Are pensions better than ISAs?
If you are saving for retirement and looking for better options than a pension, including comparing to ISAs, I simply haven't found one. As long as you can afford to invest your money, knowing it isn't accessible until 55 (or whenever the scheme rules say), pensions are undeniably the most tax efficient way to invest for your retirement.
A pension is simply a tax-advantaged investment wrapper. It's tax advantages are significant; the money you pay in is topped up by tax-relief. Moreover, the idea is to put money away where it cannot be easily accessed. So, the fact that it isn't accessible. I don't see it as a disadvantage.
Did I hear you say buy- to- let's are your plan for retirement? Please read my blog 'Dark clouds over buy-to-let investments' if you are open to a gentle challenge.
Not understanding how pensions work could hurt you financially. Here is an honest, genuine account from Jason Zweig, author of 'Your Money and Your Brain: How the New Science of Neuroeconomics Can Help Make You Rich', a book worth adding to the 'Money' section of your library.
In 1993, the mutual fund editor at Forbes magazine was contributing 5% of his salary, just half the allowable maximum, to his 401(k). When a friend asked why he didn’t put more into his 401(k), the editor shot back, “Because I can do better with my money than they can, that’s why.” Looking back more than a decade later, the former editor calculated how much this decision had cost him. I know the answer, because I was that editor. The cost of my overconfidence is more than a quarter of a million dollars- so far.
Tax Treatment (Are pensions better than ISAs?)
One area where pensions and ISAs differ is on the tax breaks given to individuals when payments are made, and when funds are accessed.
Pension:
Money In: Pensions enjoy tax relief on contributions. For DC schemes, savers will typically pay in an amount net of basic rate tax, with the provider adding basic rate tax to the fund*. Any higher or additional relief is claimed through self-assessment. So a £10,000 pension contribution will require a payment of £8,000. A higher rate taxpayer would be able to claim a further £2,000 tax relief via their tax return, and this will reduce the tax they pay on their other income. So the net cost to an investor paying higher rate tax is £6,000. *Some occupational schemes will collect the gross employee contribution from total pay before tax is collected under PAYE. Employees will get tax relief at their highest marginal rates immediately and do not need to make any claims through self-assessment.
Money Out: Up to 25% of the pension fund can be taken completely tax-free. The balance is taxed at the saver’s highest marginal rate of income tax.
ISA:
Money In: There’s no tax relief for payments into an ISA.
Money Out: All withdrawals from an ISA remain tax-free.
Source: Standard Life: Spotlight on Pension v/s ISA Other related resources: