ISA or Pensions?

Pensions legislation has changed again recently and so too have the allowances on ISAs. Many of our clients ask which tax wrapper they should use. In many cases it’s interesting to see that a pension will more than likely outperform an ISA (assuming the same net contribution and returns) because pensions have the ability to offer 25% of savings tax free when drawn out and upfront tax relief on pension contributions.  If salary sacrifice is used for pension contribution then the pension becomes a clear winner for higher rate tax payers after tax has been taken into account when the benefits are drawn.

For a higher rate tax payer, paying a single (gross before tax relief) lump sum of £25,000 into a pension costs the same as paying in a £15,000 ISA contribution. If the investment is held for 10 years at a real rate of return of 2.5% assuming that the underlying investments etc are the same it makes interesting reading:

ISA

Pension – individual contribution

Pension – employer contribution by salary sacrifice

Original Investment at a net cost of £15,000

£15,000

£25,000

£29,431

Fund value after 10 years

£19,200

£32,000

£37,674

Net spendable value if a 20% taxpayer when savings taken

£19,200

£27,200

£32,023

Net spendable value if a 40% taxpayer when savings taken

£19,200

£22,400

£26,372

Additional assumptions:

  • The personal allowance is not affected by payments in or income taken
  • The pension does not attract any annual allowance charge nor lifetime allowance charge
  • No claim is being made for Child Benefit
  • Tax rates and allowances used are at 2014/15 levels

The main factors affecting the outcome are:

  • 25% of the pension taken is tax free. Everyone benefits from this.
  • Different tax rates between when contributions are made to the pension, and when income is taken.  E.g. you are paying tax at higher rates when you are working and contributing, than when you are in retirement, which will be typical of many people.
  • National Insurance savings as a result of salary sacrifice are paid into the pension.

So far the conclusions drawn are based on the tax reliefs available and using the same assumptions in terms of the returns etc. A number of other considerations need to be taken into account such as:

  • ISAs will obviously be preferable over pensions for savings that you will need access to before age 55.
  • The proposals for the new pensions world still have some way to go, and final legislation could also influence strategy.

For further information or advice on this subject, contact Simon Claxton on 0118 923 5090  or complete an enquiry form.

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Author: Simon Claxton | June 19th, 2014

Contact the author

Simon Claxton
Get in touch:   Reading: 0118 916 5480   London: 020 7036 8767   info@macbeths.co.uk