It would be fair to say that the common perception of pensions as being complicated when compared to ISAs has kept them in the doldrums, when considering whether to commit regular savings or a one off amount to either of these types of investments. Recent changes and proposed changes mean that this investment decision may merit a revisit.
Pension changes announced in the Budget of 2014, go hand in hand with consultation periods and yet further announcements throughout 2014 have given a real shot in the arm to pension planning. Not to be overshadowed, ISAs have been rebadged as NISAs (New Individual Savings Account) and are equally afforded wider investment freedom, a boost to the contribution limits and proposed inheritance tax sheltering deferment.
NISAs in the current tax year allow a contribution of £15,000. You can choose to invest in cash, stocks and shares or a combination of the two. From 1st July you can move freely between cash and stocks and shares; this previously being a one way street from cash to stock and shares. If you fail to take advantage of your NISA contribution limit in any one tax year you cannot reclaim or claw back this allowance; the allowance is lost.
The amount you can pay into a pension is unlimited, however the maximum contribution to qualify for tax relief is the lower of your earned income or £40,000 gross per year. With certain conditions having been met you can reclaim or carry forward unused allowances from previous tax years. With the maximum allowance having varied in recent years, with adequate earnings, and prior membership of a pension, you could pay in as much as £190,000.
Even without any earnings, a contribution of up to £3,600 gross per year can be made and qualify for 20% tax relief i.e. you pay £2,880 and £3,600 is invested.
Advantages of making a contribution
Both NISAs and pension have the ability to grow in a tax privileged environment.
On encashment, NISAs are free of income tax and capital gains tax.
Pension contributions have the advantage of enjoying income tax relief at an individual’s highest rate of tax. As an example, a personal contribution of £20,000 for a higher rate taxpayer would require an initial outlay of £16,000 (£20,000 less basic rate income tax of 20%). The additional 20% income tax £4000, would be reclaimed via a self assessment or by sending a letter to the local tax office. If you are fortunate enough to be an employee where your employer makes use of a salary exchange scheme (also known as salary sacrifice) then you can enjoy tax relief at source for higher and additional rate taxpayers and personal National Insurance savings. Furthermore, your employer may agree to pay their National Insurance savings into your pension, which could be boost of up to 13.8% of your salary sacrificed to your contributions.
When can I get my hands on the money?
A NISA will allow you access to your funds at anytime. For NISAs held in cash you may want to check for any penalties that may be imposed on the rate of interest for early access.
Your pension savings will generally be tied up until at least your 55th birthday, rising to 57 years of age from 2028.
The biggest changes to pensions and proposed changes for NISAs are on death. Of course, of little comfort to the individual, but a great opportunity to plan.
Currently, the tax friendly build up of NISAs funds on death stops and the proceeds form part of your estate and are generally liable to inheritance tax (the main exemption is ISAs holding AIM stocks). What is being proposed is that married couples and those in civil partnerships will have an additional NISA allowance, equal to the amount the deceased spouse had in their NISA. These particular changes have not yet been finalised so some changes may occur.
In brief, for most private pensions from 6th April onwards or for the payment of death benefits post this date, the pension fund can be passed onto whomever you chose to nominate or to a nominated trust. The “passing on” of the fund to future generations is unlimited. The age at which you die will determine whether the pension is passed free of income tax or is subject to income tax of the recipient. The pension, in most instances, will not be within your estate for inheritance tax purposes.
So ISA or pension?
As usual, it depends on:
- When do you need access to the money?
- Will you need to replace your income at some point?
- What can you afford to save each year?
- Do you want to have the ability to pass money on to future generations?
Certainly if you are in the position of being able to draw on these types of investments (NISAs or pension) you should carefully consider which ‘pot’ to ‘dip’ into first before taking any actions.
Eligibility – any UK resident can invest in a NISA, Junior ISAs are also available. Pensions, any UK resident under the age of 75 can contribute to a pension and receive tax relief