Pensions vs ISAs: How to protect your money ‘tax-efficiently’ – which is better?

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The Retirement Podcast Cafe gives expert advice

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With inflation soaring, many Britons will want to make sure they don’t lag behind as the purchasing power of cash deposits diminish. Consequently, for long-term planning many will turn to investments. But which option will suit people best?

Tim Clay, Wealth Planner at Succession Wealth, shared insight on pensions versus Individual Savings Accounts (ISAs), alongside their benefits and drawbacks.

He firstly stressed it is vital for Britons to ensure their money is working as hard as possible when planning for retirement.

Mr Clay explained: “Whilst both pensions and Individual Savings Accounts (ISAs) may be appropriate vehicles for retirement savings, they do work in different ways and each has its own unique set of rules. 

“However, both are considered tax-efficient ways to save for retirement and making regular monthly contributions, whether into a pension or an ISA, will help to ride out stock market volatility.”

Paying in to a pension can have substantial benefits, as Britons benefit from tax relief, and can take 25 percent of their pot tax free.

They will also be able to carry forward unused relief from three preceding years.

However, contributions are limited to an annual allowance of 100 percent of earnings, or £40,000 – whichever is the highest.

Similarly, there is a Lifetime Allowance of £1,073,100 in 2022/23, above which an additional tax of 55 percent may be payable. 

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Alternatively, there are a variety of ISA options available, each with their own individual rules, but they are still a popular method of saving.

One of the key benefits of an ISA as opposed to a pension is that money can be withdrawn at any time.

In addition, there is no income or capital gains tax paid when a person chooses an investment, or Stocks and Shares, ISA.

ISA investments should be undertaken for the medium to long term, and Britons should be aware there are some risks – as they could get less back than they originally put in. 

There are chances of inflation beating returns with investment, as people ride the peaks and troughs of the stock market. 

However, when it comes to ISAs, there are key issues to bear in mind, which may impact the decisions a person makes.

Primarily, unlike pensions, people who use ISAs cannot get tax relief on the contributions they make.

In a similar sense, the maximum contribution in a year is limited to £20,000 at present.

Employers will not be able to make payments on a person’s behalf into an ISA, so people will have to go it alone.

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ISAs, also dissimilar to pensions, may be liable to inheritance tax (IHT) when a person dies.

As IHT is charged at 40 percent of the value of an estate above a certain threshold, many people will want to avoid this levy.

Ultimately, the decision a person makes has to be taken on a very individual basis, depending on circumstances.

Some may choose one option or the other, while an alternative approach could combine both vehicles when planning for retirement.

Mr Clay concluded: “What is clear is that using all these allowances together may provide the opportunity for you to increase the amount of savings and investments to be sheltered as tax-efficiently as possible.

“As always, taking advice from a suitably qualified financial adviser will help you steer a steady course through the options that are open to you, enabling you to set an appropriate investment strategy whilst optimising your planning from a tax perspective.”

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