A pension or an ISA?

Our financial advisor explains that while a pension is one of the most common ways to save for retirement, it may not be your only option for retirement income and that an individual savings account (ISA) may provide an alternative.

Difference between a pension and an ISA

One of the main differences between a pension and an ISA is in the way they are taxed. Your pension payments will qualify for tax rebates up front, at your highest rate of income tax, but then the retirement income you receive later on will be taxed. With an ISA, the money you contribute will have already been subject to tax, but any withdrawals you make will be tax free. It’s also useful to be aware that your pension income counts towards your personal tax-free allowance, while your ISA withdrawals do not.

You might think that, thanks to the tax relief, a typical higher rate taxpayer saving the same annual amount into both an ISA and a pension plan over their working life will find that by the time they reach retirement age the pension fund is larger. This is obviously fully dependent on their investment choices and tax regulations remaining consistent but the tax rebates are important as they add to the value up front and therefore influence the size of annuity that can be bought. However, the retirement income from your annuity is likely to be taxable, unlike ISA withdrawals. But, your annuity payments are guaranteed for life and withdrawing the equivalent from an ISA may eat into your capital. It is therefore possible that the ISA capital eventually runs out.

Other pension benefits include the fact that employers can pay into a company or stakeholder pension scheme, and the annual contribution limits for pensions are much higher than for ISAs. Nevertheless, an ISA is much more flexible. With a pension, you have to wait until you are aged 55 to make withdrawals, whereas an ISA can be accessed pretty much whenever you like.

With longer life expectancies, as well as some high profile issues concerning the way in which a minority of pension funds have been managed, many investors’ funds will not provide quite as much retirement income as expected. As a result, some people are now looking to boost their pension funds by topping up their company pension, or by using additional investment vehicles. One other solution however, could be to use the ISA option and help ensure your retirement income is as healthy as possible.

Your options for retirement can be complex and will depend entirely on your own personal circumstances. If you’d like to speak to one of our financial advisors about pensions or ISAs they would be more than happy to take your call on 0141 764 0040.

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