How your ISAs could rescue your retirement
- 31 March 2020
- 10 mins reading time
ISAs and pensions are both tax efficient ways to save for retirement.
ISAs can add flexibility to your retirement income strategy.
Combining both can give you further tax efficiencies and flexibility.
If you thought your credit card was your flexible friend, think again. (It’s probably your flexible enemy!) Your ISA could be your real flexible friend, giving you the key to build more flexibility into your retirement income plan.
To encourage us all to save, the UK government has established two tax-efficient regimes: pension savings and ISAs. They work in different ways (see our comparison table below), but combining the two within your retirement income plan could provide you with greater flexibility in the future.
How can ISAs and pensions work as a winning team?
A quick internet search will reveal a raging debate about pensions vs ISAs for retirement savings, but we think you can enjoy the best of both.
Pensions offer much greater tax advantages up front, especially for higher-rate tax payers, but you can’t touch your savings until the age of 55. ISAs have less tax advantages up front but provide the flexibility to be able to withdraw money at any time tax free.
Life doesn’t always go to plan, so using both pensions and ISAs means you can access some of your money in an emergency whilst retaining some tax efficiency.
Pensions are limited to investments of no more than £40,000 a year in a pension pot. If you have more than this to invest, using an ISA can be a great way of benefitting from potential returns free of tax during the investment period.
Investing in both is also a good way to put your eggs in different baskets, a fundamental of wise investing.
So what does this mean for your retirement income?
Accessing your ISA is straightforward; any money you withdraw is free from capital gains and income tax. This can be a really useful boost to your income in later life. Let’s look at three of the many ways in which you can combine ISAs with your pension to fund your post-work life.
You could take money just from your ISAs in the early years of your retirement and draw on your pension when the ISAs are exhausted. This allows your pension to benefit from any further potential growth, and can provide inheritance tax advantages as your pension remains outside of your estate if you die before the age of 75.
You could take annual lump sums from your pension. Of this, 25% would be tax-free cash and the remaining 75% taxed as income. By aiming to keep the taxable element as low as possible any shortfall could be met from your ISA savings.
Where you don’t have sufficient cash available, you could withdraw the full tax-free cash allowance from your pension (currently 25%), use some of it as your first year’s income and reinvest some of it in an ISA for future use. The remainder could be left on deposit in the bank for a year then used to support next year’s spending and/or a further investment in your ISA.
Make a plan to maximise tax savings and flexibility
Using both ISA and pension saving accounts not only takes advantage of different tax efficiencies, it has the flexibility to provide a number of retirement options, and allows you to dip into your savings if necessary. And remember the sooner, and more, you save, the greater the benefits may be.
However, nothing is guaranteed and much depends on future investment returns which are unknown (unless you’re a member of a defined benefit company pension scheme where your final pension benefits are clear). And you may prefer the security offered by purchasing an annuity.
Everyone’s situation is different and a conversation with a financial adviser could help you understand what you might be able to achieve based on your specific circumstances and goals.
All tax details from www.gov.uk, based on 2019/20 tax year.
This article is for information only and is not a personal recommendation. If you’re unsure about the suitability of an investment you should speak to an authorised financial adviser.
Any views expressed are our in-house views as at the time of publishing.
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In preparing this article we may have used third party sources which we believe to be true and accurate as at the date of writing. However, we can give no assurances or warranty regarding the accuracy, currency or applicability of any of the content in relation to specific situations and particular circumstances.
Forecasts of future performance are not a reliable guide to actual results in the future; neither is past performance a reliable indicator of future results. The value of investments, and the income from them, may fall as well as rise and cannot be guaranteed and the investor might not get back their initial investment.
Pensions are a long-term investment. 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.
Always seek a professional opinion as tax rules can be complex, depend on individual circumstances and are subject to change.
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