Pension vs ISA when basic rate tax payer...

Bostonerimus1

For most people the pension will end up a better investment than the ISA, but it depends on future tax rates and legislation so we can’t know for sure. But personal finances isn’t all about maximizing your money, it’s also about prudent saving and having access to money when you need it and the ISA gives you tax free growth and withdrawal flexibility that you don’t get with a pension. So give the pension precedence, but don’t forget the ISA and maybe use it for a rainy day or to help with early retirement.

bjorn_toby_wilde

Bostonerimus1 said:

For most people the pension will end up a better investment than the ISA, but it depends on future tax rates and legislation so we can’t know for sure. But personal finances isn’t all about maximizing your money, it’s also about prudent saving and having access to money when you need it and the ISA gives you tax free growth and withdrawal flexibility that you don’t get with a pension. So give the pension precedence, but don’t forget the ISA and maybe use it for a rainy day or to help with early retirement.

True. We don’t know the OP’s age. Maxing out pension contributions may not be a good idea if you then find you need the money but have locked it away until retirement.

22225

Thank you all. Flexibility is important. But it was more understanding the maths that's important. Eg how does tax affect the 'compound interest'.
Thank you all

eskbanker

22225 said:

Thank you all. Flexibility is important. But it was more understanding the maths that's important. Eg how does tax affect the 'compound interest'.
Thank you all

It was pointed out on page one that it (the sequencing of growth and taxation) doesn't matter:

NoMore said:

We can ignore investment gains in all this because tax x contribution x gain (Isa) is the same as contribution x gain x tax (pension)

1961templar

1. Pension Contributions:

   • When you put money into a pension, you get tax relief on your contributions, meaning you can invest more of your money upfront. However, when you start withdrawing money from your pension in retirement, the income is subject to income tax. The amount of tax you pay will depend on your total income at that time and the tax bands that apply to you.

2. ISAs (Individual Savings Accounts):

   • Money invested in an ISA grows tax-free, and when you withdraw the money (whether as interest, dividends, or capital gains), there is no tax to pay on it. This makes ISAs a very tax-efficient way of saving or investing for the future, as there are no taxes on the income or gains you make while the money is in the ISA or when you take it out.

So, to summarize:

• Pension: tax relief when contributing, but income is taxed when withdrawn.

• ISA: no tax relief on contributions, but tax-free growth and withdrawals.

Each option has its advantages depending on your financial goals and situation. 

NoMore

1961templar said:

1. Pension Contributions:

   • When you put money into a pension, you get tax relief on your contributions, meaning you can invest more of your money upfront. However, when you start withdrawing money from your pension in retirement, the income is subject to income tax. The amount of tax you pay will depend on your total income at that time and the tax bands that apply to you.

2. ISAs (Individual Savings Accounts):

   • Money invested in an ISA grows tax-free, and when you withdraw the money (whether as interest, dividends, or capital gains), there is no tax to pay on it. This makes ISAs a very tax-efficient way of saving or investing for the future, as there are no taxes on the income or gains you make while the money is in the ISA or when you take it out.

So, to summarize:

• Pension: tax relief when contributing, but income is taxed when withdrawn.

• ISA: no tax relief on contributions, but tax-free growth and withdrawals.

Each option has its advantages depending on your financial goals and situation. 

You have missed the most vital difference, the 25% tax free available from a Pension, this is what makes Pensions more tax efficient than ISA, as its truly tax free, having no tax on either contribution (ISA) or withdrawal (rest of Pension).

Sarahspangles

NoMore said:

You have missed the most vital difference, the 25% tax free available from a Pension, this is what makes Pensions more tax efficient than ISA, as its truly tax free, having no tax on either contribution (ISA) or withdrawal (rest of Pension).

There’s also an angle that you could see it as HMRC ‘loaning’ the tax relief so that it’s available for investment for longer. If investment generates a return, then HMRC get more tax back, but if investment return is poor they lose some of the original ‘deferred tax’ stake.

QrizB

If you're a long way from retirement it might possibly make sense to use an ISA rather than a SIPP. SIPPs tend to have slightly higher fees than ISAs, which will erode the 6.25% advantage over time. Plus you'll be able to get at the ISA more easily if you have a complete change of plans along the way.

And then once you get into your late 40s you can start paying the ISA into your SIPP (subject to earnings limits etc) and still get the 6.25% uplift.

kempiejon

Some can begin their SIPP withdrawals as their only source of taxable income so using up to the personal allowance without a tax fee on that income. Some higher rate tax payers can contrive contributions at 40/5% and withdrawals at basic rate to rinse a little more profit from the tax.

LHW99

kempiejon said:

Some can begin their SIPP withdrawals as their only source of taxable income so using up to the personal allowance without a tax fee on that income. Some higher rate tax payers can contrive contributions at 40/5% and withdrawals at basic rate to rinse a little more profit from the tax.

Then again, it may make sense for people to build up / use ISA funds as a bridge / top-up to cover early years if eg they have gone part-time, and can therefore defer drawing on the pension.