28th April 2022
So if you are thinking about investing for your retirement, would a pension or a Stocks and Shares ISA best meet your requirements?
The contribution limit for ISAs is straightforward. Any UK resident over 18, regardless of income or tax position, can invest up to £20,000 per year in a Stocks and Shares ISA.
Pensions are more complicated. The main contribution limits are:
Clearly when it comes to simplicity, ISAs are the frontrunner. But depending on your earnings, you might be able to pay more into a pension.
When you pay into an ISA, there is no immediate tax relief.
Pensions, on the other hand, offer an instant uplift to your personal contributions. For example, if you want to contribute £3,600, you only need to pay in £2,880 and HMRC will credit £720 directly to your pension. This applies even if you are a non-taxpayer.
Higher and additional rate taxpayers can claim further tax relief (20% and 25% respectively) via self-assessment.
Employer contributions are an allowable expense for corporation tax purposes. Additionally, you don’t pay any tax or National Insurance on pension contributions from your employer.
Both ISAs and pensions grow free of tax. You don’t pay any income tax or capital gains tax on your funds while they remain invested.
Pensions are the clear winner when it comes to tax relief on your contributions.
Historically, pensions were provided by insurance companies, which offered a limited range of funds. This would usually include the provider’s own funds as well as a few from external managers.
ISAs were typically available from fund managers, and would offer only the provider’s own range of funds.
Today, the distinction is pretty irrelevant. Most platforms now offer both pensions and ISAs, which can normally invest in the same funds from the whole of the market. You can access thousands of investment options with as little as £50 per month.
That is not to say that all pension or ISA products offer the full range of funds, but if you are just starting to invest, your fund choice should not be limited by the tax wrapper you select.
Pensions do have a few additional features. Some pension providers will allow you to invest in commercial property or private equity. However, these options are suitable for a tiny minority of investors.
For most people, ISAs and pensions are equally suitable in terms of investment options.
Both ISAs and pensions can be transferred to other providers without losing tax relief. This can be useful if you have built up multiple funds over the years and would like to consolidate them.
If your funds are invested on a platform, rather than with an insurance company, it might even be possible to transfer your shares directly without selling them first. This avoids time out of the market while the transfer completes.
The portability of your pension or ISA depends on where the money is held and where you want to move it to. In this category, it is a tie between pensions and ISAs.
Accessing Your Money
You can take money out of your ISA without tax or penalty. Some providers even allow you to replace money you have taken out, providing this is done in the same tax year.
Pensions are now more flexible than ever. You can withdraw the full fund as a lump sum if you want to. However, only the first 25% is tax-free. Over and above this, you will pay tax on your pension income at your marginal rate.
Additionally, if your pension is valued at over the Lifetime Allowance (currently £1,073,100) when you take benefits, reach age 75, or die before age 75, you will pay tax on the excess at a rate of up to 55%. ISAs do not have any limits on the fund value you can build up.
There are no age limits on taking money out of your ISA. To withdraw money from a pension, you need to be at least 55 (rising to age 57).
When it comes to taking money out of your fund, ISAs are more flexible and the withdrawals are tax-free.
What Happens When You Die?
You can pass your ISA to a spouse without losing tax benefits. However, if the money goes to anyone else, the ISA status is lost. ISAs also form part of your estate for Inheritance Tax purposes.
Pensions can pass to any beneficiary you choose, either as a lump sum, or a beneficiary drawdown plan.
The benefits are free of tax if you die before age 75. The beneficiary pays their marginal rate of tax if you die after age 75. Pensions can be passed tax-efficiently through the generations.
Pensions offer more advantages when it comes to estate planning.
What About Lifetime ISAs?
You could think of a Lifetime ISA (LISA) as an ISA-Pension hybrid. It works as follows:
If you are thinking of getting on the property ladder but don’t want to neglect your retirement funding, a LISA could allow you to keep your options open.
Should You Invest in a Pension or an ISA?
A pension is the best option if:
Ultimately, both pensions and ISAs have a valuable place in any financial plan. It’s a good idea to incorporate both.
Please don’t hesitate to contact a member of the team to find out more about retirement planning.