One of the questions I’m often asked is Pension or ISA and we’re talking personal pension or the normal ISA. People have the choice of which one they invest in to have the best tax outcome and here are some ideas about how they are similar and how they differ that might be helpful.
When you invest into a personal pension, you get tax relief, there’s no other investment out there that does that for you, a 20% (at least) leg up on day one; if you’re a higher rate tax payer, 40% leg up on day one – that’s a great opportunity. But you can’t access the money until you’re at least age 55 and in fact the age for access is going up to age 58. So it has to be appropriate for you to leave the money in there for at least that long. If you’re already in your 50’s, then that might not seem like a long time, if you’re in your 30’s it might seem like forever away and you might not be interested in that deal.
In an ISA there is no age restriction when you can access the money that’s in there, but you don’t get that lovely tax relief on the way in. Both the pension and the ISA do enjoy growth which is tax-exempt, so no tax on the interest, dividends or capital growth in the plan; when you come out of an ISA it’s all tax-free, so tax-free returns completely.
When you come out of a Pension however, only a quarter of the money comes back to you tax free, the rest of it is taxed as income in the year that you receive it. So, you get tax relief going into a Pension, tax free growth while you’re in there, but only a quarter of it comes back to you tax free, the rest is taxable as income in the year that you receive it.
In an ISA, no lovely tax relief on the way in, nice tax free growth while you’re in there, tax free exit, so a tick in that box. Don’t forget there’s an age restriction when you access the pension and that might really impact on your decision making. I hope that was useful.