Battle of the tax efficient heavyweights: Pension versus ISA05 March 2019
The end of the tax year is fast approaching, when savers are encouraged to ensure they have made the most of the allowances available to them. And we end up facing that age old question: ‘which should be prioritised Pension or ISA’?
Andy James, head of retirement planning at Tilney, puts forth the case for pensions:
“Pensions are the most tax efficient saving route. Savers contributing into a pension receive tax relief at the same rate they pay income tax, meaning that returns are boosted at the outset which will lead to higher returns than an ISA on a like for like basis. Essentially, for higher rate taxpayers, a contribution of £10,000 will only cost £6,000 after tax relief and for those on the additional rate of tax the net cost of a contribution will be £5,500. In addition to this, you can receive tax free cash on up to 25% of the fund available when you are taking benefits. The annual saving limit for the majority of savers is also a gross sum of £40,000 – significantly higher than the ISA limit of £20,000.
“If we look at a person saving £10,000 into an ISA, and placing the equivalent cash amount into a pension, the difference is quite stark. Assuming a 6% annualised rate of return net of costs for both, over 20 years the ISA saver would end up with £17,908 after 10 years and £32,071 after 20. However, a higher rate tax payer subscribing £10,000 into a pension will see it get topped up by basic rate tax to £12,500. They will also receive a £2,500 tax credit reducing their tax bill for the year. Based on the same timescale and return assumptions, the saver would end up with a higher amount of £22,385 after 10 years and £40,089 after 20 years but for a lower net entry cost of £7,500. Essentially, a higher rate tax-payer would end up with an extra £8,018 return, for £2,500 less cost and they could of course choose to invest the £2,500 tax saving outside the pension as well, for example into an ISA, further boosting returns.
“One of the main aspects of a pension that could have been off-putting to savers in the past was the lack of flexibility over how pension assets could be accessed. However, with the introduction of the pension freedoms in April 2015, savers have considerable choice on how they choose to access their pension after the age of 55 and are no longer required to use their pension to purchase an annuity.
“ISA allowances also suffer from a ‘use it or lose it’ system – if you don’t use your entire allowance by the end of each tax year, it is lost. However, the pensions allowance can, in some circumstances, be mopped up within three years through a mechanism known as ‘carry forward’.
“Saving into a pension can also be beneficial from an estate planning point of view in a way that ISAs are not. Money purchase pensions are outside of the estate for inheritance tax purposes and thus a highly efficient method of passing on wealth.
“But while it looks from the above sums that pensions clearly have the edge over ISAs, it is not as straightforward as you may think.”
On the other hand, Ian Dyall, head of estate planning at Tilney, believes ISAs certainly have their part to play:
“An ISA is the most efficient and flexible vehicle. When taking benefits from an ISA it is all tax free, whereas pension income is taxable. Similarly, while pensions have become much more accessible in recent years, they are still not as flexible as ISAs. An ISA will allow you to access your savings at any given point in time, rather than having to wait until you are 55. ISAs can therefore be used for a wide range of goals such as paying off a mortgage, funding the costs of a degree or dream holiday as well as part of a retirement income strategy.
“Another major benefit of an ISA over a pension is that there is no upper limit on the amount that can be accumulated in them, unlike pensions which are subject to a lifetime allowance, a level of assets over and above which a punitive tax charge will apply when benefits are taken. There have also been various cuts to the amount you can pay into your pension over the years – most notably, the recently introduced tapered allowance for high earners – which is something to bear in mind when planning for the future.
“Finally, an ISA could be beneficial to basic rate tax payers, especially if they are under 40 and able to utilise the Lifetime ISA. LISA contributions are topped up by the government with a 25% bonus but they are designed to be used for two specific purpose: purchasing a first property or retirement.
“The decision between a pension and an ISA will ultimately depend on your individual circumstances and in many case a combination of ISAs and pensions should be used together as part of a financial plan.”
Tilney is a leading investment and financial planning group that builds on a heritage of more than 180 years. Our clients are private investors, charities and professional intermediaries who trust us with over £23 billion of their assets. We offer a range of services including financial planning, investment management and advice and, through our Bestinvest service, a leading online platform for those who prefer to manage their own investments.
We have won numerous awards. Tilney has been awarded Best Conventional Advisory Service at the 2018 City of London Wealth Management Awards, Best Advisory Service in the 2015 City of London Wealth Management Awards; Investment Award – Cautious category in the Private Asset Management Awards; and Stockbroker of the Year, Execution-only Stockbroker of the Year and Self-select ISA Provider of the Year 2015, as voted by readers of the Financial Times and Investors Chronicle. Bestinvest was voted Best SIPP Provider and Best Fund Platform at the 2017 City of London Wealth Management Awards, Best Direct SIPP Provider at the YourMoney.com Awards 2017, Best Stocks & Shares ISA Provider at the 2017 Shares Awards, as well as Best Self Select ISA Provider, Best Online/Execution-only Stockbroker and Best Investment Platform 2017 at the FT and Investors Chronicle Investment and Wealth Management Awards, as voted by readers of the FT and Investors Chronicle.
Headquartered in Mayfair, London, the Tilney Group employs over 1,000 staff across our network of 30 offices, enabling us to support clients with a local service throughout the UK.