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Tax breaks are on offer from the government for savers on every level of income – make sure you make the most of them
Pensions and ISAs are the main vehicles – but working out how much to put in each can be tricky
Finding the right balance will depend on your age and how quickly you might need your money
BACKGROUND
Hands up who wants to pay more tax? We thought so! It’s a no-brainer that we should all make the most of the key tax-efficient ways of saving and investing our hard-earned cash.
But with ISAs and pensions – the main products for accumulating and increasing our money that offer tax relief – what’s the right combination?
It comes down to a very individual combination of factors, and independent financial advice to look at all the options is key. Let’s first of all consider what they are and the advantages they offer.
PENSIONS
Pensions jump out immediately as offering the biggest tax break available for UK savers. This is because for every contribution you make, the government adds tax relief on top, which effectively significantly increases that amount of money.
Basic-rate tax-payers (who pay 20% tax on earnings between £12,571 and £50,270), will see a £80 contribution into a personal pension become £100 through tax relief. That’s a 20% benefit from the government.
And you can make substantial deposits – £60,000 a year for the current 2023/24 tax year (newly boosted from £40,000) annually or 100% of your earnings – whichever is lower.
When you’re ready to take your money, there’s a further tax benefit. You can take the first 25% of your pension pot as a tax-free lump sum, and if you decide to draw down an annuity ontop of that, the first £12,570 comes tax-free, in line with the regular personal allowance for earners.
Pensions are also outside Inheritance Tax planning. So you can choose who receives your pension fund after you die, and they won’t pay Inheritance Tax on it.
ISAS
ISAs don’t have the same tax-relief on contributions as pensions – it’s on the interest or income earned from them. You can currently put up to £20,000 a year into a cash ISA, a stocks and shares ISA or a combination of both. Whatever money you earn from these will be interest-free.
Of course while you know what you’ll be receiving in terms of cash ISAs, with a stocks and shares investment ISA you could lose money rather than make a gain – and you can’t get a tax break on growth you haven’t got! There are thousands of stocks and shares investments available with a tax-efficient ISA ‘wrapper’ – you should always seek independent financial advice before choosing one.
CONCLUSIONS
You’re safe from income tax or capital gains tax with both. So what about the downsides? With pensions of course the significant reason for hesitation, despite the significant tax relief, is that they are a much longer term investment. Pension pots currently can’t be accessed until you’re 55 (which will rise to 57 in 2028). And if you start one now there are penalties if you dip into it before the current UK retirement age of 66 (rising to 67 in the next few years).
ISAs of course don’t have these restrictions – there’s no age limit on when you’re allowed to access your money. Rather it will depend on the terms of your account, for example if you choose an easy access cash account or a fixed rate for three years. But, they count towards your estate and therefore your Inheritance Tax if you die – unlike pensions.
Used smartly, and of course if you can afford to sacrifice the money in the moment and put it away for the long term, pensions can be used to reduce the amount of tax you pay on your income. For example if you’re on Child Benefit, it’s gradually reduced if one of the parents earns over £50,000. But you can put money into a pension and keep that income rate below the £50,000. Similarly, the personal allowance of £12,570 starts to reduce if you earn over £100,000 – putting money into a pension and keeping your income below that threshold keeps you away from that reduction. This is effectively the 60% tax trap. Payments into an ISA work differently, so you can’t use them to these advantages.
The good news is of course that you don’t need to choose one or the other. You can take maximum advantage of the tax benefits of both ISAs and pensions all at once. But few of us will have the luxury of such a large income that we can max out on both. Picking the right combination will certainly depend on your age and your life circumstances – primarily, are you likely to need the money immediately or in the short-term, or are you comfortable for now and can afford to put it away for your retirement or later life. It can be a complex calculation, so seek the advice of your independent financial adviser.
