‘No one over 50 should be investing in ISAs any more’
Savers in their 50s should “think twice” before putting more cash into their ISAs, according to insurance and advisory firm Drewberry Wealth.
With just over a week left to shelter savings from the taxman for 2016/17, Neil Adams, head of pension planning at the firm, said assuming you already have some ISA savings put away by the time you reach 50, it makes far more sense to put your money into your pension instead.
He lists four reasons why savers aged 50+ should prioritise pensions over ISAs:
The tax relief on contributions coupled with pensions freedoms, which allow those aged 55+ unfettered access to their pension pot, is one reason.
Drewberry Wealth encourages many clients who are approaching their 50s to start drip-feeding their accumulated ISA savings into their pensions as they’ll receive tax relief on anything they pay in (within their annual allowance) while regaining access to the fund again in just a few years.
Adams says putting any spare cash into a pension rather than an ISA especially makes sense for 40% taxpayers.
“This is because pension contributions attract tax-relief at your highest marginal rate. This means that anything a higher-rate taxpayer contributes to their pension will receive 40% tax relief as well as the benefit of subsequent tax-free growth within a pension wrapper. Basic-rate taxpayers will receive 20% tax relief.”
2) Withdrawing money
There are big differences between ISAs and pensions when it comes to withdrawing your money and some people may be put off pensions because of a lack of accessibility.
Adams said: “With a pension, your funds are locked in until at least age 55 – which means that pensions aren’t a great home for funds that you’re likely to need back again in the short-term. However, it also means that those aged 50+ who’ve already salted away money into ISAs will only be ‘locking up’ their funds for a maximum of five years.
“You can access 25% of your entire pension pot tax-free so this will essentially be the same as taking money from your ISAs. After this, any pension funds you withdraw will be subject to your marginal rate of tax. But because the vast majority of 40% taxpayers become 20% taxpayers in retirement, they’ll still be significantly better off investing in a pension than an ISA.”
And Adams said that many basic-rate taxpayers are likely to become zero-rate taxpayers in retirement so they stand to benefit from the same 20% tax relief differential as higher-rate taxpayers.
“Don’t forget that the average UK pension pot at retirement is still only a measly £29,417, so the income from a pot of this size – when added to the state pension – is unlikely to push a zero-rate taxpayer back into the basic-rate bracket,” he said.
3) Carry forward rules
The annual pension allowance is £40,000, or the equivalent of an individual’s annual salary if it’s lower. But Adams said very few of us use our full annual allowance.
“While you can invest twice as much into a pension as into an ISA (£40k v £20k in 2017/18) every year, by using ‘carry forward’ you can also make use of previously unused pension allowances from the last three years. For many people, this will mean they can invest a six-figure sum in their pension and receive tax relief on the whole amount (subject to the carry forward rules).”
Adams said carry forward is especially important for those high earners who, since 6 April 2016, have been subject to the new tapered annual pension allowance.
“This can reduce their annual allowance from £40,000 to as little as £10,000. However, the carry-forward ‘window’ will effectively close at the start of 2019 tax year, so Britain’s higher earners will need to move fast if they’re to make the most of this generous provision,” he said.
4) Inheritance tax and bankruptcy
Pensions also have two other major benefits over ISAs, according to Adams. The first is that pension assets can be passed on after death free of inheritance tax (IHT), whereas ISAs form part of your estate for IHT purposes. The only exception to this rule is if the ISA is passed to a spouse or civil partner.
Adams said a pension is basically a trust that holds your assets outside of your estate. Recipients may have to pay income tax on inherited pension funds but they’ll never have to pay IHT.
“Those with larger ISA portfolios will need to start thinking about the IHT bill that their hard-earned savings will attract if they pass away. For many people, their pension will be the ideal way to navigate around this problem,” Adams said.
The second advantage is undrawn pension funds remain one of the few assets that are protected from creditors in the event of bankruptcy, which can be an especially important consideration for those who run their own small business.
When ISAs might be a good option
Despite the above points, Adams says ISAs should be the first port of call for people who have reached the lifetime pension allowance of £1m.
“ISAs are still head and shoulders above most other types of mainstream investment – except for pensions,” he says.
If you have started to access your pension and find yourself on the wrong side of the Money Purchase Annual Allowance (MPAA), it might be time to start thinking about ISAs again.
The MPAA is the annual amount people over 55 can contribute to a pension once they have started accessing their pension flexibly. On 6 April, the MPAA is being cut from £10,000 to £4,000.
Adrian Lowcock, investment director at Architas, said that with the ISA/pension debate, things aren’t always that simple.
“The best time to save in a pension is sooner rather than later as the tax relief benefit you get has longer to grow which would mean you need to contribute less into your pensions. The other time to do it is when you are a higher rate tax payer as the tax relief is the most generous,” he said.
“ISAs tend to be more popular when we are younger because they offer greater flexibility for investors and do not tie your money up for a long time. They also offer the benefit of no longer attracting extra tax so offer a tax-free income in retirement which doesn’t need to be declared to the tax man. Pensions on the other hand have more complex tax treatments to consider.”
Lowcock said that topping up your pension contributions in your 50s “would make a lot of sense”, especially if you are a higher rate tax payer and could do so out of income via salary sacrifice as this would give you the most tax efficient contribution.