The two main tax-efficient wrappers in the UK are pensions and ISAs. Both provide a valuable shelter against income tax and Capital Gains Tax, but there are some important differences.

How much can you pay into tax wrappers?

You can pay a maximum of £20,000 per year into an ISA (or £40,000 if a couple were to use both their allowances). This allowance is only available for a given tax year. The standard pension annual allowance, the amount that can be contributed into a pension and benefit from tax relief, is £40,000. Contributions for non-earners are limited to £3,600. Savers may be able to increase tax-incentivised contributions by carrying forward unused allowances from previous tax years.

ISAs vs. pensions

Investment ISAs typically offer better returns than their cash ISA counterparts, which have very low interest rates. Investment ISAs can often be accessed flexibly, as opposed to pensions, which can usually only be accessed from age 55. It’s always prudent to maximise ISA contributions before paying into a general investment account (GIA). GIAs can be accessed at any time and there is no limit on contributions, but they don’t benefit from the same tax shelters. Pensions are outside of the estate for inheritance tax (IHT) purposes, whereas ISAs may be subject to IHT, unless left to a spouse/civil partner. Pension withdrawals are subject to marginal rate income tax (25% can be taken tax-free), whereas ISA withdrawals are free from tax.

Tax relief for high earners

Basic rate taxpayers receive income tax relief of 20% on pension contributions, while higher and additional rate taxpayers can benefit from 40% and 45% respectively. Those earning between £100,000 and £125,140 can receive 60% tax relief. Tax relief means pension contributions may be more attractive for certain high earners, when compared to ISA contributions.

Making full use of your various tax wrappers and allowances is the cornerstone of a robust financial plan. Call 03300 564 446 to speak to a Lumin expert, or book a free introductory meeting by visiting luminwealth.co.uk/contact.

If you would like more information about the interplay between ISAs and pensions, then you can download our factsheet on the subject by clicking here.