Many of our clients will be aware of the advantages that can come from tax free saving with an ISA or pension to save for your future. If you are not currently a client however, or are unfamiliar with the tax benefits available, then it is worth briefly recapping just what you could be missing out on!
Both pensions and ISAs offer various ways to reduce the amount you pay in tax. Though there are many different types of pension – and two different types of ISA – the main difference between the two is broadly that, with a pension, you are typically locked in to saving for longer, whilst with an ISA you could access your money whenever you wanted to, though this may affect the returns you generate.
Deciding on which one is right for you or whether actually, as many clients do, that you would like to pursue both options, is a matter for each individual’s financial planning. If you are saving for an income in retirement, for example, then typically a pension would normally be appropriate. If you are perhaps planning on a large purchase in your 50s then it could be that an ISA, along with other more sophisticated financial planning strategies, can help you to achieve that.
The tax benefits of both savings options can be significant and are worth considering when deciding on your financial plan. ISAs present the promise that, in most cases, you pay nothing on any income you withdraw from your ISA account. The money you put in will more than likely have been subject to income tax already, so rather than taxing the money twice, ISAs allow you to report a gain, without incurring another tax bill. Depending on how and when the money is invested, and how long it is invested for, the gains from ISAs can potentially be sizeable, so the fact that there is no tax to pay can form significant extra income.
Pensions, meanwhile, save on tax at source. By paying in to a pension, you do not need to pay income tax on the sum submitted to your pension savings, as you do with the rest of your income. When you retire and gain access to your pension, you can take 25% of it tax free and then pay a rate of income tax on anything else you withdraw from your pension pot. If this amount lands you in a lower tax band than you had when you were working, then you could make a further tax saving here.
When it comes to deciding on how to leave your inheritance too, there is also a decision to make on how you save and pass on your wealth. More pensions than ever will now avoid the so-called ‘death tax’, which saw some pensions taxed at 55% before they were passed on to beneficiaries. This potentially makes pensions a very good option for passing on wealth, as ISAs form part of your estate for Inheritance Tax purposes, whilst pensions do not. If your estate is worth more than £325,000 on death, anything above this amount is taxed at 40%.
As you can probably tell from the above, careful individual financial planning can really help to make sense of when ISAs and pensions can be most beneficial for you and your family. There’s little doubt, though, that as part of a properly conceived financial plan, both could help to provide a real boost to your savings, helping you out in both the short, medium and long term.