The introduction of workplace pensions has been a gamechanger for most employees, leading them to wonder how much they should invest in pensions and how much they should dedicate to an ISA.
The benefits and tax consequences can be confusing; fortunately, seeking advice from independent financial advisors (IFAs) can help with the choice. Software for IFAs is increasingly playing a part in their ability to find a solution to this dilemma.
The introduction of Lifetime ISAs (Lisas) in April last year has also complicated matters for those aged under 40. Any savings you put into this instrument before your 50th birthday will attract a 25 per cent bonus from the government. Until this cut-off point, you can invest £4,000 per year.
Although you can withdraw the money at any time, you will lose the government bonus and any interest or growth if you do so before your 60th birthday. You cannot currently access your pension fund until age 55.
The government has stressed that Lisas are not a replacement for a pension plan but an additional savings scheme.
It should also be noted that enrolment in a company pension scheme offers tax relief on your contributions. For every £100 you contribute to the scheme, a further £25 is added if you are a basic rate taxpayer.
On receiving your pension, it will be taxed if you exceed the tax threshold. In contrast, ISAs see interest or capital gains paid tax-free, but remember that you will already have paid tax on the money paid in.
Investment risk is another issue where your pension is concerned, as your pension pot may rise or fall depending on the markets it is invested in. In contrast, a cash ISA will only be affected by inflation or the unlikely collapse of your bank; even then, you will be covered for up to £85,000 by the Financial Services Compensation Scheme.
Seeking financial advice from a recommended professional will help you to make an informed choice. Software for IFAs available through Intelliflo and other providers will aid their analysis.
Pensions win out over ISAs when it comes to tax efficiency; however, the flexibility of an ISA in terms of drawdown suggests that you should spread your investment between the two after seeking advice.