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ISAs vs Pensions - which should people invest in?

14th March 2017 Print

With the tax free allowance on savings now set at £1,000, people are beginning to consider what the benefit is of investing in an ISA and whether there are other options, such as pensions, that they would be better off investing in.

There are many similarities between ISAs and pensions, for example both grow free of income tax and capital gains tax, neither incur capital gains tax when they are accessed and both can be used to invest in a range of different instruments such as cash, shares, bonds and commercial property.  Whether it’s best to invest in an ISA or a pension essentially comes down to people’s individual circumstances.

Why pensions?

The recent changes to pensions tip the balance when it comes to inheritance tax planning.  Pensions are generally outside of the estate when calculating the inheritance tax liability and can now be passed to any nominated individual, including children and grandchildren.

Unlike ISAs, with a pension people can benefit from tax relief on their pension contributions, making them particularly attractive for higher earners while the pot is building up. However, the income you take from them later on is subject to income tax.

If people are employed, employer payments boost their contribution and are often tiered, meaning the more the employee pays in the more the employer will contribute.  Who can resist what is essentially free money?

Pensions can only be accessed after age 55, so may not be suitable for people who need access to their money sooner.

Why ISAs?

Unlike pensions, ISAs don’t attract tax relief on contributions, but any income taken from them later on is tax free.

ISAs are also a more flexible option as they can be accessed at any point, so they are suitable if people require access to their savings before they reach age 55.

Everyone needs to have a pot of cash for immediate or unexpected expenses which couldn’t be met from their income, and a cash ISA can be a good place to keep this money. For higher or additional rate taxpayers at retirement, ISAs provide the option for additional income or lump sums without incurring any further income tax liability.

Amanda Cook, a financial planner with Saga Investment Services, gives some hints and tips to investors.

“If people are in the position to do so, then they should consider using both their pension and ISA allowances to fully maximise the tax advantages.

“Consider holding cash outside of an ISA to take advantage of the new tax-free interest limits and using the ISA allowance for stocks and shares, particularly give the reduction to the dividend tax free allowance announced in the Budget.   In the current climate, shares may provide a better opportunity for growth and income.  However people need to be aware that there is always a risk their investment may go down as well as up if they invest in stocks and shares.

“People should consider a pension if they don’t need access to the money before age 55 and should think about the bigger picture, working with a financial planner will ensure they are always taking the right action towards achieving their goals.”