Both ISAs and pensions can play a role in your retirement plans, but you need to understand their potential uses and relative merits. We outline their key differences.
To encourage us to save, the UK government has set up two main tax-efficient options: pensions and ISAs (or Individual Savings Accounts). As we show in the table at the end of this article, these work in different ways. But combining the two could increase the flexibility of your retirement planning and help you deal with life’s uncertainties.
A pension scheme is a type of savings or investment plan to help set aside money for later life, when you may want to work less or retire. It can provide reassurance when you’re older and it offers certain tax advantages.
ISAs, often described as ‘wrappers’, can also protect investments and savings from tax, but you can draw from them at any time, not just in later life. Investments or savings held inside an ISA wrapper will be exempt from income tax, capital gains tax (CGT) and tax on dividends. Investments or savings that are not held (or ‘wrapped’) in an ISA, could be subject to tax.
Pensions offer significant up-front tax advantages, especially for higher rate taxpayers, perhaps most notably because employees can deduct pension contributions from their earnings for tax purposes. But you can’t usually access your pension savings until the age of 55 (or 57 from 6 April 2028).
In this article, we consider what are known as ‘defined contribution’ pensions. In this type of pension, you build up a pension pot based on how much is paid into the pension and how the pension investments perform.
Unlike pensions, ISA investments are not deducted from earnings for tax purposes. But they do offer you the flexibility to withdraw money at any time and, in contrast to pensions, ISA funds are not taxable when you come to draw on them. More specifically, any money you withdraw from an ISA is free from income tax, capital gains tax and dividend tax.
ISAs can then be a tax-efficient way to boost to your income in later life. And using both pensions and ISAs can allow you to access some of your money in an emergency while retaining some tax efficiency.
Moreover, you can’t usually invest more than £60,000 a year in a pension. So if you have more than this to invest, then an ISA could be a great way to do so tax-efficiently during your pre-retirement period.
There are many ways to combine ISAs and pensions to fund your retirement and the arrangement that might suit your financial needs would depend on your unique circumstances. For illustrative purposes, we look at three arrangements here:
These three examples are shown for illustrative purposes only. But they do indicate how ISAs and pensions could potentially be combined to take advantage of different tax efficiencies and meet different financial circumstances.
At Schroders Personal Wealth, one of our key principles is to have regular reviews with a financial adviser. This can help ensure your financial arrangements remain in step with your evolving financial circumstances and that you are making the best use of available tax-efficient opportunities.
| ISA | Pension | |
|---|---|---|
Age you can invest | From age 16 for cash ISAs, 18 for stocks and shares ISAs, 0 for Junior ISAs (JISAs) | Age 0 to 75 |
Age you can withdraw | From age 16 for cash ISAs, 18 for stocks and shares ISAs, 18 for Junior ISAs. Age 60 or to buy your first home for a Lifetime ISA | From age 55 (age 57 after 6 April 2028), possibly earlier if you’re seriously ill and meet certain conditions. |
Amount you can invest each year | £20,000 for 2023/24 tax year, £9,000 for Junior ISAs | Usually (but not always) £60,000 or 100% of your earnings (whichever is the lower) for 2023/24 tax year |
Total amount you can invest | As much as you like | As much as you like |
Income tax – putting money in | You’ve already paid tax on the money you put in | Taxpayers could benefit as money goes straight in without having to pay income tax on it. This will also lower income overall, which could save even more on income tax |
Income tax – taking money out | No income tax to pay | 25% is tax-free, and there is income tax to pay on the rest |
Capital gains tax | No capital gains tax to pay | No capital gains tax to pay |
Inheritance tax | Included in your estate unless passed to a spouse or civil partner | Not included in your estate if you’re under 75. Counts towards heirs’ income tax if you’re aged 75 and above |
Types of investment allowed | Cash, shares, government and corporate bonds, and investment funds | Cash, shares, government and corporate bonds, and investment funds |
Employer contributions | None | Possibly some |
Technical detail in this article comes from the Gov.uk website (www.gov.uk).
This article is for information purposes only. It is not intended as investment advice.
Fees and charges apply.
The retirement benefits you receive from your pension plan depend on a number of factors including the value of your plan when you decide to take your benefits which isn’t guaranteed and can go down as well as up. The benefits of your plan could fall below the amount(s) paid in.
The value of investments and the income from them can fall as well as rise and are not guaranteed. The investor might not get back their initial investment.
Tax treatment depends on the individual circumstances of each client and may be subject to change in the future.
Cash savings and investments are protected to the value of £85,000 per person per institution by the Financial Services Compensation Scheme (FSCS).
In preparing this article we have used third party sources which we believe to be true and accurate as at the date of writing but can give no assurances or warranty regarding the accuracy, currency or applicability of any of the contents in relation to specific situations and particular circumstances.
Any views expressed are our in-house views as at the time of publishing. This content may not be used, copied, quoted circulated or otherwise disclosed (in whole or in part) without prior written consent.
