Q. I am looking to invest a lump sum, as well as a regular amount each month. I can’t decide whether to choose an equities based Individual Savings Account (ISA) or a Personal Pension.
Which do you think is best?
A. It’s fair to say we’ve been asked this question a few times over the years!
As ever, without knowing your full circumstances it’s impossible to give you an accurate answer, however, hopefully we can give you some pointers in the right direction.
On paper, the pension appears to be the better option due to the tax relief that you receive upfront on your investment.
A £10,000 lump sum invested in an ISA would be worth £33,863 after 25 years, assuming a return of 5% pa after charges.
For a higher rate taxpayer (40%), the £10,000 would be grossed up to £16,667 when investing into the pension. Using the same return as the ISA, this would be worth £56,440 after 25 years – a 167% increase over the ISA.
The figures are even more attractive for 50% taxpayers and for those who earn more than £100,000 and less than £112,950. For the latter, it’s possible to earn an effective rate of income tax relief of 60% as earnings within these amounts suffer a gradual loss of the personal allowance, which is currently £6,475 (so if you earn £112,950 pa you will have £0 personal allowance).
Using alternative example figures, were you to invest £4,000 into an ISA over 25 years, and assuming 5% pa after charges, you’d get back £13,545.
If you invested the £10,000 gross into a pension (and assuming you received 60% tax relief, see above), the fund would be worth £33,863 – a 250%increase over the ISA.
Now, what you have to consider is the access to your monies after the 25 years.
With the ISA, you can access it all at any time and there is no further tax to pay.
With the pension, whilst the end fund is bigger you can only access it from age 55. 25% of the fund can be taken as tax free cash (known as ‘pension commencement lump sum’), with the remainder providing you with an income, usually in the form of an annuity.
This income is then taxable in the same way that you pay tax on your earnings at the moment.
Where the pension may have an advantage is if you are a higher rate taxpayer now and foresee being a basic rate taxpayer in retirement. That way you’ll have received 40% tax relief up front and then only be liable for 20% tax on the way out.
My advice is to look to make any decisions taking into account ALL your financial affairs.
Good luck!
