28th February 2017 at 9:38am
How do you get the most from your savings?
You want to have the chance to get good returns, easy access to your money when you need it and the ability to pass your wealth on tax efficiently.
There are plenty of options out there, but if you are edging into your 50s or towards retirement and have savings in a pension and ISA, there are three very good reasons why your pension could be a better home for your money now, in the future – and when it comes to leaving a legacy.
Here’s how and why.
1. Pensions are a very tax efficient way to save
What you save into your pension benefits from tax relief, as long as you are within your allowances such as the £1m lifetime and annual allowances.
Tipping your ISA savings into your pension could boost your funds thanks to tax relief at 40% if you are a higher- or 45% if you are an additional-rate taxpayer. It’s 20% if you pay basic rate tax.
Read more about tax relief on your pension contributions in our blog.
Compare that to an ISA, where your savings accumulate tax free but with no tax relief on what you save.
Crunch the numbers
If you tip your ISA funds into your pension, the figures speak for themselves. It’s true even if you pay tax on what you take out of your pension.
The example here shows what your pension could be worth for the same net cost as the funds in your ISA. It assumes you’d pay higher-rate income tax but a basic-rate taxpayer would see their ISA funds boosted too.
|Your ISA savings||What they could be worth inside your pension with higher-rate tax relief||What they could be worth if you take it out of your pension and pay 40% income tax|
*After higher rate tax relief, £16,667 in your pension would cost you just £10,000. Take your money out again and pay higher-rate tax on it and you’d get £11,667, which is £7,500 after tax plus £4,167 of your tax-free cash, giving you a 16.67%, or £1,667, return. The figures don’t factor in any investment returns.
It’s worth bearing in mind that most people pay less tax when they stop working because their total income is less. According to the Centre for Policy Studies, fewer than one in seven higher-rate taxpayers still pay higher-rate tax when they retire.
2. You want to be able to access your money easily
Yes you can take your ISA funds any time but the same is now true of pensions, which are much more flexible than they used to be.
You can access your funds, take a lump sum, take an income or both and take tax-free cash when you turn 55.
3. Pensions pass wealth on tax efficiently
While the numbers speak for themselves, pensions have another distinct advantage.
Compared to ISAs, they are more flexible and tax efficient when it comes to passing your wealth on to your family. It’s something which is hugely important to many people.
In a change brought in as part of the 2015 pension freedoms, you can now choose who you want to inherit your pension pot and they can simply carry on taking an income from it.
They don’t need to have reached the normal pension age of 55 and it means anyone of your choosing, including your children or grandchildren, can get immediate access to your pension fund.
If you die before age 75, there’s no tax for them to pay.
If you die after the age of 75, beneficiaries are taxed on it at their marginal income tax rate, which could be 20, 40 or 45%, or even no tax if it’s within their personal allowance.
Some careful planning on their part around when they take an income from your fund can help them manage how much tax they need to pay.
ISA rules also changed recently. They give a surviving spouse or civil partner an increased ISA allowance equal to the value of their late civil partner or spouse’s ISA at the time of their death.
The ISA inheritance allows them to benefit from continued tax-free investment returns on their late spouse or partner’s investments. However, this doesn’t apply if a couple is living together, or to other family members.
What about inheritance tax?
Passing on the ISA assets – even within the allowance – doesn’t take the ISA out of the surviving spouse or partner’s IHT estate. When they die, the fund could still be liable for a 40% IHT charge where their assets are more than the IHT nil rate band. In short, the assets are still within the IHT estate.
Pensions, on the other hand, are typically free of IHT. Keeping your money within your pension benefits from the same tax-free investment returns as an inherited ISA but your pension can be passed to anyone.
Crucially, those inherited pension funds aren’t part of your beneficiary’s estate for IHT.
Is moving your ISA right for you?
Of course, you may need a mix of savings throughout your life and ISAs have their place.
They are particularly useful for saving up for big expenses such as weddings, education and home deposits when you will need to access your savings in your 20s, 30s or 40s.
But when you’re in the lead up to retirement, it just could make more sense to consider saving into a pension over an ISA because you typically get more spendable income on a like-for-like basis and you can take your money when you want after 55.
Factor in the ability to pass on your wealth – sometimes tax free – as well sitting outside of inheritance tax and the case for doing just that becomes even stronger.