I came across a debate about pensions and ISAs in the pub just recently. It only goes to show that many everyday financial issues still confuse most people. As it happens, the debate was between friends of mine and I arrived (late) to find them locked in discussion. There was a sort of time delay – you know, like an overseas phone call – before one of them remembered I am an Independent Financial Advisor and therefore might be able to help them resolve their dispute.
My mate Mike said “I’ve got some money – a few thousand – and I want to put it towards my retirement (This provokes laughs and ageist comments from the others), Should I put it in my pension or an ISA?”
Here’s (roughly) what I said…
Pensions have the advantage of the government giving you tax relief on contributions, effectively meaning that a £1 contribution will cost a basic rate tax payer 80p. Growth on the pension fund investment is free of Capital Gains Tax and you have the option to take 25% of the value of your pension fund as a tax free lump sum. However any income which you draw from the pension will be subject to income tax.
However, recent cash-strapped governments have been tinkering with pension regulations in an attempt to balance books and retain more money in the Exchequer: The lifetime allowance for contributions has been slashed from £1.8 million to £1.5 millions and the annual allowance for contributions has been decimated to £50 000 from £225 000. And you can’t get your hands on your lump now until you’re 55, not 50, as it used to be.
All this has meant that ISAs have been seen in a better light as another string to the retirement planning bow. With ISAs there is no tax relief on contributions but (like pensions) all earnings (from investments, interest etc) from an ISA are tax-free. And, unlike pensions, there are no restrictions on what you can do with the money. Furthermore, any income drawn from an ISA is not subject to income tax.
There is no quick answer to the pension versus ISAs question. ISAs offer excellent flexibility, which is good if the government decide to carry on tweaking the pension regulations. But pensions remain highly effective as a tax shelter because of tax-free contributions. The solution is to seek advice based on your personal circumstances – and it doesn’t have to be an either/or scenario. Many people’s retirement planning portfolios have mixtures of the two and indeed other investments.
“That’s a bit clearer” said Mike “But I still don’t know what I should do”
“Well, it all depends on your own circumstances, Mike, so I suggest you see a good Independent Financial Advisor!” I retorted
“Do you know one?” Mike shot back.
Everyone laughed again.
I suppose I deserved that one.