ISA or Pension?
The end of the tax year is coming and you have some spare cash. Where’s the best place for it?
Let’s assume for now that the mortgage is paid off, you have no short-term debts and your emergency funds and holiday funds are already in place.
Most people think ISA. Cash ISAs for the shorter term, Stocks & Shares ISAs for the longer term. It makes sense – tax-free interest, no Capital Gains Tax, nothing to declare to the tax man.
But interest rates are pretty ropey. It’s hard to get excited about interest rates of 1.5% even if they are tax-free.
Is there an alternative? Yes, there is. It won’t be right for everyone and so you should always take advice, but read on.
The much maligned Personal Pension offers the same tax freedoms as an ISA for invested capital but also offers tax relief on all eligible contributions. So, for a basic rate tax payer (or a non-tax payer) it only costs £0.80 to invest £1.00. For a higher rate tax payer it only costs £0.60 to invest £1.00 (although Mr Osborne may have something to say about that in the forthcoming Budget!).
Once you are over the age of 55 your pension fund is completely accessible. A quarter may be withdrawn tax-free, the balance is taxable as income.
So look at the difference between a Cash ISA investment of £2,880 and a pension contribution of the same amount:
The Cash ISA receives no tax relief, receives tax-free interest of (say) 1.5% in year 1 and so is worth £2,923.20 at the end of the year.
The pension contribution receives tax relief and so is grossed up to £3,600 for a basic rate or non-tax payer. Assuming the same tax-free return over 12 months the end of year value is £3,654. If this was withdrawn the benefits payable would be £913.50 (25%) tax-free plus £2,160 (75% less basic rate tax) which comes to £3,073.50. That’s £150 more than the Cash ISA – an extra 5.2%.
For a higher rate tax payer the grossed up contribution is £4,800 and the net benefit available (after tax) at the end of year one is currently £3,360. That’s £436 more than the Cash ISA – an extra 15%.
For an individual who contributes as a higher rate tax payer but draws benefits when a basic rate tax payer the net benefit available after a year is a whopping £4,080. That’s £1,156 more than the Cash ISA – an extra 40%.
Personal circumstances will obviously dictate whether or not this is a good idea but this is not an opportunity to be overlooked lightly.
For further information please contact us.