The ISA and the pension come with tax wrappers from the government that help you to make the most of your savings and benefit from compound interest. But what should savers consider before deciding which of these to prioritise?
Setting a savings timeline
Before choosing between the ISA and the pension the first thing you need to consider is your savings goal. When you are likely to need the money will have a huge impact on whether you save into a pension or an ISA.
If you’re saving for retirement and won’t need any of the money until you’re at least 55 then the pension is designed for this sort of savings. But if you’re looking for something more flexible that you can access throughout your life, or you’re already over 55, then an ISA might be the better option.
Tax relief available
Currently you can contribute up to £15,240 into your ISA. This is an annual allowance that gets refreshed each year, unfortunately if you don’t use a portion of your allowance in a given tax year that won’t roll over to the following year. When saving in an ISA you have the choice of a cash ISA, a stocks and shares ISA, or an innovative finance ISA. Each of these allow you to save free from income tax and capital gains tax, leaving you with more of your returns which can benefit from compound interest. It’s worth checking that your ISA is flexible, you should be able to top up and withdraw from your ISA without impacting your allowance, not all providers offer this, but if they do you can benefit from the tax wrapper, and have money available when the fridge breaks.
The pension is a little bit more complicated than the ISA. You get your income tax back on anything you pay into your pension, that means for every £1 you pay into a pension, you get between 20p and 45p back from the government that goes into your pension pot. This allows your pot to grow a little faster and benefit from that magic compound interest. There is a lifetime allowance of £1 million, once you hit that you will start paying tax on the contributions above that. When you withdraw your pension at retirement you will be taxed at the lower rate of income tax, you need to ensure you consider that when looking at the size of your pension savings. The good news is you can take 25% of your pension pot out tax free.
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