Blog: To ISA or to pension – that is the question
In this blog Norman Dalgleish discusses strategies for saving and the benefits of the new pension rules.
Following the recent reforms of pension rules, which overall are highly beneficial to savers, the question has arisen as to whether people should be putting more money into their pension and should they change their strategy in relation to other forms of saving. While this question can only be answered properly when you have taken your own unique situation into account, we are able to come to some general conclusions:
The most important issue now for anyone facing the choice of whether to bolster their Individual Savings Account (ISA) or their pension is when they want to access that money. If you are happy to leave the money locked up until you are 55 (the age at which you can start to drawdown from your pension – you can access your ISA savings at any time), then pensions seem to trump ISAs as the most effective way to save. But this is a big question, and age bears a huge influence on the right decision.
If you are in the your 20s you might not think you need the money for another 30 years, but throw in kids, a mortgage and the general presumption that circumstances can change and you might want to have access to a larger part of your savings. If, however, you are nearer the 55 threshold (it’s changing to 57 from 2028) then having that lockdown doesn’t seem so onerous.
So, what makes pensions in general a more generous saving system? During the period when the money is inside the wrapper, the advantages for pensions and ISAs are much the same in that they are both shielded from taxes; they differ in that you pay your income tax before you invest your money with an ISA (you invest money gross of taxes in a pension), whereas you pay income tax when you redeem your money from your pension wrapper.
The first advantage comes in the fact that 25 per cent of your pension can be taken out tax free – no such bonus shield exists on entry or exit for an ISA. So therefore under most circumstances you will benefit more in money terms from a pension, given the combination of the tax relief at the start and the 25 per cent relief on the total amassed. This uplift is then even greater for those whose marginal rate of income tax during drawdown is lower than it was when the pension contributions were made.
Taken to an extreme, there is an argument that some, particularly those close to or over 55, should be taking existing ISA savings and using these to fund pension contributions to the maximum level possible (up to the annual allowance, or the level of earned income if lower) due to the immediate uplift provided by the tax treatment of the pension.
As I said at the start, everyone’s circumstances are different, so any decision has to be taken within your full financial context. But it’s safe to say that more people should be taking advantage of the new pension arrangements.
- Norman is a senior financial planner at Turcan Connell Asset Management, you can view his profile here.