Financial planning for your future may include the consideration of tax efficient investing. Two investment methods you may consider are Stocks and Shares ISAs and pensions. But which should you prioritise to help you reach financial goals? In this article, we’ll discuss the different allowances, access rules and tax benefits for ISAs and pensions.
Stocks and Shares ISAs
Annual allowance
If you choose to invest in an ISA you have an annual allowance of £20,000. You can invest in multiple ISAs within a year, including both Stocks and Shares ISA and Cash ISA options. The annual allowance is the total amount you may contribute to, excluding Junior ISAs, across any held ISAs. Different ISAs can be invested in to work towards different financial goals.
Tax relief
Unlike with pensions, no tax relief is available from the government on ISA investments.
Accessibility and withdrawals
Investment growth* earned from ISAs is free from both income and Capital Gains tax. It is possible to access and withdraw funds from your ISA whenever you like, with no age restrictions applicable. The longer your money remains in your ISA, the greater potential there is for growth. The exception to ISA accessibility is Junior ISAs. These may not be accessed until the child turns 18, though they take control of investments from 16.
Should you choose to withdraw money from your ISA, then reinvest a portion of it, the reinvested amount is included in your allowance. For example, imagine you invest £10,000 in your ISA, then withdraw £5,000 later in the year before reinvesting £1,000. A total of £11,000 of your annual allowance has been used.
Inheritance Tax
When you pass away, your estate value over £325,000 may be subject to Inheritance Tax (IHT), at 40%. Any ISA investments you hold will be included in your estate value, and subject to IHT.
Pensions
Annual allowance
Most people have a contributions annual allowance of £60,000 across any private or workplace pensions you hold, to be eligible for tax relief. This allowance includes tax relief earned and employer contributions invested in workplace pensions. Any contributions made above this amount will not be eligible for tax relief. Tapered annual allowances may be applicable if you earn over £200,000 per year. Read more about how a tapered allowance may impact you in our previous blog post. You can calculate your tapered allowance on the government website.
Tax relief
The government will add 20% tax relief to any pension contributions you make up to your allowance. This is added automatically to your pension pot. Higher and additional rate tax-payers can claim a further 20% and 25% respectively, via self-assessment tax returns. This is a tax-efficient way to build your pension pot, without it costing you additional amounts.
Accessibility and withdrawals
Unlike with ISAs, your pension pot is not accessible at any age. The earliest you are able to withdraw funds from your pension is at age 55. This will rise to 57 from April 2028. Once this age threshold is passed, you can withdraw 25% of your pension pot tax-free. Further withdrawals can be made, but the amount you withdraw will be added to other income. It will then be subject to tax at the relevant tax rate.
It’s worth noting that the longer you leave your funds in your pension, the more benefit it will be to you. Your investment has a greater opportunity to grow*. Also, if you are retired before withdrawing pension funds, your income will likely be lower than pre-retirement. This mean the tax you pay on withdrawals beyond the 25% tax-free amount will be less.
Inheritance Tax
At the time of writing, pension pots are not subject to IHT. However, from April 2027, this will no longer be the case. From this time any unused pension funds will be included in the calculation of your estate value. Anything over the £325,000 tax-free threshold will be subject to IHT of 40%.
ISAs and Pensions at a glance
The differences between Stocks and Shares ISAs and pensions can be confusing and overwhelming. Our summary table below may help you may sense of which is the right investment type for you.
ISA
- Annual allowance – £20,000
- Tax relief on contributions – No
- Growth* subject to income or Capital Gains Tax – No
- Accessibility – Immediately
- Tax-free withdrawals – Yes
- Included in estate value for IHT – Yes
- Tax-efficient investing – Yes
Pensions
- Annual allowance – £60,000 for many (tapered allowances may apply)
- Tax relief on contributions – Yes
- Growth* subject to income or Capital Gains Tax – No
- Accessibility – No withdrawals before age 55 (rising to 57 in April 2028)
- Tax-free withdrawals – No – first 25% is tax-free then tax at relevant band
- Included in estate value for IHT – Not yet – from April 2027
- Tax-efficient investing – Yes
Which investment type to prioritise
There is no ‘one size fits all’ answer to whether ISAs or pensions are a ‘better’ investment for you. The answer will be different for everyone. For example, if you require the ability to quickly access your funds, an ISA would be better to prioritise. Alternatively, if you are retirement planning with no need for access until you retire, prioritising a pension could be the right choice for you. The ideal would be a balance of both to effectively meet your financial goals.
Whichever option you choose, the longer your money is left invested, the greater the opportunity for it to grow*. Whilst growth with investments is not guaranteed, the longer the funds are invested, the lower the risk. Any downturns in investment value have longer to reverse and recover.
How Willday Wealth Management can help
It should also be remembered that the decision of which to prioritise isn’t finite. You may choose to prioritise ISAs in the short-term, but this priority may change to pensions in the medium-term. As your life priorities change and funds allow, your investment priorities can also change. The team at Willday Wealth Management is on-hand to help you make the right decision for your financial goals both now and in the future.
Call us on 0116 222 0119 or email hi@willdaywm.co.uk to book an initial consultation.
*With investing your capital is at risk and you may get less than what you invested
