ISAs versus Pension Contributions

By Kim Faulkner - Nestegg Financial Services, www.nestegg.co.uk
Telephone: 01756 700903.

The subject of ISA investment - pension investment is much debated, and the benefits of each route will depend largely on your personal circumstances. They are both savings vehicles, but differ widely in their structure, taxation on entry and exit, and access to capital.

Pension Contributions

Contributions to a pension will attract immediate basic rate tax relief on investment, with higher rate taxpayers able to claim the marginal rate through their self assessment tax return. Under legislation which came into effect in April 2006 you can contribute up to 100% of your earnings to your pension (maximum £235,000 for 2008/09), or £3,600 per tax year, whichever is higher. This means that even non-taxpayers can benefit from tax relief on pension contributions.
There are however restrictions on taking benefits from a pension. Under current legislation you can only take retirement benefits from age 50, rising to age 55 in 2010.
The maximum pension commencement lump sum (formerly known as tax free cash) you will be able to access from a personal pension will be 25% of the fund value at the time you retire. If you have a company pension your entitlement could be higher or lower than this.
Although the pension commencement lump sum will generally not be subject to tax, the remaining fund must be used to purchase an income which is then taxed at your highest rate. There are also restrictions on the maximum level of income you are able to take from your pension fund.
Access to your capital is therefore severely restricted, with income levels carefully monitored and taxed. Contributions may also affect your entitlement to Pension Credits.

ISA Contributions

Conversely ISA contributions are usually paid from income or savings which have already been taxed. This therefore reduces the value of the initial investment when compared to that made to your pension, particularly for higher rate tax payers.
The maximum ISA contribution you can make in the 2008/09 tax year is £7,200. This can either be wholly made into a Stocks and Shares ISA with one provider, or split between a Cash ISA up to £3,600 and the balance into a Stocks and Shares ISA up to the £7,200 maximum. You can hold the Cash and Stocks and Shares elements with different providers.
There are however no restrictions on the age at which you can access the capital, or the level of capital withdrawal. This means that you can withdraw all of the fund if you wish - however fixed term and restricted access products are available and you should check exit terms with the provider prior to investment.
Gains realised from an ISA investment on withdrawal are not subject to capital gains tax, and income is not limited by legislation or taxed on withdrawal. Consequently the income and withdrawals from ISAs do not need to be declared on your tax return.

Summary

The following table gives a brief overview of the main points to consider:

	ISA	Pension
Maximum contribution in the 2008/09 tax year	£7,200	£3,600 or Up to £235,000
Tax relief on contribution	No	Yes
Capital withdrawals available at any age	Yes	No
Restricted lump sum availability	No*	Yes
Lump sum withdrawals free of Capital Gains Tax	Yes	N/A
Income paid without further tax liability	Yes	No
Compulsory annuity purchase before age 75	No	Yes
Ability to vary income	Yes	No*
Capital passed to family on death	Yes	No*

* Under some circumstances these options may apply to your contract, and you should refer to the terms and conditions for further information.
In order to maximise the tax and investment benefits of each route, most portfolios will carry an element of each type of investment. Your adviser will be able to assist you in reaching the optimum potential for your personal circumstances in each tax year.