This article has not been updated with the Lifetime Allowance (LTA) abolition changes that came into effect from 6 April 2024. Visit our LTA Hub for more information.
What is the right investment?
When you are saving for retirement, you want to make sure that as much of the money as possible goes into your pot, rather than to HM Revenue & Customs. Whether that should be in a pension or an ISA depends on when you need the money, as well as how you are planning to spend it. In fact the best strategy could be a combination of different products.
Pension pros
One of the best things about pensions is the tax break you get: when you pay into the pension you automatically get basic rate tax added to your pension. You can then claim any higher or additional rate tax you paid on that money back from HMRC. Another major positive is that if your provider had discretion over who receives death benefits, it will be classed as sitting outside of your estate, which could make it tax efficient. And finally, when you take money out of your pension, the first 25% is tax-free (up to an overarching limit).
ISA pros
With an ISA, you don’t get the tax you’ve paid back when you put the money in. But your money can grow in an ISA without paying capital gains or income tax. As well as this you are not restricted about when you want to use the money (except with a Lifetime ISA – you can only withdraw it at 60 or to buy a first house).
Caps and limitations
Both ISAs and pensions have annual limits on how much you can invest. You can pay £60,000 a year into a pension (this could rise with inflation) and the current annual limit with an ISA is £20,000. Pensions also have a total limit called the lifetime allowance, which is currently £1,073,100, though you are able to hold more than that in your pension pot.
When you come to take money out of your pension 25% is tax free and 75% is taxable as income. After you have used your lifetime allowance 100% of what you take out is taxable as income.
Spending your money
Money from your pension and money from your ISA are treated differently when you withdraw them. With a pension, after the tax-free 25%, as a taxpayer you’ll pay income tax on what you withdraw. ISA money is not taxed, because you’ve already paid the tax on it. In many cases a mixture of both pensions and ISAs and a carefully planned withdrawal strategy will be the best way to save and spend in the long term.
Speak to your financial adviser, who can consider every facet of your particular situation, and can help you decide which is the best product for you – or how best to combine them.