ISA, pension (or other)? What’s the best way to save?

Both offer tax benefits, but are very different ways to fund your future, explains Gavin Porritt.

pile-of-coins-cropped

The goal of retirement planning is to ensure that by the time you want to take a step away from the metaphorical grindstone there is sufficient money accumulated to provide an income that will keep you in the style to which you have become accustomed.

Pensions are the traditional approach to do this, but ISAs, shares, cash, property, selling a business, writing a book or inventing a widget are all equally valid means. Indeed these days it’s likely to be a combination of several methods. As long as there is a valid plan in place to get from A to B then the methods are immaterial providing they are realistic. Winning the lottery, while a plan, is not really stacking the odds in your favour!

A commonly asked question on this theme is about the differences between using ISAs and pensions. Let’s first look at their technical aspects:

table1

Which of these two routes is more appropriate will mainly depend on:

Personal circumstances – For example if an employer is going to “match” contributions then that will almost certainly be the route to go, however when looking at additional provision deciding whether the capital might need to be accessible, or indeed better “locked” away, may be the determining factor.

Tax position – This can only ever be an guesstimate as no-one knows what the prevailing tax rates will be in five years, let alone twenty, thirty, forty or more years ahead.

Looking at this latter point in more detail, if we take a hypothetical 35 year old who is looking to retire at 65 and therefore save £600 per month towards this end there are four likely scenarios:

table2

Therefore unless you can guarantee a lower-tax rate in retirement then access to the capital has been given up for no tangible benefit. Clearly there are a whole raft of assumptions being made here and there are potentially more tax-efficient ways of deriving an income from your pension pot, but this merely highlights the importance of considering each option thoroughly with professional advice.