We all need to keep one eye on our retirement funds. If you’re already thinking about investing money to guarantee a comfortable life after work, the big question is this: where should you invest?
Do you choose an ISA, a pension, or a blend of both? And with the government’s turbocharged ‘Lifetime ISA’ – also known as ‘Lisa’ – on the horizon for 2017, your decision is about to get more complicated.
Choices like these form the core of developing your own lifetime financial management plan, creating a nest egg that will deliver the retirement you deserve. In this article we’ll compare ISAs and pensions, and consider the questions you need to ask yourself as you decide on how best to save for the future.
When do you need the money?
The biggest difference between an ISA and a pension is the age at which you can withdraw money.
With a pension, your money is locked away until you reach 55 at the earliest. Whereas money kept in an ISA tends to be accessible at any time. As we’ll see later, 2017’s ‘Lisa’ vehicle goes a step further.
How do you want to manage tax?
Pensions and ISAs are tax efficient: pensions offer tax-free options, while ISAs are completely tax-free as long as you stay within your annual £15,240 tax-free allowance. But pensions have a number of significant tax-related advantages. If you’re a higher rate tax-payer when you pay into the pension, you will receive tax-relief at your highest rate of income tax, 40% or 45%, depending on your earnings.
However, when you come to drawdown money from the pension you are more likely to be a 20% basic rate tax payer, so you’ll immediately be paying less tax on the proceeds than when you paid into the pension. In other words, you’ll be quids in all the way.
2017: Definitely Lisa’s year
The government’s Lifetime ISA option should be introduced in April 2017. Anyone under the age of 40 who opens a ‘Lisa’ will receive a 25% bonus on their savings amount, roughly equivalent to basic rate tax-relief.
The maximum you’ll be able to pay into a lifetime ISA in any financial year is £4,000, so with the government’s free 25% bonus you’ll be saving £5,000 a year tax-free.
Here’s the catch: Lisas are designed to get young people saving for retirement, so although you can withdraw your money at any time before you turn 60, you’ll lose the government bonus (and any interest or growth you’ve built up) and you will have to pay a 5% charge for doing so.
There is one exception though, and that is to use the funds for a deposit on your first house (in the same way as the Help-To-Buy ISA)
Saving in a Lifetime ISA should be for the long term – wait until you’re 60 to make a withdrawal and everything you take out of it will be tax-free.
Decision time. Pension or ISA?
But as ever, the bottom line is all about individual requirements. Do you need access to your money in the short term, or can you find the will power (and, perhaps, luck) to be able to save over the longer term? The reality for most people today is this: investing in both an ISA and a pension at the same time is the best way to guarantee a long and prosperous retirement.
Looking deeper
If you’d like to find out more about pensions, ISAs or Lifetime ISAs – and how you can take advantage of the benefits they offer – get friendly, no-obligation financial tips from Flying Colours. Get in touch with us here.
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