Should you move your ISA into your pension?

Savings

Julie Hutchison

14th May 2015 at 1:13pm

Are you over 50 and thinking about your finances when you stop working? Moving an ISA into a pension could be one way to give your retirement income a significant boost. The case study below shows how £50,000 can turn into £75,000 – a really helpful increase as you approach retirement.

When pensions were more restrictive, it’s unlikely you’d have thought about cashing-in your ISA to pay into your pension. But modern pensions give you access to your money when you want from the age of 55. They also have the added attraction of giving your savings a substantial boost because of the way tax relief works – ISAs generally don’t.

How do the numbers add up?

Let’s assume Tom is 56-years-old, has a salary of £96,000 and stocks and shares ISAs worth £50,000. He has a pension valued at £300,000 and cash savings for an emergency.

If Tom closes his ISAs and pays the £50,000 into his pension, his contribution would turn into £62,500 because of the tax relief top-up in tax year 2015-16. That’s £12,500 the tax man has added to his savings, just because they now sit inside his pension instead of his ISA.

Tom could also choose the same investment funds inside his pension as he used to have inside his ISA. So moving his money is really about changing the ‘tax wrapper’ which sits around his investments and the tax relief top-up on that money on the way in.

And because Tom is a higher rate taxpayer, his finances will get a further uplift if he files a tax return and claims higher-rate tax relief. If he does, he’ll get an income-tax refund of £12,500 from HMRC because more of his income will be taxed at 20% instead of 40%. That’s more money Tom can save for his future.

So far, so good. But there’s a restriction on the annual amount which can be paid into a pension, and this is £40,000. Tom has exceeded this, so needs to use the carry forward rules linked to unused annual allowance from the past three years. Luckily Tom has some carry forward available as he did not make full use of his pension allowances in recent years.

What about inheritance tax?

It’s also worth remembering that money held in a modern pension is normally outside your estate for inheritance tax purposes. It’s different for an ISA which is usually inside the IHT net if your total assets, including property, are worth £325,000 or more, unless an exemption applies. Pensions are useful for passing on wealth, tax efficiently.

A final consequence of an ISA-to-pension transfer is the tax treatment of withdrawals. You don’t pay any tax when you take money out of an ISA. With a pension, 25% of what you take out is tax free, and the rest is taxable, depending on what rate of income tax you pay. But if Tom is going to be a basic rate taxpayer when he retires, then the sums stack up in his favour in terms of the overall benefit of rehoming his ISA money. Indeed, the sums could work out well for him even if he is a higher-rate tax payer in retirement.

Watch out for your annual allowance

Calculating any unused annual allowance is not straightforward because different pensions have varying contribution periods and are not the same as the tax year. And if you don’t get it right, you’ll face a tax charge. You should speak to an expert for help to keep you right.

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This blog is not financial advice. A pension and a stocks and shares ISA are investments. Their value can go up and down and may be worth less than you paid in. Laws and tax rules may change in the future. This information is based on our understanding at May 2015.