15 Oct 2014

Pension vs NISA: Which is best for retirement?

Pension vs NISA: Which is best for retirement?

Alan Davidson, Financial Adviser, looks at the changes made in the 2014 Budget which aim to encourage more people to save money for their futures but, with improvements made to both NISAs and pensions, which savings vehicle is best? 

Alan Davidson, Financial Adviser, looks at the changes made in the 2014 Budget which aim to encourage more people to save money for their futures but, with improvements made to both NISAs and pensions, which savings vehicle is best? 

While putting money into a pension regularly is the way most of us plan for our retirement, it is not the only option. Individual savings accounts, now called NISA's can have an important part in retirement planning, too. 

Both NISAs and pensions benefit from an exemption from tax on investment gains and income, apart from the non reclaimable dividend tax credit. At a first glance, pensions look better than NISAs because you get upfront tax relief on your contributions up to an annual allowance.  For 2014/15 the annual allowance is £40,000, with personal contributions also limited by your relevant UK earnings, i.e. if your earnings are less than £40,000, you may have unused relief to carry forward). This means that if you are a higher rate taxpayer, you get 40% tax relief on every £1 you put in to the extent that the income you put in would otherwise have been subject to income tax at that rate. So, if you would have paid 40% tax on £5,000 of your income but you put that income into a pension instead, you could get 40% relief on it; if you would have been subject to the 40% rate on only £3,000 of that income then you could get 40% relief on that and 20% (the basic rate) on the remaining £2,000. 

Similarly for basic rate taxpayers and non taxpayers there’s 20% relief on pension contributions made within allowable limits. Even people with no earnings can contribute up to £3,600 per annum gross into a pension and receive 20% tax relief upfront.  So it could cost a higher rate taxpayer £60 to put £100 into a pension or £80 for a basic rate or non taxpayer. Additional rate taxpayers could benefit from 45% tax relief on pension contributions again to the extent that those contributions would otherwise have been subject to income tax at that rate. 

When you take money out from your pension pot you can take 25% tax free. With the rest you will be subject to tax at your marginal rate of income tax at the time of withdrawal.  In comparison, there is no upfront tax relief on savings within a NISA. But with NISAs there are no tax liabilities when you take money out. 

These two different tax positions mean that NISAs and pensions may work well together as part of your retirement planning. They also complement each other on accessibility. You should always remember, however, that like other investments, they can fall in value as well as rise and you may end up with less than you put in. Money in a NISA can be withdrawn whenever you wish. So if you need to pay for, say, children’s education costs, or your daughter’s wedding, you can take the money out even if you are years from retiring. You can’t access your pension until you are at least age 55 – rising to age 57 by 2028. 

But while the flexibility of a NISA is attractive, it does offer the temptation of withdrawing your money before you retire, damaging your retirement planning. With pensions, you have the inbuilt discipline which means the money has to be left untouched until at least age 55. However from next year you won’t be obliged to use cash from your money purchase pension to buy an annuity, so pensions are becoming more flexible. That, of course, brings its own risk of blowing the cash rather than using it to provide a regular retirement income. 

Pensions beat NISAs in two other respects. First, if you have a workplace pension then your employer will usually contribute as well which doesn’t happen with a NISA. Secondly, you can potentially put a lot more each year into a pension than a NISA, for example £40,000 per tax year compared with £15,000 for a NISA. The value to you of all these favourable treatments will depend on your own individual circumstances. 

So while contributions into a pension might benefit from upfront tax relief the flexibility of NISAs means that both NISAs and pensions deserve to be included in your retirement planning but remember that pension and tax rules can change at any time in future and their benefits could be made unavailable to you. 

Alan Davidson, Financial Adviser

Authorised by the Law Society of Scotland. Authorised and Regulated by the Financial Conduct Authority. The Financial Conduct Authority does not regulate tax advice.


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