On his Youtube channel, financial planner Chris Bourne explained how people can balance these two concepts to provide “a great lifestyle in retirement”. He mentioned the mistake people make when paying into their ISAs for retirement.
Britons can save tax free with Individual Savings Accounts (ISAs).
Every tax year people can put £20,000 into an ISA.
The tax year runs from April 6 to April 5.
People can save up to £20,000 in one type of account or split the allowance across some or all of the other types.
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Mr Bourne said: “A big pension mistake I see people make is stopping pension contributions prematurely in order to solely fund ISAs.
“The reason they do this is simple, they realise that all gains can simply be taken out of ISAs tax free whereas pension withdrawals are subject to income tax.
“What they fail to realise though is the power of compound interest on the tax relief awarded on top of their pension contributions.
“This is money physically added to pension contributions for you by HMRC.”
Mr Bourne explained ignoring pensions solely in favour of ISAs “can harm retirement” for people.
It is important to be aware of pension mistakes and avoid the pitfalls which could potentially save someone thousands of pounds within their lifetime.
Another mistake Mr Bourne mentioned was trying to avoid the lifetime allowance charge on pensions.
People are doing this by inhibiting the growth they can achieve on their pension investments.
The Lifetime Allowance is the total tax efficient amount of money people can hold in pensions in their lifetime.
The Lifetime Allowance for most people is £1,073,100 in the tax year 2022/23 and has been frozen at this level until the 2025/26 tax year.
If people exceed the threshold, they are liable to pay an additional tax charge on the excess amount when they crystallise their pension.
He said: “Limiting the amount of growth you can achieve just to avoid paying more tax is pointless.”
Mr Bourne gave an example. If someone is already £100,000 over their lifetime allowance and they do not want to make the tax charge any worse so they invest their money in a way they only get one percent growth, they will lose out.
Over 10 years, their £100,000 will be £110,462, but if they crystalised their whole pension pot, and transferred the excess into drawdown, the tax would be £27,615 (25 percent), leaving people with a net excess of £82,846.
If these funds kept on growing and there was five percent annual growth, over a 10-year period, the £100,000 excess would have grown to £162,889.
The tax charge on this amount would be £40,722 (25 percent), which is more money, but the net excess would be £122,166. This is a £40,000 improvement.
As a result, Mr Bourne added: “Don’t cut your nose off to spite your face by avoiding growth.”
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