The need to save for retirement is being drummed home by government, encouraging the entire working population to change its attitude toward saving for old age by offering incentives. Contractors and freelancers should take advantage of the newly relaxed rules for pensions and ISAs (or NISAs, New ISAS), as both are good savings vehicles, but which is best?
ISA or Pension?
NISAs are tax efficient savings and investment accounts. You can use them to save cash, or invest in stocks and shares. The maximum you can put into an NISA per annum (2014–15) is £15,000, and that can be split between cash, and stocks and shares NISAs if you like. You must pay into the NISA before the end of the tax year to reap the benefits of your allowance for that year.
- No tax to pay on the interest or dividends you receive from your NISA.
- You don’t have to inform HMRC that you have an NISA.
- Profits from investments are free of CGT.
- You can take out cash from your NISA at any time.
- You can swap between cash, and stocks and shares NISAs.
You can save into a Junior ISA (JISA) for your children, which they can’t touch until they’re 18. The allowance for a JISA is £4,000.
- No immediate tax advantage (as with a pension)
- You can’t carry forward an unused ISA allowance (as you can for pensions)
- Losses on ISA investments cannot be used to reduce CGT on profits from investments outside the ISA.
Government encourages pensions saving by giving immediate tax relief on pension contributions, which reduces your tax bill or increases your pension fund. The maximum you can save into your pension fund in any year (2014–15) is £40,000.
- Immediate tax relief on contributions up to £40,000.
- You can carry forward unused pension allowance for up to three years.
- After age 55 (age 57 by 2028) you can take out 25% tax-free.
- You can take out the whole lot after age 55 and invest it elsewhere; or
- You can take out an annual lump sum after age 55.
- If you take out your whole pension pot after age 55, anything over 25% will be taxed at the marginal rate which can be 20%, 40% or 45% depending on the size of your pension pot and other taxable income in the year of withdrawal.
ISAs make sense because you can take the whole pot tax-free whenever you want, regardless of how old you are when you retire.
Pensions are good for higher-rate taxpayers because they can gain tax relief of 40% or more on contributions – and, if they are a basic-rate taxpayer in retirement, will pay only 20% tax on the income.
Pensions are one of a few remaining tax breaks available to contractors and freelancers, so definitely, exploiting the tax efficiency of pensions by reducing tax liability makes sense. In the long-term, however, having retired and taken your 25% tax-free, taking small lumps over the years and recycling some of that into an ISA maximises your investment and gives you the freedom to dip into your savings as and if you need to.