A question I get asked very frequently is how much to pay into pension and how much to pay into ISA. If you have £500 per month, say, to invest for your future, what should the split between the two account types be?
The answer is, maddeningly enough – it depends. It depends on your life stage – how close you are to retirement. It depends on the provision at work – is there a pension scheme there or not? And it depends on your own circumstances – maybe you’re expecting an inheritance in the near future which might change the split for you. In general terms I advise the following:
If you are employed and there is a pension scheme at work – join it. Don’t think about it, don’t umm and ahh, just join it. Your employer is obliged to pay into a pension for you if you join it, so by not doing so you’re literally turning down free money.
Pay into the pension the maximum you can to attract the top level of match from your employer. For example, the current rules say that your employer must pay in 3% of your salary, and you put in 4%. Add tax relief to your bit and you get an extra 1%, so that’s 8% going in to your pension.
Think about that. You put in 4% but 8% goes in. That’s a doubling of your money immediately. Some employers though will increase their contribution if you do, up to a certain limit.
I have some clients paying in 9% of their salary because their employer will do the same. I even have one client whose employer will double their contribution up to 9%. So, he’s paying in 9% and the employer is putting in 18% – nice work if you can get it! Get the most amount of money out of your boss – simple.
After that, pay everything else you have available to invest into an ISA. Keep going like this for a few years. This will amass money outside of a pension which remember is more flexibly accessible, should you need it.
Many of you reading this will be fans of the FIRE movement and will be wanting to work towards retiring early, say at age 50. If you do that, and you can’t access your pension until 58, then there’s a gap where you will need access to funds – an ISA is perfect for that.
As you go through life, I would gradually even up the balance between pension and ISA, and eventually in favour of your pension. The tax breaks of pensions, particularly for higher rate taxpayers are so good that it definitely makes sense to tilt the balance towards there before too long.
I would tilt the balance towards ISAs if you’re under 40 and then start to shift towards pensions after that. That’s a huge generalisation though, so if you’re unsure, seek professional advice.
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