Pensions vs ISAs

The argument has raged for some time over the preferred savings vehicle – pension or ISA?

Steven Jackson TaypatBy Steven Jackson, Taylor Patterson.

The latest stage of the pensions revolution – the scrapping of the “death tax” announced recently by George Osborne has potentially made pensions a much more attractive option.

Finding the answer involves weighing up tax implications as well as your own wishes and family circumstances.

Is ISA the winner?

ISAs come out top if you want access before the age of 55. They are simpler to understand and administer, and if you are a basic rate tax payer the benefits of pensions over ISAs are relatively small.

If you are thinking what you will leave your family if you die, an ISA can be better than a pension if you have accessed your pension benefits, because the pension fund would currently be taxed at 55% “death tax”, whilst the ISA would be tax free if you are unlikely to pay inheritance tax (IHT).

Pension maybe the winner

From April ‘15 when the 55% death tax is scrapped this makes the pension far more competitive.

As it stands now for basic rate taxpayers the only clear-cut benefit of pensions over ISAs is the 25% tax free lump sum available to be taken from 55. The tax relief on contributions is cancelled out by the income tax you pay on the income taken from a pension. It’s a different story for higher-rate and top-rate taxpayers, as long they pay a lower rate in retirement. They would receive 40% and 45% tax relief when the money goes in but pay 20% when it comes out, plus a 25% tax free lump sum.

After the 55% rate is scrapped, this makes matters much better for anyone looking to leave a pension for their descendants. Under proposals, the 55% tax will be scrapped entirely on death before age 75, beneficiaries can spend the money with no tax to pay. If death is after 75, whoever inherits your pension can leave the money in the pension plan and pay no tax, although any money withdrawn will be subject to income tax at their normal rate.

This could lead to using pension plans as multi generation trust funds, with each generation taking income, at any age. Impossible under current rules. With an ISA, the problem is IHT becoming payable on bigger pots, pensions are almost always outside the estate and so exempt from IHT.

If an inherited pension fund is used carefully, even basic rate income tax could sometimes be avoided. For example, you could take an income when not working. Equally, it could be an emergency fund to fall back on, even at the cost of paying income tax.

Pension vs ISA : The debate continues….

The importance of looking at your family’s tax, wealth and debts together when deciding between ISAs and pensions is highlighted by the difference in fund growth between basic, higher and top-rate taxpayers. Ultimately using both ISA’s and pensions offer a good balance to everyone’s savings plans, but the regulation changes have brought Pensions to the fore thought in the financial planning arena.