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End of tax year – to put money in a pension or an ISA?

24 March 2019

With the end of the tax year rapidly approaching, clients will be increasingly seeking to work out whether their money is best invested in an ISA or pension, but the solution, unsurprisingly, very much depends on personal circumstances, according to BestInvest. 

Pensions offer the more superior tax perks, with pensions receiving tax relief equivalent to the basic rate of income tax. This means an £8,000 personal subscription into a pension will receive a £2,000 government top-up, resulting in a £10,000 investment.

Pensions are especially advantageous for those on the higher 40p or 45p tax rate. In addition to the government top-up, these tax payers can also receive a further reduction on their income tax bill for the year so that the total tax relief received is at their marginal rate

Following comments from the Chancellor that pension tax is eye-wateringly expensive, BestInvest warned that “there is no guarantee such generous features will remain available in the future so should be utilised while they are available”.

A fund bought within a pension is also more likely to result in a higher return than the same fund purchased within an ISA, BestInvest says. A £10,000 investment into a fund that grows at 6% per annum over 20 years would result in £32,071 if held within an ISA. However, if an investor were to contribute to the same fund through a pension it would be topped up by £2,500 to £12,500 at the start which would result in a pension pot worth £40,089 over the same time period based on the same return.

Yet, while pensions have the upper hand when it comes to attractive tax relief, ISAs continue to prove popular for their flexibility. Although the pension freedoms have helped the situation enormously since their introduction in 2015, the earliest date of access to funds is still restricted to age 55 and the tax-free lump sum that can be withdrawn is limited to 25%. In contrast, money can be taken out of an ISA at any point and will not be subject to tax. For clients seeking accessible cash to pay for a child’s education, cover mortgage repayments or a dream holiday, an ISA is more suitable.

Importantly, ISA savers have the option to start their ISA in cash and then transfer to stocks and shares fund at a later date. According to BestInvest, this could be particularly useful for clients concerned about the current political and economic uncertainties.

There has been also much discussion around death benefits, with the introduction of tiered probate fees causing debate and inheritance tax continuing to be an important issue for many individuals.

For those with ISAs, when a person dies their surviving spouse or civil partner is provided with a one-off additional ISA allowance equivalent to the value of their deceased partner’s ISA, enabling them to reinvest the same amount in their own name. However, apart from this feature, ISAs cannot be directly “inherited” by other beneficiaries such as children or grandchildren and the value of any ISA will ultimately form part of an estate for inheritance tax purposes.

In contrast, pensions provide an attractive means of passing on wealth to future generations. Assets placed in a defined contribution scheme will not be subject to inheritance tax on death and can be left to whomever the person chooses. However, clients should be made aware of the catch surrounding when the age of the person at death. If they die before age 75, the beneficiary will have no tax liability. If they die after their 75th birthday, beneficiaries may need to pay income tax at their own income tax rate when they make withdrawals

While clients may seek to make the most of their annual ISA allowance on a “use it or lose it” basis before the 6th April deadline, pensions also have various benefits and the carry forward process enables unused pension allowances to be mopped up at a later date.

Professional Paraplanner