a future government could abolish or restrict availability of this.

ISA'S

Isa pros

Flexible options

ISA's come in two types: a cash ISA's (basically a savings account) and stocks and shares ISA's (a wrapper that you can either place individual shares in, or more often a fund that will pick shares and bonds on your behalf).

- Instant access

This is what makes ISA's such winners. With both cash and shares ISA's, you can get at your money as and when you want. Even fixed-rate cash Isas only see your money tied up for a few years. For those keen to ensure they can access their savings in an emergency – ISA's are the ideal solution.

- Simple tax rules

Once your money is in a cash ISA, you will not be taxed. It won't be taxed as it grows and the income you take is totally tax-free.

- The 'wrapper' effect

Easy access: ISAs are the winners in a cash emergency

Stocks and shares ISA's act as tax 'wrappers'. As well as tax-free growth, you do not have to pay Capital Gains Tax . The only tax payable is dividend tax at 10%, which applies for both basic and higher rate taxpayers. Outside ISA's, higher rate taxpayers pay 32.5%. And if you use a fund supermarket as your SA 'wrapper', costs are significantly cheaper than with a pension.

 

- Means-testing in retirement

Used as a source of income, ISA's have certain benefits for retirees. The Isa really comes into it's own at the time the person decides to stop working and start drawing an income from the fund.

Tax free income from an ISA has no impact on age related allowances for the over 65s, no impact on personal allowances for those with income over £100,000 and there is no requirement to record on a tax return.

- Lasting simplicity

Its like the okey cokey - You put your money in, you take your money out - it's very, very simple.

ISA cons

- No tax relief on contributions

There's no tax-back incentive as described for pensions above. So any growth isn't as powerful. On paper a pension will always produce a bigger fund for the same contribution because of the tax relief.

- Saving limits

You can only pay a maximum of £10,200 into ISA's each year. You can invest all of it into a stocks and shares Isa, or save up to £5,100 into a cash Isa. These limits might well be sufficient for most people. Think about it, over the course of a 40-year working career, you can put away £400,000. But what about those wanting to save more or who start late? Perhaps you can only afford to start saving for retirement when you reach your 40s - the limit here is serious restriction.

For most people allowable contributions to pensions are much higher.

- No employer contributions

Employers can't pay into ISA's but can pay into pensions. So if your employer will pay into your pension, it is nearly always best to receive this.

- Means-testing while young

While you are still working, an ISA will affect most means tested benefits, such as income support, whereas a pension pot pre-retirement will not.

CONCLUSION

ISA's provide an ideal way to grow tax-free cash savings as well as building capital by investing in the stock market. ISA's are a better choice if access to savings is needed before age 55 or if 100% of the capital is required at once.

In reality, most people should spread their savings between an ISA and pension, so they have funds which they can access if they need to, whilst at the same time taking advantage of the tax benefits of pension for retirement savings.

Basic rate taxpayers should maximise their ISA's before paying into pensions. The flexibility of the ISA  gives it a clear edge, especially as with the pension they will get basic rate tax relief up front but end up paying basic rate tax on most of the income.

For higher rate taxpayers, especially those that are likely to be basic rate taxpayers in retirement, the pension has the advantage, if you are comfortable with the inflexibility and the risk of government meddling with the rules. Where employers are paying into the pension scheme, this opportunity should be maximised.

For bespoke pension and investment advice contact Credencis

We are situated near to Derby, Leicester, and Nottingham.

Credencis

"Live for today, Invest for tomorrow"

 

 

Views expressed by our author, are the personal views of the author alone, and are not intended in anyway to be construed as advice.They should only be used as guidance and are not necessarily suited to the personal circumstances of every individual in the UK.If you are interested in seeking advice further then please contact Credencis direct.