An illustration of the differences between investing into an ISA and into a pension fund.
A taxpayer invests £10,000 into a pension fund (net cost, £6,000). That amount has subsequently grown to £14,802, with £3,700 of that amount to be taken tax free. If the remaining £11,102 is taxed at 20% rather than at 40%, the taxpayer receives £12,581 in total.
Had the taxpayer invested the same net cost of £6,000 into an ISA, at the same rate of growth this would be worth £8881.
As a result it is clear that the pension fund offers a better return than the ISA in terms of tax saving.
Those who are paying tax at 45% receive an increased benefit. If they in employment with their money purchase pension scheme being funded by employer contributions, rather than being self-employed, the advantage over an ISA is enormous. Employee’s National Insurance contributions at 2% and employer’s National Insurance contributions at 13.8% are saved, enabling an even higher amount to go into the pension pot in comparison with the possible ISA investment.
There are other factors which need to be taken into account in this instance. Firstly, pension funds can only be accessed from age 55 whereas ISA money can be drawn at any time. Secondly, the annual limit on investment is much lower for ISAs, despite the increase to £15,000 announced in the Budget this year. Thirdly, the charging structure for pension funds is less clear than it is for many other forms of investment, so the direct comparison may not be as straightforward as the above examples suggest.
It is important to note that the above calculations comparing ISAs and pension policies are based on identical investment returns and can therefore be characterised purely as theoretical tax advice. It is important when considering annuities to take investment advice from an independent financial adviser.
This article is only designed to give theoretical tax positions, and is not to be regarded as advice to take or refrain from taking any action.