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Pensions v ISAs: Tax relief makes a huge difference to your calculations

When you’re saving for long-term goals, choosing the right place to put your money is crucial. It could mean you have far more financial freedom later in life.

If you’re thinking about retirement or your later years, you have multiple options, including pensions and ISAs. While ISAs are more accessible, read on to find out why contributing to a pension could be more effective in the long run.

Pension tax relief could significantly boost your long-term savings

ISAs provide you with a tax-efficient way to save or invest. You can add up to £20,000 in 2023/24 to ISAs, and you don’t need to pay Income Tax or Capital Gains Tax (CGT) on the interest or returns.

A pension is a tax-efficient way to save for retirement. Not only are returns free from CGT, but the government also provides tax relief. So, assuming you stay within the limits of the Annual Allowance, contributions will benefit from a boost at the highest rate of Income Tax you pay. Pensions, including tax relief, are usually invested to provide an opportunity for long-term growth.

The tax relief, and the compounding effect when it’s invested, means your money could go a lot further when you choose a pension.

According to a report in the Telegraph, a worker on £80,000 a year and saving £1,000 a month over 20 years, assuming 4% growth, inflation of 2.5%, and charges of 1%, would have:

  • £201,781 in an ISA
  • £336,301 in a pension.

So, saving into a pension would mean you have 66% more to spend in your retirement. The significant difference is due to tax relief.

What’s more, your employer will usually contribute on your behalf if you save into a pension. If you’re eligible, they must contribute a minimum of 3% of your pensionable earnings, and some employers choose to match your contributions.

Once you factor in employer contributions, the gap becomes even wider. In the above scenario, if an employer matched your pension contributions, you’d have a nest egg of £538,082 in 20 years.

As a result, if you’re thinking about ways to build up long-term wealth, considering increasing your pension contributions could be worthwhile.

What about Lifetime ISAs?

Lifetime ISAs (LISA) benefit from a government boost to help people buy their first home and encourage workers to save for retirement. However, for many, pensions are still more efficient.

In 2023/24, you can add £4,000 to a LISA, and the government will provide a 25% bonus. So, if you deposit the maximum amount, you’d have an extra £1,000 in your savings.

However, if you access the savings before you are 60, for a purpose other than buying your first home, you will usually need to pay a penalty. You can open a LISA if you’re aged between 18 and 40, and you can contribute until you’re 50. You can choose between a Cash LISA and a Stocks and Shares LISA.

The government bonus means LISAs can provide a helping hand to aspiring first-time buyers, but for those saving for retirement, a pension may still make more sense financially.

As pension tax relief is given at the highest rate of Income Tax you pay, the bonus from a LISA isn’t as valuable for higher- and additional-rate taxpayers. What’s more, the pension Annual Allowance is up to £60,000 or 100% of your annual earnings, whichever is lower, in 2023/24. So, you’re likely to be able to save more for retirement through your pension.

Despite this, a LISA can be a useful way to supplement your pension and may be right for some people.

For example, non-taxpayers can add up to £2,880 into a pension each tax year while benefiting from tax relief at 20%. In this instance, a LISA could provide a way to efficiently save more for the future.

Choosing the right option for you

While tax relief often means that saving into a pension for retirement goals makes sense, it’s important to consider the drawbacks too.

With a pension, your money won’t usually be accessible until you are 55, rising to 57 in 2028. So, if you want to access your savings sooner, an alternative may be better suited to you.

Even if a pension is right for your long-term savings, there is likely to still be a place for ISAs in your wider financial plan.

Contact us to talk about what you want to achieve and how your finances could support your aspirations. We’ll work with you to create a plan that suits your needs.

Please note: This blog is for general information only and does not constitute advice. The information is aimed at retail clients only.

A pension is a long-term investment not normally accessible until 55 (57 from April 2028). The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available. Past performance is not a reliable indicator of future results.

The tax implications of pension withdrawals will be based on your individual circumstances. Thresholds, percentage rates and tax legislation may change in subsequent Finance Acts.

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