The key thing to know here is that wrapper choice is primarily about tax and access. The combination of a pension and an ISA gives you the best of all worlds when it comes to the two main drivers of wrapper choice.
(By the way, wrapper is a term I use to mean the different kinds of account. So pensions and ISAs are wrappers. So are EISs and VCTs, and so are onshore and offshore investment bonds, and general investment accounts. Got that? Good).
If you have both a pension and an ISA, you can determine where to put the money that you’re saving towards the best end. Generally, paying into a pension gives you the most bang for the buck because you’re getting tax relief from the government to pay in.
Don’t get confused by that term tax relief, it simply means that the government gives you some of your tax back for paying in, either directly into your pension if you’re a basic rate taxpayer, and also to your bank account if you’re a higher rate or additional rate payer.
The downside of that nice tax relief is that the money you take OUT of a pension down the line is taxed, or at least partially. ISAs, on the other hand, give you no special tax breaks for putting money in, but there’s never any tax on the way out either. And there’s no age restriction.
Many fans of the FIRE movement talk about using their ISAs to bridge the gap between stopping work and being of pension age. If you want to retire at age 50 and you can’t get at your pension until age 58, then you’re going to need somewhere else to get money from for eight years.
So you can see how blending the two kinds of accounts really provides all the flexibility most of us will need. When you also think that the ISA contribution limit is £20,000 per year and the pension contribution limit is £40,000 or 100% of your salary, whichever is lower, someone on, say, £80,000 per year could potentially contribute £60,000 to their ISA and pension combo each year.
Only a fraction of people reading this will be in a position to save more than five grand a month between those two accounts. Tax and access and decent investment limits – that’s the reason why ISA and pension are all that most of us need.
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