Which is the best way to save for the future – An ISA or a Pension?

ISA or PensionBoth ISA and Pensions offer savers big tax breaks that should not be overlooked especially at this time of year when many of us do our financial planning. While we are in a period of low interest rates and also, returns from many investments, are modest. Therefore, minimising the tax you pay on your savings is very important.

 

What is an ISA?

A tax-efficient way of holding Shares, Bonds, Cash and collective funds like Unit trusts, and OEICS.

 

How much can you pay in to an ISA?

Up to the maximum of £11,280 this tax year, (going up to £11,520 next tax year). Up to half can be in a Cash ISA with the balance invested in investments outlined above. Or you can put it all into an investing Isa wrapper. Many people choose to buy an investment fund within an ISA wrapper, either from an Independent Financial adviser or a fund manager.

 

How is and ISA treated for tax?

There is no tax to pay on income from a cash Isa. It does not have to be declared on a tax return and any income does not count towards any personal allowances. Investments in cash or investment bond ISAs pay out gross income to Isa investors. Dividends from equities ISAs are paid after a ten per cent tax credit has been deducted which Isa investors cannot reclaim. All profits on Isa’s are free of capital gains tax.

 

The pros and cons of ISA investments

Isa’s are flexible. Payments into an Isa can be varied as your budget permits, both for lump sums or regular payments. The tax breaks make more sense for higher-rate taxpayers, as they do not have any extra dividend tax to pay on investments. Even if you are not a higher rate taxpayer now, one day you may be.

 

What is a Pension?

A tax-efficient way to put away earnings today to produce an income in later life. Pensions may be either arranged through your workplace, where contributions are taken direct from your salary or by you seeking advice and making your own arrangements.

 

How much can you pay in to a Pension?

There is a £50,000 annual limit on pension contributions, which includes any money paid by your employer. You can also use any unused allowances from up to three previous tax years as long as you have sufficient earned income this year. There is also a lifetime maximum value of a pension fund, including investment growth, of £1.5 million. If your fund exceeds that limit, you will pay more tax to pay when you take money out. The annual allowance is about to be cut to £40,000 and the Lifetime limit cut back  to £1.25 million in April next year.

 

How is a Pension treated for Tax?

As well as the Government adding tax relief to your own contributions, money invested in a pension grows free from income or capital gains tax. The way tax relief works is that for those who are in company schemes, contributions are mainly taken from their salary before any tax is deducted. (For some work defined contribution pensions they may be taken after tax.) So, where a saver pays into a personal pension from their taxed income, the pension company will claim basic rate relief for every pound you pay in. Higher-rate taxpayers can then claim extra relief on their pension savings through self-assessment.

 

The Pros and Cons of investing in a Pensions

If your employer makes contributions or will match your payments, a pension should be a priority. This ‘free’ extra pay makes the pension a great option. The tax relief boost to what you pay into a pension is a big plus. For basic rate taxpayers that means it only costs them £80 to pay £100 in and for higher rate taxpayers it costs even less at £60.The downer is that you can’t access the money until you are 55 under the rules, then after taking a tax-free lump sum of up to 25 per cent, there are rules on how the rest of it is used. This inflexibility of Pensions can be either a positive or a negative. Some savers like the discipline of knowing they cannot touch pension savings until 55, others dislike tying money up.

 

But what about having both an ISA and a Pension?

As you can see, there are pros and cons to investing in both a pension and an Isa. The flexibility of an Isa is a big draw, but the tax relief at 20 per cent or 40 per cent of contributions paid into pensions makes them extremely attractive especially for many high earners. Fortunately, the ISA against Pension debate is not one or the other. Having a balance between the two is probably the best option.

If you would like to contact us confidentially, call on 0161 928 2706 or fill in the form below and we will contact you.

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After many years experience working in Bancassurance and have recently moved to Parsonage, Chartered Independent Financial Planners in Altrincham as an IFA

Posted in Getting Good Financial Advice

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