How best to use your ISA savings when it comes to retirement
Pensions aren’t the only option – an ISA can top up your income
Pensions are typically the best way to save for retirement, due to tax relief and potential employer contributions – but ISAs can also provide an effective way to boost your retirement income.
The benefit of ISAs is that all growth and returns are tax-free. You won’t have to worry about capital gains tax or income tax on withdrawals. This means that in retirement, you could withdraw some of your ISA to top-up your income without having to pay tax.
Everyone in the UK has a personal allowance of £12,570 a year that you can earn without paying any tax. The state pension is £10,600 a year (rising to £11,502 from April). Withdrawals from a pension that take your income above the personal allowance could be subject to tax – although the first quarter of pension withdrawals are tax-free.
Maximising your cash
Nick Onslow, a chartered financial planner at Progeny, says it is common in retirement to take the state pension combined with a further 25 per cent taxfree cash from your private pension. You could then top-up your income from a variety of tax-free wrappers such as ISAs or using allowances such as the £1,000 savings and £500 annual dividend allowance.
“The best way to achieve a great retirement plan is to be as tax-efficient as possible,” says Nick. “The most effective way to achieve this is to build an income that incorporates a variety of income tax allowances and tax wrappers such as ISAs and pensions.”
The other benefit of saving into an ISA for retirement is that it gives you the chance to retire earlier.
Private pensions can only be accessed from the age of 55, rising to 57 in 2028.
If you want to retire before this age, you’ll have to rely on savings elsewhere – and it makes sense for most of this money to be in a tax-free ISA.
Saving for the future
You can save up to £20,000 a year into an ISA. So, if you saved the maximum amount over 10 years, and achieved returns of 5 per cent a year, you would end with a total balance of £265,867.
This could then be used to provide an income before drawing from a pension, or to top-up pension income.
The downside of ISAs is that money you save into an ISA comes out of post-tax income, unlike money saved into a pension where you get tax relief.
You’ll also miss out on employer contributions of at least 3 per cent of your salary if you are employed.
So financial advisers typically say to prioritise pension saving first before considering ISAs, although an ISA could be a good place to put additional savings.
There’s nothing to stop you paying into both, if you can afford to.
The best way to achieve a great retirement plan is to be as taxefficient as possible