How you save for your retirement is one of the most important decisions you will ever make. Not having something in place is no longer an option, but with the savings options available today, choosing the right format for you and your circumstances is not an easy thing to do.
In this article, we will analyse the pension or ISA argument (primarily looking at Self Invested Personal Pensions – SIPPs for short) to help you make a more informed decision.
Understanding how much money you will need in retirement
Many people tend to overestimate how much money they need to live to the standards they are accustomed to in their retirements. A common understanding is that you will need between half and two-thirds of your final salary. But it all depends, of course, on what sort of standard of living you aspire to achieve.
Research undertaken by the Loughborough University and the Pensions and Lifetime Savings Association (PLSA) suggests the following guidelines:
- To achieve a minimum standard of living – £10,200 per annum (£15,700 for couples)
- To achieve a moderate standard of living – £20,200 per annum (£29,100 for couples)
- To achieve a comfortable standard of living – £33,000 per annum (£47,500 for couples)
According to Which, in August 2019, the state pension provides those with the maximum NI contributions as follows:
- Men – £8,329 per annum
- Women – £7,933 per annum
- Couple – £16,262 per annum
So, to enjoy a moderate standard of living, a couple needs to get another £13,000 per annum over and above their state pensions, but there is no accurate way of predicting the length of one’s retirement.
Most people would, of course, prefer a comfortable standard of living, which means having a pension or ISA that provides £31,000 in addition to the state pension. That is a serious amount of money – especially when you consider it would hopefully be required for many years to come.
The differences between pensions and ISAs
The first thing to remember when contemplating pensions vs ISAs is that both are tax-efficient ways of saving money, making them excellent choices when it comes to large, long-term investments. The same also applies to SIPPs. But there are crucial differences between the products that you need to understand when considering a pension or ISA for retirement.
These differences have to do with access and tax. Let’s look at access first.
Pensions vs ISAs – accessibility
If you search around, you will find that you can access similar investments whatever your choice – pensions or ISAs.
You can often get access to the same – or very similar investments whether you are investing in a pension or an ISA. The product which works best for you will probably depend on your savings goal. If it is specifically for your retirement, a pension is a purpose-built vehicle.
But because retirement is the aim of a pension, your money is tied up until you reach 55 (from 2028, the access age changes to 57). You cannot be tempted to spend it before you reach the access age – the same applies to SIPPs.
With an ISA, you can access your pot at any time. While it is not ideal from a temptation point of view, if you need access to cash to cover an emergency or any other significant expenditure, an ISA gives you this option. Please note, however, that this does not apply to fixed-rate Cash ISAs.
Pensions vs ISAs – annual contribution allowances
How much you can invest in pension or ISA package each year also changes. With pensions or SIPPs, you can invest as much as you like. However, you only get tax relief up to £40,000. Anything after that will be subject to tax.
With an ISA, the maximum annual personal allowance is £20,000 per annum, and if you are running more than one type, the allocation is split between the different accounts.
The other thing you should know is that the ISA personal allowance cannot be carried over into the following year, whereas with pensions or SIPPs, it can be carried forward for up to three years.
Pensions vs ISAs – taxation
While pensions, SIPPs, and ISAs are all tax-efficient vehicles, the way that tax is dealt with differs depending on the product. So when considering the ‘should I invest in pension or ISA’ question, here’s what you need to know about how they are taxed, starting with any contributions.
There is no tax relief on ISA contributions, but there is with pensions and SIPPs. The taxman allows tax relief on up to £40,000 per annum or 100% of your annual income (whichever is smaller). You can invest more than £40,000 but, if you do, it will be subjected to tax.
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Any profits generated from pensions, SIPPs or ISAs will not be taxed.
The way that withdrawals are treated with regard to tax is, however, different.
With an ISA, you can withdraw as much as you like, when you like. With a pension or SIPP, you can only withdraw 25% of your pot tax-free. Any withdrawals over and above this will be taxed.
Pensions vs ISA – inheritance
With regards to the pension ISA UK scenario, the following applies.
With the state pension, for married couples or couples in a civil partnership, where both parties reached pensionable age prior to the 6th of April 2016, when one partner dies, the other could be entitled to receive a higher state pension. It all depends on the deceased partner’s NI contributions and only applies where the surviving partner has not managed to build up the full state pension.
In terms of ISAs and SIPPs, upon your death, your fund will be transferred to your nominated beneficiary. In the case of a Self Invested Personal Pension, where the death occurred before the deceased person’s 75th birthday, the fund is transferred without any tax liability.
With an ISA, however, on transference, any funds will be subject to inheritance and other taxes.
Which is best – a pension or ISA for self employed people?
If you are self-employed, you cannot benefit from a workplace pension. The options open to you are an ISA or a SIPP. You must consider what is most important for you.
- Being able to make tax-free contributions up to £40,000 per annum.
- Being able to access your savings as and when you need to.
It is worth pointing out that a Lifetime ISA (LISA) also offers an attractive benefit as it offers a 25% boost to savings worth up to £4,000 in any tax year – it means a potential top-up of £1,000 per year from the government.
A personal pension or stocks and shares ISA – which is best for you?
Deciding between ISAs or pensions is no easy thing. But is it really necessary? Why can’t you have the best of both worlds?
Most people have a range of savings goals. While everyone wants to enjoy a comfortable retirement, taking foreign holidays, buying a new car from time to time etc., they also want to have access to their savings as and when they need them.
Why does it have to be a question of asking, ISA or pension, which is better? If you can afford it, why not have both?
If you can’t make up your mind right now, you might want to put the decision off until a later time, and part of your thinking might revolve around “can I move my pension to an ISA if I change my mind”? The answer is both yes and no.
Ordinarily, you are not allowed to move your pension funds across to an ISA. But that is not the be-all and end-all. When you reach 55, you can access the money in a personal pension, so at that stage, there is nothing to stop you from transferring the money into an ISA if that is your wish.
Why choose a stocks and shares ISA?
On its own, the state pension may only provide enough to fund a minimum standard of living in your retirement. Taking out a personal pension or a SIPP, in addition, could provide the extra cash you need. But if you do need access to your savings before the age of 55, you will find yourself hamstrung.
In this instance, the decision between personal pension or Stocks and Shares ISA is quite clear-cut. The ISA option gives you easy access to your pot should you need it, and the returns your investment could make will outstrip inflation if history is anything to go by.
The risk is minimised by investing in the long term and by purchasing a diverse range of stocks and shares for your portfolio. But at the end of the day, you do need to be willing to take a degree of risk.
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