Pensions and ISAs
Benefits, drawbacks and characteristics
Both pensions and ISAs are tax efficient wrappers that are advantageous to investors for a multitude of reasons. There are, however, important differences between the two.
We will examine the benefits of each, potential drawbacks and how both can be used effectively for different purposes throughout your lifetime.
Accessibility
Pensions
- Unless you have a protected retirement age, you can access your pension savings from age 55, rising to 57 from 2028.
ISAs
- You can access your Stocks & Shares and Cash ISA savings as and when required (albeit there could be exit penalties if in a fixed-term arrangement).
- Different rules apply to Lifetime ISAs, Help to Buy ISAs, Junior ISAs and Innovative Finance ISAs.
Tax Relief
Pensions
- You can receive tax relief on contributions made into your pension, which can play an important part in boosting your retirement savings. The amount of tax relief you can claim depends on the method your contributions are being paid and the rate of Income Tax you pay. For example, if you are a basic rate tax-payer (20%) you will get tax-relief on your contributions of 20%. If you are a higher rate tax-payer (40%) you will get tax-relief of 40% on the amount of contribution in the higher rate. The same theory applies for an additional rate taxpayer (45%).
- Scenario – Peter, a basic rate taxpayer, pays £100 into his pension plan. Peter will receive tax relief of £25 on this contribution, resulting in a total pension input of £125.
ISAs
- You do not receive tax relief on contributions into an ISA arrangement.
Tax Implications
Pensions
- Under normal pension rules, you can receive 25% of the value of your pot as tax-free cash, capped by the Lifetime Allowance (this can sometimes be higher if specific protection has previously been granted). From the 2024/25 tax year, the introduction of the Lump Sum Allowance (LSA) and Lump Sum and Death Benefit Allowance (LSDBA) will also be relevant.
- The remaining 75% of the value of the pot will usually be taken as income payments and taxed at your marginal rate of Income Tax, although a lump sum may be payable.
- At death, your pension savings are not usually part of your estate, so your chosen beneficiaries won’t pay any Inheritance Tax on the money received.
- In the case of an annuity, the pension dies with the annuity holder, or on occasions the surviving spouse may inherit a portion of the annuity value. Capital protection and guarantees may be included.
- Should someone die before age 75, the pension can be paid as a lump sum or drawdown to the beneficiary tax-free. From the 2024/25 tax year, lump sums will be tested against the LSDBA which will be reduced by any Tax Free Cash previously taken. On death after 75, the benefits can be paid as a lump sum or drawdown taxed at the beneficiary’s marginal rate.
ISAs
- The total value of your ISA can be withdrawn without any tax implications.
- At death, your ISA is included as part of your estate, so your chosen beneficiaries may need to pay inheritance tax. In the case of a married couple, the surviving spouse can inherit the deceased’s ISA and this sum does not count towards their own personal ISA annual allowance.
Investment Options
Pensions
- Pensions can be invested in a wide array of holdings including cash, funds and shares. It is important to ensure that you are invested in a manner which aligns to your attitude to risk, capacity for loss and any ethical, social and governance preferences that you may have.
ISAs
- ISAs can be invested in a wide array of funds and shares. It is important to ensure that you are invested in a manner which aligns to your attitude to risk, capacity for loss and any ethical, social and governance preferences that you may have.
- You can also hold a Cash ISA, which as the title infers, is held as cash.
Annual Allowances
Pensions
- The limit for Pensions in the 2023/24 tax year is £60,000 or 100% of your earnings, whichever is lower. Your allowance may be lower if you’re a high earner or if you’ve already started taking money from your pension savings.
- If you are a non-earner, the maximum you can contribute into a pension each tax year is £3,600 gross.
ISAs
- The limit for ISAs in the 2023/24 tax year is £20,000. It is important to note that £20,000 is the limit regardless of how many ISA’s you may have. For example, if you hold a Cash ISA and a Stocks & Shares ISA, you could contribute £10,000 into each, totalling £20,000. You could not put £20,000 into each in the same tax year.
Timeframes
Pensions
- Pensions are designed for the long-term, helping you save for retirement. If it is likely you will need to access your money in the short term, then placing money into a Pension is not preferable.
ISAs
- ISAs can be used for the short, medium and long-term. If you require money in a short period of time, a Cash ISA can be useful to hold this sum. For investment horizons of five years or longer, it can be beneficial to use a Stocks & Shares ISA with the aim of benefitting from investment growth on the funds within.
As you can see, pensions and ISAs are both very powerful and valuable tools when it comes to financial planning. Each have similar characteristics, but also important differences and how you choose to invest your money will be specific to your individual circumstances and requirements.
There are, of course, other variables that should be considered, and pensions in particular can be of a complex nature that require technical planning.
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DisclaimersThe information set out in our publications is for information purposes only and does not constitute advice to undertake a particular transaction. Appropriate professional advice should be taken on specific issues before any course of action is pursued. Any advice provided by a Crowe Consultant will follow only after consideration of all aspect of our internal advice guidance. Past performance is not a guide to future performance, nor a reliable indicator of future results or performance. The value of investments, and the income or capital entitlement which may derive from them, if any, may go down as well as up and is not guaranteed; therefore investors may not get back the amount originally invested. The Financial Conduct Authority does not regulate Trusts, Tax or Estate Planning. |
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