An ISA (individual savings account) is often assumed to merely be a vehicle for saving cash. Yet it can also be a powerful tool for retirement planning. In fact, it can be argued that ISAs can be a credible alternative to pensions. In this article, our financial planning team here at Vesta Wealth offers their thoughts on how these can be utilised to prepare for a comfortable retirement, also including respective strengths and weaknesses to consider. We hope you find this article useful and invite any questions you may have about how this could affect your financial plan, via:
t: 01228 210 137
e: [email protected]
ISAs – their potential for retirement purposes
In 2020-21 the ISA rules stipulate that you can save up to £20,000 into your ISA accounts – provided you are a UK resident. There are different types of ISA including the Cash ISA (which offers low risk and easy access to your money) and investment style ones such as the Stocks & Shares ISA and the Innovative Finance ISA (e.g. allowing you to engage in peer-to-peer lending). These latter two offer more investment risk but also a higher possibility of return.
One of the compelling reasons to consider using your annual ISA allowance is due to the tax benefits. At present, anything invested in an ISA can grow with interest, capital gains and dividends, without attracting taxes. Over time, this offers you the potential to accumulate a large tax-free portfolio. For instance, suppose you saved the maximum amount (£20,000) every year over the next ten years. That could result in £200,000 saved into your ISAs – even setting aside the investment growth you would likely achieve in that period.
When you retire, therefore, you could withdraw some of this money (tax-free) for an income and keep the rest invested. This offers a significant advantage over pensions which are subject to income tax (e.g. 20% for basic rate taxpayers and 40% for those on the higher rate). There is also no cap on the total amount you can save into your ISAs. Pensions, on the other hand, have a lifetime allowance of £1,073,100 in 2020-21 – with a large tax charge if you go over it.
Where pensions offer more advantages
ISAs were not originally designed for retirement savings (although they can be used in this way and there is arguably one exception – the Lifetime ISA). Pensions, however, have tax incentives built into them to encourage people to save for their life after work. In 2020-21, for instance, anything you put into your pension(s) receives tax relief at your rate of income tax. In other words, a basic rate taxpayer receives an extra 20% from the government on their pension contributions (those on the higher rate get 40%).
This effectively amounts to ‘free’ money, and this becomes even more powerful when also put alongside the UK’s auto-enrolment rules. At the time of writing, these require your employer to put at least 3% of your salary into your workplace defined contribution pension (you must also put in at least 5%). Taken together, these two benefits of a pension can open up the possibility for greater investment growth compared to retirement savings put into an ISA (which are made after tax, receive no tax relief or top up from your employer). There is also another very nice aspect to certain types of pension – they can be inherited by beneficiaries without incurring any inheritance tax (IHT). However, this benefit is not strictly open to defined benefits pensions or to most state pensions, which generally do not provide a pot which can be passed on.
Pensions can come with their disadvantages, however. Firstly, a workplace pension can be quite limited in the investment opportunities available to you. It could be that your scheme does not put your money into high-performing, competitively priced funds, for instance. Or, perhaps the investments are too heavily weighted towards a particular industry or region (e.g. the UK). Pension savers can address this, however, by considering other options such as saving into a SIPP (i.e. a self-invested personal pension) which tends to offer much wider investment choice.Bear in mind, however, that this will likely not receive any contributions from your employer.
Secondly, pension schemes can sometimes present punitive charges if you try to move from one scheme to another. ISAs do not ‘punish’ you in this way. These penalties may still be worth it if you decide that the benefits of moving outweigh the downsides, but they still eat into the returns you have spent many years generating. Here, it can be wise to seek independent financial advice to survey your options and make the best decision for your unique financial goals and situation. Thirdly, pensions do have a limit on how much you can contribute to them each year. In 2020-21 this cap stands at £40,000 per year or 100% of your salary (whichever is lower). Yet this can sometimes be mitigated by accessing unused allowances from the previous three financial years.
Invitation
We hope this content has inspired your thinking. If you want to start a conversation about your financial plan and retirement strategy, then we would love to hear from you. Get in touch with your Financial Planner here at Vesta Wealth in Cumbria, Teesside and across the North of England.
Reach us via:
t: 01228 210 137
e: [email protected]
This content is for information purposes only. It should not be taken as financial or investment advice. To receive personalised, regulated financial advice regarding your affairs please consult your Financial Planner here at Vesta Wealth in Cumbria, Teesside and across the North of England.