Is the ISA vs pension debate such a saga for the over 50s?
I read an article recently that suggested no-one over the age of 50 should invest in an ISA any more. As headlines go it did its job and caught my eye. But, as always, the article wasn't as dramatic as the one-liner hinted. It was instead suggesting that, given the choice of which tax-wrapper to use for savings, over-50s are perhaps better off investing in their pension instead of an ISA. And here's why.
Four reasons for over-50s to invest in a pension rather than an ISA
Assuming that, by the age of 50, you have accumulated a decent pot of ISA money, there are a number of good reasons you might want to focus your savings now on your pension instead.
1. Access and flexibility
The big draw back of a pension historically has been that you can't access your money until very late in life and you would have to transfer it to an annuity. As many people save for a number of financial goals in life, like university fees, a house, holidays, rainy days and retirement, ISAs are generally more popular when we are younger, as we can access our savings any time we like.
However, for people aged 50 or above, this is less of a consideration as getting access to your pension is a matter of five years (or less) away – a period of time for which most of us would be happy to lock in our money. And if you have some money saved in an ISA, you can always draw on that in the intervening years. What's more, pensions freedoms now mean we have total control over how we invest our pensions savings.
2. Tax relief
Tax relief on pensions has always been an attraction and, for many people, their late 40s and 50s are their peak earning time, when they are likely to be in the higher rate tax paying band. So putting more money into pensions to get the 40% tax relief at this point makes sense, especially as many then fall into the lower 20% tax paying band in retirement. It also makes sense for those who are 20% tax payers now, as they are likely to become zero-rate tax payers in retirement so the tax relief differential is the same.
3) Carry forward
The annual pension allowance is £40,000, or the equivalent of an individual’s annual salary if it’s lower. Very few of us actually manage to invest that much each year. However, you can carry forward any unused allowance from the previous three years. So if you come into some money at this point, you can top up your pension with a significant amount.
4) Inheritance tax and bankruptcy
Another benefit of pensions is that their assets can be passed on after death, free from inheritance tax, to anyone – not just your spouse or partner. For anyone running their own business, another benefit is that undrawn pension funds are protected from the creditors in the event of bankruptcy.
It's just a tax wrapper
At the end of the day, what is important is that you save for as long as possible and that you use either an ISA or a pension to do so. There is no reason not to, unless you are particularly fond of HMRC and want to donate more money to them!
If you can afford to, contributing to both from an early age is even better, as you can benefit from the eighth wonder of the world: compounding.
For example, if someone invested one of those nice shiny new £1 coins a day for 70 years and achieved an annual rate of return of 7%, it would be worth £685,245. Not bad for a total investment of £25,568. The power of compound interest is considerable and it has many lessons to teach investors – no matter what their age.Past performance is not a reliable guide to future returns. You may not get back the amount originally invested, and tax rules can change over time. Darius's views are his own and do not constitute financial advice.