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ISAs and retirement planning

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You know you should save for your retirement – but is ploughing your money into a pension the best way to do it? For some people this may be the case but financial advisers agree that individual savings accounts (ISAs) can play a vital role in retirement planning.

“While not as tax efficient while putting money in, on the way out, ISAs offer a great means of saving and investing,” says Darius McDermott, Managing Director at Chelsea Financial Services. “With an annual cap of £40,000 on pension contributions, these accounts can be an ideal supplement to retirement investing.”

Making the most of the ISA allowance

The ISA allowance was increased considerably in 2014 from £11,520 to £15,000 a year and is set to rise to £15,240 for the 2015-16 tax year.

Gareth Smith, Skipton Financial Services Limited (SFS) Pension Support Manager, said:

“Opportunities to reduce your tax burden don’t come up very often, and you should grab them with both hands. Your increased annual ISA allowances offer a fantastic chance to build your savings and investments in a tax-efficient manner.

“Making the most of these allowances can make a considerable difference to your financial well-being, especially if you build up a large holding over a number of years.” 

What’s more, the way that money can be saved inside the ISA wrapper has also changed. Previously, the full allowance could be saved into a stocks and shares ISA, or half the amount could be saved in a cash ISA.

However, the whole allowance can now be saved in a cash ISA or split between a cash and a stocks and shares ISA in any way you wish. Additionally, you can now transfer from stocks and shares back into cash, whereas previously the transfer could only be done from cash to stocks and shares.

This ability to move freely between stocks and shares and cash means that ISAs should meet the needs of people throughout their lives as they plan for their retirement, says Patrick Connolly, certified financial planner at advisers Chase de Vere.

“This is important because it allows savers to build up investments in stocks and shares ISAs while they’re younger and may be willing to take more investment risk, but then they can move some, or all, of their money into cash if capital protection becomes their main goal, while not losing [the tax advantages of] their ISA wrapper,” he says.

Don’t overlook pensions

There is no denying the advantages of pensions in saving for retirement. For instance, pension contributions are topped up by tax-relief, meaning a basic rate taxpayer's contributions are boosted by 20%, while higher rate taxpayers get a top-up worth 40% and additional rate taxpayers get 45% added to their pots.

However, because pensions are intended specifically for providing for retirement, they aren't as flexible as other savings vehicles. This means you can’t access your savings until you are 55 – and that age is due to increase to 57 by 2028.

However, ISAs can also be a good option for younger people who are likely to have financial objectives other than just retirement planning, and so are more likely to benefit from the increased flexibility.

Flexibility is key

Patrick from Chase de Verre points out that this flexibility is especially useful for those just starting out in their careers, who will often have lower earnings as a result.

“This group may not benefit from higher rate income tax relief if investing into a pension, again pushing the balance back toward the flexibility of ISAs,” he says.

Investments inside an ISA are free from capital gains tax. Nor is there any tax on interest earned on bonds or bond funds, and only a 10% tax cap on income from shares or equity funds as long as they are in the ISA wrapper, points out Chelsea’s Darius. What’s more, there is no need to declare your ISA on your self-assessment tax return.

“The ISA is simple, flexible and easy to understand,” he says.

One of the most important decisions a saver must make is whether to invest in cash or stocks and shares ISAs, or a combination of both.

Chelsea’s Darius says investing in a cash ISA is an “ultra-conservative” approach if investing at the early or mid-stages of saving for a pension, because typically savers should get a better return over the long term by investing in stocks and shares.

Before investing in a stocks and shares ISA, you need to decide what you want to achieve, how long you can invest for, what access you may need to your money and the level of risk you are prepared to take, all in the context of what other investments you have. If you’re not sure what to do for the best then you should consider taking financial advice.

This article has been commissioned by retiresavvy and any opinions voiced are the author's own.

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