If you’re an Australian living in the UK for any substantial length of time, or if you’re planning to retire here, then you will clearly want to make the most of any tax-efficient opportunities you have to save and invest your money.
Two of the most popular options available in the UK are contributing to a pension arrangement and saving or investing in an Individual Savings Account (ISA).
In this article, you can find out about how each option provides valuable tax-efficiency, which can help boost your savings and mitigate the effect of taxation when you come to take your money out of each.
Tax incentives mean your pension fund sits at the heart of your retirement planning
A key component of your long-term financial plan will be building a retirement fund to provide you with an income once you stop work and no longer have a regular salary.
You could derive your income in retirement from various sources. These could include investments, property, and other assets, but it’s very likely that the bulk will come from your accrued pension fund.
To encourage you to make your own arrangements, the UK government incentivise pension contributions through tax relief.
Basic-rate relief is paid at source. This means that for every £80 you contribute, an extra £20 is automatically added without you having to claim anything. This effectively gives you an immediate 25% uplift on your contributions!
You can then claim higher- and additional-rate relief through your self-assessment tax return each year.
In addition to this, if you are employed, your employer is obliged to contribute at least 3% of your salary to a pension, subject to your age and earnings.
You can claim tax relief on your personal contributions up to £60,000 gross each year. This is known as your Annual Allowance.
Additionally, you can carry forward any unused allowance from three previous tax years, to give your fund a boost.
Pension Freedoms legislation gives you great flexibility when you draw from your fund
There is no limit to the amount you can accrue in your pension fund, although it’s important to note that you will pay Income Tax at your marginal rate on withdrawals, with the exception of 25% of your fund (up to £268,275) that you can take tax-free.
Pension Freedoms legislation introduced in 2015 has created a high level of flexibility in terms of how much and when you can draw from your fund. Effectively, for most people, the only limits are the 25% tax-free amount, and the fact that you can only start to draw from your fund once you reach age 55, rising to age 57 in 2028.
As well as your fund being exempt from Capital Gains Tax (CGT), if you pass away before you reach age 75 your pension fund will not be subject to Inheritance Tax (IHT), regardless of the overall value of your estate.
The tax advantages and flexibility mean that your pension fund can form an integral part of your income strategy when you retire.
ISAs are a highly tax-efficient way for you to save and invest
You can save or invest up to £20,000 each year into ISAs, regardless of your earnings.
This applies to each individual, so you and your spouse or partner can save up to £40,000 between you.
There are two primary ISA options:
- A Cash ISA is effectively the same as a building society account with your contributions attracting interest each year
- Stocks and Shares ISAs enable you to hold investment funds and individual shares in a tax-efficient wrapper.
You aren’t obliged to choose between these two options, and you can split your £20,000 annual contribution to align with your financial plans.
The tax efficiency derives from the fact that you will not be liable for tax on any interest, income, dividends, or capital gains from your ISA.
These tax advantages make ISAs a highly attractive savings and investment option.
ISAs can form an important part of your savings and investment strategy
Because of their advantageous tax status, and the fact there are different options available, ISAs give you valuable flexibility when it comes to developing your savings and investment plans.
As you have read, both you and your partner have a £20,000 ISA allowance, so with careful planning you can fully utilise £40,000 each year to help you meet your financial aims.
Cash ISAs are an ideal vehicle for short-term savings, which will normally mean a timeframe of fewer than five years. As with standard savings, you may want to earmark a specific ISA account for a certain purpose, such as a new car or an expensive holiday.
The CGT exemption makes Stocks and Shares ISAs an excellent investment option, particularly as the CGT Annual Exempt Amount has been gradually reduced from £12,500 in 2022/23 to just £3,000 in the 2024/25.
This means that it can make sound financial sense to hold longer-term investments within the tax-efficient ISA wrapper.
Another advantage to bear in mind is that you can draw from your ISA whenever you want. This accessibility means they can form an effective part of your income strategy alongside your pension arrangements.
However, it’s important to note that when you pass away, unlike pensions, any ISAs you hold will form part of your estate for IHT purposes.
It’s not a binary choice between the two options
Investing in your pension fund and ISAs is not an either-or scenario.
As you have read, there are tax advantages to both options, and it can help to look to make the most of both in alignment as part of your investment and income planning, rather than separately.
There are various factors that you should take into account when it comes to deciding how, when, and how much to contribute to each. These include:
- Your investment or savings time frame
- What the money you’re setting aside is for
- When you will want to access your fund.
For example, the ability to draw from your ISA at any time, can make one ideal for an earmarked specific investment purpose, such as school fees for your children.
The longer-term nature of pensions can make them a better and more appropriate option for retirement savings.
However, there is nothing to stop you using an ISA as a retirement savings vehicle. For example, this can be an advantageous option if you have maximised your Annual Allowance in a particular year.
Find out more
We have written two previous articles about ISAs and General Investment Accounts (GIAs) that you may find helpful.
If you are an Australian resident, ISAs and GIAs could create tax issues for you
What could you do with your ISAs and other investments if you move to Australia?
Get in touch
If you would like to talk about your savings and investment strategy, then please get in touch with us.
Please note
This article is for information only. Please do not solely rely on anything you have read in this article and ensure that you conduct your own research to ensure any actions you may take are suitable for your circumstances. All contents are based on our understanding of ATO and HMRC legislation, which is subject to change.
A pension is a long-term investment not normally accessible until 55 (57 from April 2028). The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available. Past performance is not a reliable indicator of future performance.
The tax implications of pension withdrawals will be based on your individual circumstances. Thresholds, percentage rates, and tax legislation may change in subsequent Finance Acts.
The value of your investments (and any income from them) can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance.
The Financial Conduct Authority does not regulate estate planning or tax planning.
