What to take into account before deciding whether to put money into a pension or an ISA.
If you are looking for a way to save to help meet your financial objectives, you may wonder whether to invest in a pension or a stocks and shares ISA. Both options have their advantages and disadvantages, so it's important to understand how they work and what they can offer you.
A pension is a type of account that allows you to save money for your retirement and get tax relief on your contributions. This means that the government will add money to your pension based on how much you contribute. For example, suppose you are a higher-rate taxpayer and would like to have an additional £100 in your pension.
How much you actually pay into your pension: £80
Amount of basic-rate tax relief added to your pension by the government: £20
Amount of higher-rate tax relief you can claim back through your tax return: £20
This could be £25 if you are an additional rate tax payer.
The total amount of tax relief you earn: £40
The total cost of your pension contribution: £60
There are limits on how much you can contribute and how much tax relief you can get depending on your earnings. There will be tax when you withdraw money from your pension, but with a careful financial plan, you can minimise this tax to ensure a net benefit.
A stocks and shares ISA is another type of account that allows you to invest your money in a range of assets. You don't get tax relief on your contributions, but you don't pay any tax on the withdrawals making it highly tax efficient and available to achieve a broader range of financial objectives.
When might you use them
Your age may influence your decision to invest in a pension or a stocks and shares ISA. Generally speaking, a pension is more suitable for long-term saving, as you can't access your money until you reach 55 (57 from 2028). This means that you can benefit from tax relief on your contributions and compound growth over time. However, a pension also means that you have less flexibility and control over your money; therefore, it could be beneficial to have another type of investment.
On the other hand, a stocks and shares ISA is more suitable for medium-term saving, as you can access your money at any time and without penalty. This means that you can use your money for other goals or emergencies, as well as retirement. Depending on your discipline, a stocks and shares ISA also means you have less incentive to save for retirement, as you may be tempted to spend your money before then!
If you are a business owner, you can contribute to your pension directly from your business account, reducing corporation tax – this is impossible with an ISA and can be an incredible planning tool. There will be another article coming soon on this subject.
The below graph illustrates the benefit of tax relief over the long term. Assuming 5% growth and £8,000 per year investment, you will see that after ten years, you would have £25,000 more in the pension and after 15 years £43,000 more.
As you can see, both options have their pros and cons, so it's important to consider your personal circumstances and financial objectives before deciding which one is best for you.
If you would like to discuss your options, please do not hesitate to contact us.
Article written by Aaron Pitt, Chartered Financial Planner at Kellands Bristol
This article is simply intended to summarise some of the features of ISAs and pensions and does not constitute financial advice. If you need help with investment decisions, speak to an independent financial adviser.