PENSION DOCTOR
Use your Isa to dodge a tax charge on pension payouts, says Kate Smith
Over the past 10 years, the amount that can be paid into a pension each year with tax relief and the overall maximum that can be held without suffering a tax charge have become less generous. Over a similar time period, we’ve seen increases to the Isa allowance.
Together, this has meant more people are using Isas to help them fund their retirement. A combination of saving into pensions and Isas gives people more choice and flexibility.
This is particularly true for those affected or potentially affected by the frozen pension lifetime allowance of £1,073,100 until April 5 2026. For them, Isas have become more attractive as part of their retirement planning. It’s a good idea to have both to give you more options.
The main difference between pensions and Isas is their tax treatment. Pensions are the most tax-efficient way of saving for retirement with tax relief on personal contributions equal to the top rate of income tax you pay.
They also benefit from employer contributions, especially as many employers contribute more than the statutory 3pc auto-enrolment contribution, and may go further by matching employees’ contributions.
However, for some, the attraction of contributing to a pension may diminish as pension savings get close to, or above, the lifetime allowance. Funds above this limit face additional taxes of up to 55pc.
Isas can also be used to provide an income in retirement. Contributions are paid from taxed income, so are “taxed” on the way in. A major attraction of Isas is that withdrawals are tax-free. For pensions, apart from the 25pc tax-free cash sum, the rest is taxed at your income tax rate.
The lifetime allowance limits the value of pension benefits that can be taken from all your registered pension schemes, whether it’s a lump sum or retirement income, without triggering a tax charge. There’s no lifetime limit on the amount you can hold in an Isa. If you are concerned about breaching the lifetime allowance, consider diverting some or all of your pension contributions or other savings into Isas.
A word of warning – stopping your own pension contribution could mean that you lose your employer’s pension contribution. If you’re paying high pension contributions, an alternative is to reduce these to the level where you still receive your employer’s contribution. Then pay the difference into your Isa.