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Sheltering your savings from the taxman: ISA or pension?

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08/02/2016
Looking for a home for your savings? We take a look at the pros and cons of ISAs and pensions.

If you want to keep the taxman’s hands off your savings, you may want to consider an ISA or a pension.

These are both examples of tax wrappers, which are savings vehicles where gains and interest earned are sheltered from the tax authorities to some extent.

Which wrapper you go for will depend on a number of factors including: how much you earn, how old you are and when you’ll need to access your money.

Access

One of the big benefits of an ISA is you can access your money whenever you want, without having to pay any tax.

Pension money, on the other hand, cannot be accessed before the age of 55. And when you do withdraw your pension, there are tax implications to consider.

Of course, pension freedom rules introduced in April 2015 gave savers full access to their pension pots but only savers aged 55 or over.

Tax

All ISA withdrawals are tax-free.

Pension withdrawals, however, are taxable. The first 25% of your pot can usually be withdrawn tax-free but the remainder will be subject to your marginal rate of income tax.

Patrick Connolly, a financial planner at Chase de Vere, says this is where people need to be careful:

“Withdrawals above the 25% tax-free element will be added to somebody’s income in that particular tax year.

“If larger withdrawals are made in the same tax year there is an increased likelihood that more of those amounts will be subject to higher rate income tax at 40% or additional rate tax at 45%.”

A benefit of saving into a pension is you receive tax relief when you make contributions up to certain limits. So, if you’re a basic rate taxpayer the government will give you £20 for every £80 you put into your pot. If you’re a higher rate taxpayer, the government will contribute £40 for every £60 you contribute.

That’s under the current rules.

In the next Budget set for 16 March, Chancellor George Osborne is expected to introduce a flat rate tax relief scheme on pension contributions.

Experts suggest the new flat rate will be set between 25% and 33%.

If it were set at 25%, you would get £25 from the government for every £75 contribution, according to Fidelity International. At 33% you would get £33 for a £66 contribution.

Death benefits

The rules surrounding what happens to your pension savings when you die were changed in April 2015, meaning you could potentially pass on your pension pot tax-free to your loved ones.

Previously, there was a 55% ‘death tax’ on pots passed on at death.

If you die before age 75 there will be no tax to pay. After age 75, the tax due on the pension fund will be determined by the income tax position of the person inheriting the pension.

Thanks to these changes – and because pension savings currently sit outside an estate for inheritance tax purposes – you can now pass your pension wealth through the generations.

ISAs also have no charges on death, however they do remain as part of somebody’s estate for inheritance tax purposes. However, if you leave your ISA to your spouse or civil partner there will be no IHT due as married couples and civil partners are allowed to pass assets to each other without having to pay this tax. They will also benefit from an additional one-off ISA allowance equal to the amount you had in your ISA.

It’s also worth noting that AIM shares incur no IHT if held for two years. So, if you hold these within an ISA wrapper your holding will incur no IHT but you must hold the shares directly and not within a fund structure.

 

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