subject: Isas And Pensions Compared [print this page] Are you thinking of beginning to save for your retirement? Have you wondered whether paying into a stocks and shares ISA would be more effective than paying into a pension? This article looks at the advantages of both.
With an ISA investors can make up to 10,680 worth of investment each year. The main advantage is that there is no tax to pay on any interest earned. This is advantageous over a pension, where income tax needs to be paid. As a pension counts as income, anything earned over the income tax threshold each year is taxable. For most, this means losing 20% off most of their pension. With an ISA you would get the whole amount the fund is worth.
ISAs allow you to take money out when you wish; you dont have to wait until you retire. Of course, the aim may be to fund your retirement but an ISA does allow you some added security. Should you suddenly find that you need the money you have been investing then you can have access to it.
A disadvantage of an ISA for some is the limit. The maximum that can be invested into an ISA each year is 10,680. There is a limit to a pension but it is much higher. Although most dont reach the ISA limit anyway, for those looking to save a large amount it could be the deciding factor.
You may have to pay tax on the pension you receive but there are tax benefits when paying into a pension. If your employer is contributing then the pension contributions are paid before income tax is taken off, so you are not paying income tax on what is effectively part of your earnings. For personal contributions you have to pay income tax on your earnings before you make the payments (as you have received it as monetary income) but the pension provider will claim back tax at 20%. This means that to pay 100 into your pension, you only have to contribute 80. Over the course of many years this can build up significantly. For example, if paying 200 a month for forty years you will be contributing 96,000 towards your pension fund. Once tax is paid back this would be 120,000, a 24,000 difference, the equivalent to the average UK gross salary.
Another tax advantage of pensions is the possibility of taking a lump sum when you first retire. If you choose to, you can immediately take 25% of the total pension fund as a tax-free lump sum. This means no income tax is paid on this amount. There will still, however, be income tax to be paid from future sums received.
There are both advantages and disadvantages of stocks and shares ISAs and pensions when it comes to saving for retirement. Some financial bodies have carried out research looking at the differences, and the truth is the end result in terms of yearly payments after retirement will be very similar on average. Therefore a decision should be made on other preferences, for example some would prefer an ISA because of the security of being able to take some back if you choose, or a pension because of the higher limit.
