ISA or pension? Here’s how both could rescue your retirement

The pension vs ISA debate is a popular one when it comes to retirement, due to their different tax and access features. But rather than looking at this as a binary either/or option, we argue that a both/and approach will bring the biggest benefits in the future.

| 7 min read

The UK government has established two tax-efficient regimes to encourage people to save for the future: pensions and ISAs. They work in different ways, as illustrated in the table below, but combining the two within your retirement income plan could provide you with greater flexibility in the future.

Essentially, you fund your ISAs from taxed income. But all capital growth, interest and income generated within the account are tax free, and you can take any amount of money out of your ISA without paying any taxes or even declaring it to the tax man.

Pension savings are funded from untaxed income. Employers often deduct your contributions from your salary before calculating income tax and National Insurance, and you can claim income tax rebates for contributions into your private pension pots. Again, any growth, interest and income generated within the account is free from tax.

But when you come to access your pension savings, you can generally take up to 25% of it tax free with the rest taxed as income in the usual way. The tax-free element can be taken as a lump sum, or you can decide to use it each time you make a withdrawal. The tax treatment of pensions depends on individual circumstances and is subject to change in future.

Pension vs ISA: how are they different?

Age from which you can invest16 for a Cash ISA; 18 for a Stocks & Shares ISA; 0 for a Junior ISA0 to 75
Age from which you can withdraw16 for a Cash ISA; 18 for a Stocks & Shares ISA; 18 for a JISA (converts to an ISA)55 currently although it’s possible to access earlier if you have a life limiting health condition
Amount you can invest£20,000 for a Cash or Stocks & Shares ISA; £9,000 for a JISAUp to £60,000 or 100% of your salary if lower
Total amount you can investUnlimitedUnlimited
Income tax position when fundingFunded from income after tax.

Contributions taken before tax in many employer schemes. Contributions paid net of basic rate tax in private pension schemes (pension promoter claims this back from the government); higher and additional rate taxpayers claim tax rebates via self-assessment forms.

Capital Gains Tax position when withdrawingNo Capital Gains Tax to payNo Capital Gains Tax to pay
Inheritance Tax (IHT) situation on death

Treated as part of your estate. And if you haven’t used all your allowance for the year, your spouse or civil partner has the ability to add it to their own allowance. It’s as if you had used some of your estate to make your full subscription which is then inherited tax free by your spouse or civil partner.

Outside of your estate. Can be taken tax free if you die before the age of 75; taxed as income if you die after the age of 75.

*Correct as at 22 December 2023

How ISAs and pensions work as a winning team

Pensions offer much greater tax advantages up front, especially for higher rate taxpayers, but you can’t touch your savings until the age of 55 (rising to 57 from 2028). ISAs have less tax advantages up front but provide the flexibility to be able to withdraw money at any time tax free. And with a flexible ISA – like the Charles Stanley Direct Stocks & Shares ISA – you can access the ISA like a savings account. You can take money out and return it in the same tax year without it counting towards your annual allowance, though bear in mind that investments are best left undisturbed for the long term.

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 tax efficiency.

Is an ISA or a pension best for retirement income?

Accessing your ISA is straightforward: any money you withdraw is free from income tax and capital gains tax. This can be a really useful boost to your income in later life.

Not being able to access your pensions until the age of 55 can limit any dreams of a really early retirement. But your ISAs can come up trumps by providing you with access to tax free money to fund your lifestyle. Even if you don’t have enough to fund yourself fully, they can provide the freedom to move to part-time or consultancy work, with the peace of mind your essential spending is covered. Even more so when you reach the age of 55 and have the freedom to tap into your pension pots, too.

But even if you don’t want to retire before the age of 55, your ISAs can provide an important part of a retirement strategy. Taking money just from your ISAs in the early years of your retirement 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.

If you don’t take the 25% tax-free lump sum, the first 25% of any withdrawals from your pension would be tax-free with the remaining 75% taxed as income. By using your ISAs to generate tax free funding you can reduce the total amount you take from your pensions, keeping your tax bill as low as possible.

Manage your ISAs and pensions in one place

Using both ISA and pensions for retirement offers flexibility to dip into your savings from time to time, while also taking advantage of different tax efficiencies. It’s therefore likely you’ll need to manage more than one account. An online platform that can host your investments and cash savings in one place can really help with this.

With our Direct Investment Service, you can open and choose between a wide range of accounts to suit your financial goals You can also switch between savings and investment accounts quickly and easily, although this is dependent on the different rules and investment limits outlined in the table above.

Speak to someone about your options

Pension freedoms provide greater flexibility when you come to retire but this also brings complexity. Making the wrong choices can have repercussions later so you need to make the most informed decisions you can. Everyone’s situation is different and a conversation with a financial professional could help you understand what you might be able to achieve based on your circumstances and goals.

The Retirement and Savings Plan from Charles Stanley OneStep Financial Plans can help you take control, so you have financial security and flexibility over when and how you retire. For a fixed fee (£900 inc VAT), you will receive expert guidance from a qualified financial planner who will help you understand your current situation and provide you with a written action plan, and additional tools and materials, tailored to meet your needs.

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Nothing on this website should be construed as personal advice based on your circumstances. No news or research item is a personal recommendation to deal.

Are you ready for Tax Year End?

Tax years run from April 6 to April 5 and in most cases if you don’t use the various allowances before the end of the tax year they are lost forever. Find out how to save tax with an ISA, SIPP or Junior ISA.

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