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Where is the best place to put your hard-earned cash, if you want to save for a rainy day? A common question we are asked by clients is whether an ISA or pension is the best vehicle.
ISAs are perhaps the most attractive alternative to pensions:
- There isn’t any tax relief on contributions but while your money is in an ISA it is sheltered from income and capital gains tax in the same way that it is in a pension.
- You can withdraw your money without any tax being deducted, which is better than the 25% tax free lump sum you get from a pension.
- You can take your money out at any time, whereas pensions make you wait till you are 55 (and this age is soon to rise).
- ISAs can hold pretty much the same wide range of investments as pensions can.
However, there are a few factors in favour of pensions to consider:
- Money held in a pension can be passed on free of inheritance tax, while an ISA forms part of your estate (though from April 2015 it has been possible to pass on your ISA allowance to your spouse).
- The maximum ISA contribution is £15,240 per year, whereas you can pay up to £180,000 into a pension each year without triggering the annual allowance tax charge (the effective limit varies person by person).
- You get instant tax relief when you contribute to a pension, adding at least 25% to your initial investment, and potentially as much as 81%.
- Pensions remove the temptation to spend the money while you are young!
- You may be able to get matching employer contributions to a pension, doubling your money.
- Pension contributions can stop you losing your child benefit, or your personal allowance, depending how much you earn
The choice between an ISA or pension isn’t binary, and the right answer is usually a mix of the two, depending what your income and tax situation is. Pensions offer an initial tax saving that few other investments can touch, but if you know you will need the money before you reach retirement then ISAs have a lot going for them.
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