Personal pensions and ISAs are, arguably, two of the most well-known ways in which people can save for the future. But which is best? In this post I will set out the key differences.
If you are interested in setting up either a pension or ISA, book a free initial meeting with one of our experienced advisers. Please visit our Contact page, call 01642 477758 or email reception@boblittle.co.uk
Contribution limits
ISAs are relatively simple in terms of contribution limit: you can pay in up to £20,000 per person per tax year.
In contrast, pension contribution limits are quite complex. For most people, this will not matter because the average pension contribution is well below the limits. However, for some people these limits can make a significant difference.
Technically, you pay in whatever you want. However, if you breach the limits then income tax relief might not be added, or if it is added automatically it could be taken away.
Most people can can get relief on contributions up to:
- Your pre-tax earnings, or £40,000 if lower
- £3,600 if you do not have any earnings such as a salary
Some people can pay in more than this (particularly if their employer makes contributions on their behalf or if they have a large amount of earnings and have not contributed the maximum in recent tax years).
Other people can pay in less than this, including if they are subject to a special allowance which restricts higher earners or if they have already accessed some of their pension benefits.
Our advisers regularly help clients establish the maximum amount they can pay into a pension, as well as recommending a suitable pension provider, investments and contribution method.
Up-front tax relief
The main benefit of a personal pension is the up-front income tax relief available on contributions. The way in which this is added will vary depending on how the contribution is made:
- If it comes from your pre-tax wages, income tax is not payable on the contribution amount in the first place. The deduction from your wages is simply added to the pension scheme.
- If it comes from your post-tax wages or from your savings, your pension provider will add some tax relief to your scheme. Higher-rate taxpayers might be able to claim additional tax relief.
As an example, if your employer deducts £100 from your pre-tax monthly wages, £100 will be added to the scheme. Alternatively, if you pay £80 from your bank account into a pension scheme, the pension provider will claim £20 of tax relief and your total contribution will become £100.
This initial boost can be highly valuable. It means more money can be invested, and this can result in better long-term investment returns.
ISAs do not benefit from up-front tax relief. ISA contributions cannot be taken from your pre-tax wages. If you pay £80 from your bank account into an ISA, your total contribution will be £80.
Tax on growth
Investments held in an ISAs or a personal pension will grow free of taxes:
- Investment gains are not subject to Capital Gains Tax
- Income earned from the investments (such as dividends, interest and rental income) is not subject to income tax.
Tax on withdrawals
From a tax perspective, taking money from an ISA is extremely simple: withdrawals are not subject to income tax or Capital Gains Tax.
Personal pension withdrawals are quite complex:
- You should be able to take some money out without paying income tax, but there are limits to this and some pension schemes have special rules
- Any other withdrawals are potentially subject to income tax
- Withdrawals are also subject to a Lifetime Allowance test. This will not affect most people but those with larger pension provisions should be very mindful of this test.
- There are restrictions on how you can take your retirement benefits, depending on what your provider allows, and some methods are far riskier than others.
Our advisers regularly help people access their pension benefits. This includes setting out the options available, recommending the most suitable option and advising on the tax consequences of of each planned withdrawal.
Accessibility
You can take withdrawals from an ISA at any age.
You can’t access pension benefits until the normal minimum pension age (unless your scheme has a protected retirement age). The current minimum age is 55, but this will increase to 57 from 2028.
Death benefits
On death, any investments held within an ISA are ultimately encashed. If the deceased was married or in a Civil Partnership, the surviving spouse can essentially contribute the ISA sale proceeds into their own ISA. This can be very useful for anyone with large ISA holdings.
ISAs will be included in a deceased person’s estate. This means they could be subject to Inheritance Tax at a rate of 40%.
Death benefits from pensions are relatively complex and vary from provider to provider. In a nutshell:
- There might be an option to take benefits as a lump sum or to place the benefits into a new pension arrangement
- Otherwise,
- In some cases, death benefits are not available
The tax treatment is as follows:
- Pension death benefits are not subject to income tax if the deceased was under age 75
- If the deceased was 75 or older, the beneficiary will pay income tax on the value of any death benefits they receive
- Death benefits are subject to a Lifetime Allowance test. This will not affect most people, but could have a big impact on others.
- Death benefits are normally not included in an estate for Inheritance Tax purposes (unlike ISAs).
We have another post which covers this topic in more detail: What will happen to my personal pension when I die?
Which is better?
This is very much a personal choice. This is a case of weighing up how much you value potentially significant up-front income tax relief versus how much you value being able to access your savings.
Although pensions and ISAs are well-known, this does not mean they are always the best way to save for the future. Numerous other options are available including onshore and offshore Investment Bonds and general investment accounts.
Our advisers can recommend which product will be most suitable for you, based on your circumstances and your future plans.
To book a free initial meeting, visit our Contact page, call 01642 477758 or email reception@boblittle.co.uk
