- Pensions and ISAs
are two powerful tax efficient vehicles
for you as a saver
that can be used to help boost your savings pot.
However, the key question is,
which is more efficient from a tax perspective
And how do you make an informed decision
as to which you should utilize?
In this video,
I will cover a refresher on what is a pension,
the most common types of pension schemes,
the tax benefits of a pension,
what is an ISA, tax benefits of an ISA,
and which is better,
a pension or ISA for tax efficiency.
Before I get into today's video,
be sure to visit our Accounting
and Tax Academy membership area,
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Pensions are designed specifically to help you
as an individual save for your retirement.
You are able to save a relatively
small amount of your income on a regular basis
across your working lifetime,
and your contributions
receive generous tax relief.
Once in the pension plan,
your money is then invested in different assets
and that's dependent
on the risk profile of the plan,
with the aim of increasing
the overall value of your savings,
and then when you eventually reach retirement age,
that money can be distributed
to you in different ways to fund your retirement.
Money saved within a pension pot
cannot usually be accessed
until you, the individual,
is at least 55 years old,
although this varies by scheme.
We've done a very useful video
on three key ways you can access
your pension pot in a tax-efficient way
by clicking on the link
in the description box below.
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There are different types
of pension schemes available to you
and which one you would pay into
will really depend
on your personal circumstances.
The majority of the working
or self-employed population
will be a member of one of the following.
Number one is an occupational pension
established by an employer
to provide benefits to employees.
An occupational pension scheme
could be a defined benefits scheme,
where the benefit you receive on retirement
is based on your earnings
and length of service with your employer,
sometimes referred to as a final salary scheme.
Alternatively, it could be
a defined contribution scheme,
where the benefit you receive on retirement
depends only on the value of the pension pot
at the retirement date.
Number two is a personal pension.
This type of pension is usually
for individuals who are not in employment.
So if you are self-employed
or if you are employed
but want to save outside of your employment,
a personal pension plan
will be a defined contribution scheme.
So the benefit on retirement
is based on the value of the scheme
at the day of your retirement.
You, as an individual,
may also benefit from the state pension,
which is currently set at 179 pounds
and 60 pence per week in the 21/22 tax year,
and contributions are made
via national insurance.
You must have 35 qualifying years
of contributions as things currently stand
on your record to be entitled
to the full state pension
when you reach the state retirement age.
The state pension age
is dependent on a few factors,
and you can quickly check
your specific state retirement age
by following the link
in the description box below
to the government state pension age checker.
Quite often, a state pension alone
isn't usually considered sufficient
to fund an average lifestyle
in retirement here in the UK,
so it is heavily encouraged
that you plan for retirement
by taking out an additional pension
or saving money elsewhere.
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By saving your money in a registered pension,
that is one that is registered with HMRC,
you will enjoy a number of generous tax benefits
that will give your savings a boost.
Those benefits include,
but are not limited to,
tax relief on the individual contributions.
HMRC are often able to give
tax relief on contributions
made by you, the individual,
usually up to the equivalent of 100%
of your net relevant earnings,
or 3,600 pounds, whichever is higher.
Tax relief is usually given
at the individual's marginal rate of tax,
so if you are a higher
or additional rate tax payer,
then you can benefit from 40% or 45% tax relief.
This means that an additional rate taxpayer
who wants to add a hundred pound
to their pension pot
can often do so by contributing
as little as 55 pounds.
Those of you who make large contributions
should be cautious of the annual allowance charge,
which can result in an additional charge
to the taxpayer, that's you,
but this only usually applies
where contributions exceed 40,000 pounds
in a tax year.
Investments within the pension
are able to grow at tax-free.
Any return that investments
within the pension generate
are usually free from capital gains
and income tax.
A tax-free lump sum.
When withdrawing a pension,
a 25% lump sum can be withdrawn tax-free,
whilst the remainder will be subject
to the usual income tax rules,
which may or may not result
in tax being payable
depending on your personal circumstances.
And finally, it is not included
as part of your estate for IHT,
that is inheritance tax.
The value of your pension scheme
is not part of this at all.
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An individual savings account
is another tax efficient vehicle
to house your savings in.
The ISA is not specifically designed
for retirement savings,
but it is suitable for this particular job.
If planned and executed properly,
the ISA offers you, the saver,
more flexibility and easier access to your money,
as some types of ISA
will allow you to access your money
with little or no notice.
You can choose between different types of ISA
to suit your needs and risk appetite.
As an individual,
you have an ISA allowance
of 20,000 pounds per tax year.
As of the current 21/22 tax share,
you can save this amount in one type of ISA
or spread it across a number
of different ISA types,
but you as an individual cannot pay money
into two ISAs of the same type
within the same tax year.
There are a number of different types
of ISAs available in the current market
to suit the different needs of you, the saver.
These include a cash ISA,
similar to a savings account,
except any interest received is free from tax.
Due to record low interest rates,
this type of ISA is currently unpopular with savers,
but as savings rates increase,
it becomes a more attractive option,
as it is extremely low risk.
Stocks and shares ISA.
Savings are invested
into listed stocks and shares.
Any income generated by those investments
is free of tax.
This includes dividend income,
which usually falls under income tax rules,
and any capital gains,
which falls under the capital gains tax rules.
Innovative finance ISA involves your savings
being used to provide peer-to-peer loans.
This is a less well-known ISA,
and as a result,
is generally less popular at the moment.
And a lifetime ISA.
Savings could be in the form
of cash or stocks and shares,
or a combination of the two.
The lifetime ISA shares
a similarity with a pension,
in that contributions can benefit from tax relief,
however, you, as an individual,
can contribute a maximum of 4,000 pounds
per tax year into a lifetime ISA,
and tax relief is only at the basic
income tax rate of 20%,
which means a maximum of 1000 pounds
tax relief can be achieved in any tax year.
The lifetime ISA offers less flexibility,
as to keep hold of the tax relief savings,
must remain in the ISA
until you reach the age of 60.
The 4,000 pound lifetime ISA allowance
is considered part of
the overall 20,000 pound allowance,
so once 4,000 has been paid into a lifetime ISA,
the individual will have 16,000 allowance
remaining for all other ISA types.
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Just like pensions,
any savings held within an ISA
can also enjoy a number of tax benefits,
but they differ slightly
from saving within a pension.
The key tax benefits include
tax relief on some contributions,
only savings in a lifetime ISA attract tax relief
on the individual's contributions.
Contributions to this type of ISA
are capped at 4,000 pounds per tax year,
and tax relief is given
at the basic rate of tax only.
Investments held within an ISA
are able to grow tax-free,
any returns that investments
within the ISA generate
are free from capital gains and income tax.
The treatment is identical for a pension or ISAs.
Tax-free withdrawal.
A hundred percent of savings held in an ISA
can be withdrawn tax-free.
There is no cap on how large an ISA can grow
and how much can be withdrawn,
although savers should be aware
that an early withdrawals,
i.e. before 60 years of age from a lifetime ISA
will result in a 25% charge,
which is HMRC recovering the tax relief
they originally gave you.
ISA balances can pass
to spouses or civil partners.
The value of an ISA is considered
part of an individual's estate
for inheritance tax purposes,
but if passed away spouse
or civil partner on death,
the spouse or civil partner will benefit
from a one-off increase in their ISA allowance,
equivalent to the value of the inherited ISA.
This means that not only do you inherit the ISA
but also the ISA's tax-free status.
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So this leads us on to which is better,
including which is more tax efficient,
and ISA or a pension.
When trying to decide
between a pension or an ISA,
it's important that rather looking
for an outright winner,
you should be looking at which options
best suit your individual circumstances
and your requirements.
Amongst other things you should consider,
how long are you happy to tie up your money for?
A pension is typically a longer term commitment.
What is the reason that you are saving?
For example, a house, a car, retirement,
or just for a rainy day?
An ISA is usually more suitable
if you are not saving for retirement.
Are you already contributing to a pension or ISA?
You should be cautious of the annual
and lifetime allowances.
So here are three simple
advantages of each vehicle.
Pensions provide generous tax relief
on your contributions,
where ISAs generally do not,
aside from the lifetime ISA.
Pensions provide a 25% tax-free
lump sum upon retirement,
and pensions are far more powerful
for higher rate tax payers,
that is 40% income tax rate payers.
ISAs have no tax upon withdrawal of your money,
whereas pensions do.
ISAs offer better protection from politicians,
yes, politicians,
they have a tendency to tamper
with pension rates, allowances and rules,
often changing the goalpost,
particularly the retirement age
when you can access your pension.
With ISAs, you get tax-free withdrawals,
whether or in 20 years time,
regardless of the political party in power.
For ISAs, you don't need earnings
in order to save them.
You can put up to 20,000 pounds per annum
into an ISA with no earnings,
but for pension contributions,
you need to be earning an income.
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The final point to consider is that
it does not have to be a question
of pensions or ISA.
There is nothing stopping you from tactically
utilizing both vehicles
and enjoying the combined benefits,
but this should be done with due thought
and planning first.
If you want to learn more
and go in depth about the pros and cons
of pensions versus ISAs,
including some common scenario
case studies with numbers,
covering directors,
the self-employed family planning,
and non-tax benefits of each
and even more than this,
then head on to our Accounting
and Tax Academy membership area,
where we have produced an in-depth course
on all of this.
This is Tony Dhanjal
for the Accounting and Tax Academy,
and as always, thanks for tuning in.
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