Working out the best way to save for retirement can feel overwhelming given the various different products currently available.
The best approach is going to depend on a number of factors including your circumstances, your goals, your attitude to risk, and your willingness to be hands-on. Whichever route you choose, the key is to build the biggest nest egg you can.
One question which is asked time and time again by savers and investors is whether to go for an ISA (individual savings account) or a pension. The answer is, there are pros and cons to each.
Many people settle for a pension because that’s what everyone else seems to do. But ISAs can also be a great way to squirrel money away for your later years. Here we help you navigate your way through the options available to you.
Pension v ISAs
A pension is a vehicle you can use to slot money away for a time when you stop working. There are several different types to choose from, including a SIPP (self-invested personal pension).
With a SIPP, you get to manage your own investments. But as it involves taking some risks, you need to know what you are doing.
An ISA is a tax-efficient wrapper for your savings. You can grow your wealth free of tax on investment gains and income, and withdraw investments when you wish to, without incurring a tax bill on the way out. There are different types to choose from: a cash ISA, a stocks-and-shares ISA, a lifetime ISA (LISA) and an innovative finance ISA (IFISA). It’s worth noting that several ISA reforms are due to come into effect in the new tax year (April 5, 2024), including a move to allow savers to subscribe to multiple ISAs of the same type.
With different products to choose from, this can help you align your ISAs with your investment preferences, attitude to risk and financial goals.
Generally speaking, ISAs might be the better choice for medium to long-term financial goals. More specifically, cash ISAs make sense if you want to access your money for short-term goals within the next five years, while stocks-and-shares ISAs are likely to be the better option for a long-term investor looking to hold onto their money for five years or more. With a stocks-and-shares ISA, you’ll hopefully be able to ride out any short-term dips or troughs.
SIPPS, on the other hand, can be a great choice for long-term financial goals, such as retirement – and give you lots of control over what your money is invested in.
SIPP v LISA
Many people can find themselves weighing up a SIPP v LISA – but what are the differences between SIPPs and ISAs, and how do the two stack up?
With a SIPP, there is typically an annual limit of £60,000. But the rules are different with a LISA. With one of these vehicles, designed to be used for retirement – or to help fund a first home – you can pay in a maximum of £4,000 a year. This will count towards your overall £20,000 annual ISA allowance.
You have to be aged between 18 and 39 to open a LISA, and you can pick between cash, or stocks-and-shares. Stocks-and-shares offer the potential for higher returns, but come with more risk. By contrast, you just need to be ‘under 75’ to open a SIPP, and there’s a wide choice of investment options.
Opt for a SIPP, and you won’t be able to access the cash you’ve tucked away until you turn 55. This age is set to rise to 57 from April 6, 2028.
Plump for a LISA, and you need to be aware the rules are complicated. You can’t make withdrawals before 60 if you’re using the vehicle to save for retirement. If you do, you’ll face a hefty penalty. (The rules are different, however, if you plan on using the money to purchase your first home, or if you have a serious illness).
Be aware that if you’re holding your money in a ‘standard’ ISA, your funds are usually accessible at any time.
What about the tax benefits?
Both ISAs and SIPPS allow your money to grow free of tax, but the tax perks are different.
Pay money into a pension, and you get income tax relief at your highest marginal rate. The tax benefits available offer a huge boost to your retirement savings.
LISAs, on the other hand, benefit from a 25 per cent bonus paid by the Government. Those who pay in the maximum contribution of £4,000 a year get an extra £1,000.
Note that with ‘standard’ ISAs, you don’t get any tax relief or government bonus.
What’s the tax situation when you access the pots?
Once you’ve reached the age when you can access your SIPP (currently 55, but due to rise to age 57 from 2028), you are allowed to take up to 25 per cent of its value as a tax-free lump sum. Take any more than this, and the money will be taxed at the your current rate of income tax.
By contrast, with an ISA or LISA, any withdrawals you make are completely free of tax. (But don’t forget that with a LISA, you can only withdraw money penalty-free once you’ve reached 60).
If you think you might need to get your hands on your cash before you retire (or reach 55), a ‘standard’ ISA could be a better fit, as you can dip into your funds as and when you need to.
What about fees?
While you won’t have to pay management fees with a cash ISA, a stocks-and-shares ISA will usually come with charges. Typically, these are calculated as a percentage or a monthly payment. SIPPS often come with similar charges to those you face when investing in a stocks-and-shares ISA. A lot will come down to the individual provider, so be sure to do your research so you know exactly what you’ll end up paying.
Can I have both an ISA and a SIPP at the same time?
In any one tax year you are permitted to hold both an ISA and a SIPP simultaneously. If you’ve got the means to do so, you can also pay into both; there’s something to be said for boosting your pension savings with an ISA of your choice. But take care to gen up on the latest tax rules, as rules can change. If you’re not sure about anything, be sure to seek advice. An independent financial adviser can help you to align your choices with your savings goals. Read more here.
So what product should I go for?
- Cash ISA – likely to be the best choice if you need to access your cash in the shorter term.
- Stocks-and-shares ISA – may be a better fit if you plan on sitting on your money for at least five years, but still want the freedom to cash in at some point.
- Lifetime ISA or pension – both of these could be an option if you are happy to lock your money away until your later years. Both remove the temptation to dip into your funds.
Pension v stocks-and-shares ISAs as you get older
Once you are in your 50s or 60s, you may be better off prioritising pensions over ISAs. Having turned 50, you’re getting closer to the point at which you can take money from your pension.
The tax relief on offer can give a significant boost to returns, and especially if you’re going to be in a lower tax band when you take the money out. So, for those in their 50s and 60s, rather than focus on ISAs, you might want to look at topping up your pension and claiming tax relief.
Also bear in mind, that unlike ISAs, money held in pensions is usually exempt from IHT. This means a pension can potentially be passed on to your beneficiaries free from IHT. Helpfully, this can be anyone – and is not limited to your spouse or family member – meaning it’s very flexible.
Which is right for me?
As you’ve probably worked out by now, the choice you make depends on your individual circumstances and goals; a lot comes down to personal priorities and preferences. You need to weigh everything up carefully to decide which approach is best for you and your money.
Photo by Robert Anasch on Unsplash
