According to HMRC, 45% of savers in stocks and shares ISAs are aged 55 or over. These savers already understand the mantra of ‘gross is good’ and have chosen an investment on which there’s no additional tax due on investment growth and income. What many investors seem to be unaware of is that the exact same tax treatment is available on funds held within a pension.
ISA savings can be dipped into at any time, there’s no need to wait until reaching age 55, so an ISA has its place if saving towards life events that are likely to occur before this age, or simply as a ‘rainy day’ fund. However, that freedom could be an unwelcome temptation for less disciplined retirement savers.
But what about those savers who don’t need access or are close to, or over, 55? Which of these investments will give them the most spendable income or provide the greatest inheritance for their families? One area where pensions and ISAs differ is on the tax breaks given to individuals when payments are made, and when funds are accessed.
Pensions enjoy tax relief on contributions. For Defined Contribution schemes, savers will normally pay in an amount net of basic rate tax, with the provider adding basic rate tax to the fund. Any higher or additional relief is claimed through self-assessment. So a £10,000 pension contribution will require a payment of £8,000. A higher rate taxpayer would be able to claim a further £2,000 tax relief via their tax return and this will reduce the tax they pay on their other income. So the net cost to an investor paying higher rate tax is £6,000.
There’s no tax relief for payments into an ISA.
Up to 25% of the pension fund can be taken completely tax free. The balance is taxed at the saver’s highest marginal rate of income tax.
All withdrawals from an ISA remain tax free.
Deciding how best to use these valuable tax efficient ‘wrappers’ follows on from the more important decisions around what you want your financial future to look like if it’s to deliver the fulfilled life you deserve. Get your financial plan right and choosing the right product wrappers to get you there becomes far clearer.