Pension vs NISA

What's NISA Pension or ISA?

The Chancellor's 2014 budget brought with it radical changes to both ISA and pension regimes. The proposed pension changes in particular set us thinking about which wrapper, ISA or pension, is a better place to save. So does tax relief on the way in (pension) beat tax-free on the way out (ISA)?

What's new?

For pensions from April 2015:

  • Anyone of pension age (55) will have complete freedom to take as much (or as little) from their personal pensions as they choose.
  • 25% will be tax-free with the balance taxed as income in the year it's taken.

For ISAs from July 2014:

  • The annual amount that can be saved in an ISA has risen to £15,000.
  • There will be no cap on how much of the annual allowance can be invested in cash.
  • There will be freedom to transfer fully between cash and stocks and shares type ISAs.

    • The tax breaks

    Pensions and ISAs enjoy the same tax privileges on their underlying investments. Both wrappers incur no additional tax on any investment growth and income. This gives them a distinct advantage over most other investment and savings vehicles.

    Where pensions and ISAs differ is on the tax position when contributions are made and when funds are withdrawn.

    Money in

    • Pensions enjoy tax relief on contributions, subject to certain annual and lifetime limitations.
    • ISA contributions do not attract tax relief.

    Money out

    • Up to 25% of a pension fund can be taken completely tax-free. The balance will be subject to income tax at the saver's highest marginal rate of income tax.
    • All withdrawals from an ISA are tax-free

    The figures

    Assuming investments grow at the same rate for both pension and ISA, what would give the best net return? The table below looks at what could you get back from an investment of £15,000 out of post-tax earnings, left to grow over an investment period of 10 years. It covers each of the conceivable combinations of tax rates on the way in and the way out.

    % tax rate in/out Pension return ISA return Pension gain/ISA gain
    45/45 £23,129 £19,201 £3,928
    45/40 £24,438 £19,201 £5,237
    45/20 £29,675 £19,201 £10,474
    40/45 £21.201 £19,201 £2,000
    40/40 £22,401 £19,201 £3,200
    40/20 £27,202 £19,201 £8,001
    20/45 £15,901 £19,201 £3,300
    20/40 £16,801 £19,201 £2,400
    20/20 £20,401 £19,201 £1,200

    Assumptions

    • Returns are based on a real rate of return of 2.5%.
    • Investments chosen under each plan are the same.
    • Neither pension payments in, nor withdrawals made, have any impact on the personal allowance.
    • Payments into the pension are made within the annual allowance.
    • Payments out of the pension don't attract a lifetime allowance charge.
    • Tax rates and allowances are at current levels.

    The table above shows that in the majority of cases, the benefit of up front tax relief and a 25% tax-free payout will outperform an ISA on a like for like basis. There are however other factors to take into account.

    Other factors

    It should not be forgotten that ISAs can be taken at any time without the need to wait until age 55.

    The taking of a large amount from pension funds in any one tax year is likely to push people into higher rate tax territory.

    Steve Hall & Adam Caga