Using a combination of ISAs and pension savings can be one way to make your retirement money go further and help you strike a balance when saving for your golden years. The yin and yang of retirement saving, if you will.
ISAS and pensions: the yin and the yang of retirement planning
Income tax doesn’t stop when you stop working.
Working in harmony
With an ISA you’re taxed on the way in. In other words, you save from income that’s already been taxed, but there’s no tax on the money you take out. With your pension, whether it’s a SIPP or a workplace pension, it’s the opposite. You get tax relief on what you pay in but you get taxed when you take it out – it’s treated as income.
Using your ISA savings first to minimise and possibly eliminate, from year to year, any potential income tax on your pension, means more money in your pension for you to spend on enjoying your later years and when you might be in a lower tax band.
Both ISAs and pensions are very tax efficient ways of investing. This is because all growth is free of income tax and capital gains tax, so your money should grow faster.
You can pay up to £20,000 a year into your ISA and, when the time comes to take your money out, your returns are completely tax-free and don’t have to be declared on your tax return.
You can pay up to 100% of your earnings or £40,000 a year, whichever is lower, into your pension and still get tax relief.
And when you come to take it out, the first 25% is usually tax free but, after that, any money you take out is taxed as income.
So it can be good to use your tax-free pension cash and ISA money to minimise the amount of taxable pension money you need to withdraw.
Taking your money out
The new era of pensions ‘freedom and choice’ introduced in 2015 means you have considerable flexibility in how you withdraw your pension money.
Many people are leaving their money invested and taking out a regular amount to replace their previous income from employment. This is a feature of ‘flexi-access drawdown’ where you can also take out occasional lump sums whenever you want, for instance if you need a new car or home improvements or a holiday cruise. Obviously you need to keep an eye on the performance of the funds in which you have invested, because if you take out more than they’ve grown by, your money could run out while you still need it.
Key to everything is recognising that the less tax you pay, the longer your money will last. Start planning now, choose your ISAs well and let a little bit of yin and yang do the rest.