Understanding ISAs
An ISA is essentially a tax-efficient wrapper in which you can hold savings and investments. Any returns you get from your savings and investments within an ISA are free from income tax, dividend tax and capital gains tax (CGT). You can pay a maximum of £20,000 into ISAs in the 2019/20 tax year. You can put your annual allowance into either a cash, an investment, or an innovative finance ISA, which puts your money into peer-to-peer lending investments, or you can split it between these different types of ISA. You can usually take your money out of your ISA whenever you want, although you’ll need to check your account’s small-print first. However, if you’ve chosen an investment (stocks and shares) ISA, you should remain invested for a minimum of five years, but preferably longer. That’s because stock markets can be volatile, and if there are any storms, this should hopefully give time for your investments to recover in value, although of course there are no guarantees. Also, if you are investing in peer-to peer lending investments these will be less stable than loans issued by major governments and companies. This sector is still relatively untested and there is a significant default risk that the borrowers are unable to repay the loans. Therefore peer-to-peer lending should be considered as high risk and complex. You won’t have to pay any tax when you come to withdraw your money from your ISA, and there’s no upper limit on the total amount you can accumulate in ISAs.
Pensions explained
Like ISAs, you don’t have to pay tax on returns from investments held in your pension. This big difference with a pension is that when you pay money in, you get tax relief on these contributions. If you’re a basic rate taxpayer, that means a £100 pension contribution will cost you just £80 , due to the tax relief. If you’re a higher or additional rate taxpayer, you can get an extra 20% or 25% on top of the 20% basic rate tax relief. So, paying £100 into your pension would only set you back £60 as a higher rate taxpayer, or £55 if you’re an additional rate taxpayer. You can claim tax relief on contributions of up to 100% of your income or £40,000 in the 2019/20 tax year, whichever is lower. There’s also a Lifetime Allowance, which limits the amount you can draw from your pension without paying extra tax. This tax year the Lifetime Allowance is £1.055m. Don’t forget too that if you’re paying into a company pension, you’ll also benefit from employer contributions, which can substantially bump up the amount you end up with in your pension pot. When you retire, you can take up to 25% of your pension fund out as a tax-free lumps sum if you want to. Once you’ve done that, you’ll pay income tax on any further withdrawals you make. You can find out more about how pension tax rules work in our blog on pensions and tax. Bear in mind that you won’t be able to access any of your pension savings until 55 at the earliest, rising to 57 by 2028.
Is a pension or an ISA right for me?
The combination of tax relief and employer contributions if you’re paying into a company scheme makes pensions hard to beat. That said, if you think you’re going to need some savings before you reach the age of 55, an ISA can provide you with flexibility, as you’ll be able to get your hands on your cash whenever you want. It often makes sense to have a combination of ISAs and pensions, so that you’ve got savings available both before and during retirement. If you’re not sure which is right for you, or you don’t know where your pension or ISA should be invested, seek professional financial advice.
