Regardless of the age at which you intend to retire, accessing your pension funds typically won’t be possible until you reach 55. While pensions offer generous tax advantages, they aren’t the only option for building your retirement savings. Individual Savings Accounts (ISAs) are also an excellent financial tool, providing greater flexibility along with attractive tax benefits.
Pensions are the conventional route for retirement planning. Both you and your employer contribute to your pension pot, and upon retirement, you can withdraw 25% of the total amount tax-free. Additionally, there’s government tax relief available—20% for basic-rate taxpayers and 40% for those in higher tax brackets. On the other hand, ISAs present a valuable alternative for retirement savings, as all withdrawals are tax-free, which can be particularly beneficial.
Last year, cash ISAs saw significant growth, with nearly £50 billion deposited, as reported by the Bank of England. Approximately 60% of the funds held in ISAs are invested in stocks and shares, reflecting a growing trend among savers. Furthermore, the Lifetime ISA, introduced in 2017, serves dual purposes: it can be used both for retirement savings and as a means to purchase a first home.
Why Are ISAs Effective for Retirement Savings?
ISAs offer the unique advantage of accessibility, allowing you to withdraw your money whenever needed. This makes them an ideal choice for those with shorter-term financial goals as well as for individuals looking to retire early. Most people will not receive their state pension until they turn 67, and private pensions can typically only be accessed starting at age 55 (soon to be 57). However, an ISA can serve as a supplemental income source during the gap between retirement and pension access.
Laura Suter, the director of personal finance at AJ Bell, emphasizes that while ISAs may not provide the same initial tax benefits as pensions, their tax-free withdrawals make them an excellent option for enhancing retirement income without increasing your tax liability. As retirement can last 30 years or more for many individuals, investing in stocks and shares ISAs can help safeguard against inflation, rather than relying solely on cash savings. With the reduction in tax-free allowances for dividends and capital gains, the tax-free growth potential within an ISA is more crucial than ever.
You can deposit up to £20,000 into an ISA each tax year, with various options available. For retirement planning, most individuals prefer investment ISAs over cash ISAs, given the long-term nature of retirement savings. Beyond the tax-free allowance, ISAs also enjoy exemptions from income tax, capital gains tax, and dividend tax, ensuring that withdrawals remain tax-free.
Moreover, ISAs can facilitate inheritance planning; while they are included in your estate, a spouse or civil partner can inherit an ISA allowance without incurring tax due to the spousal exemption. The concept of the “ISA millionaire” has emerged—referring to savers who have consistently maximized their annual contributions and now boast ISA accounts worth £1 million or more.
According to Hargreaves Lansdown, the average age of an ISA millionaire is 72, and the number of such individuals has surged by 14% in the past six months, more than doubling the figures from two years ago.
Explore More About ISAs
- The current number of cash ISAs available has reached a record high, coinciding with discussions in the Treasury about potentially eliminating them in the next Budget.
- Analysis indicates that many cash ISA holders are losing money in real terms, as inflation outpaces the interest they earn.
- Amid concerns that cash ISAs might be discontinued, there has been a notable increase in savers directing funds into these accounts.
- Considerations on whether a cash ISA is the right choice for you and what alternatives may be more advantageous.
Reaching the milestone of ISA millionaire status can happen at a younger age as well. For instance, someone who begins saving in a stocks and shares ISA at 30 could achieve this goal by 57, provided they contribute £1,666.66 monthly and enjoy a growth rate of 5%. Even with smaller contributions, saving £300 a month from age 25 at the same growth rate may lead to millionaire status by age 70.
Kate Marshall, lead investment analyst at Hargreaves Lansdown, states: “While some individuals seek quick riches through investments, the majority of ISA millionaires have built their wealth steadily over time. They typically invest as much as they can of their annual allowance into a diverse and balanced portfolio consistently over several decades.”
The Benefits of Lifetime ISAs in Retirement
Don’t overlook the Lifetime ISA (LISA), which has gained traction in recent years. In the 2022-2023 period, 755,000 LISAs were funded, with £1.87 billion deposited—representing a 10% annual increase, according to HMRC. This account allows savers to contribute up to £4,000 each tax year and enjoy a 25% government bonus (adding £1,000 if the full allowance is utilized). You can make contributions to a LISA until you turn 50, and withdrawals can commence at age 60.
However, this account is exclusively available to those under 40, with strict regulations governing when and how funds can be accessed. A 25% penalty applies to early withdrawals unless they are for a first home deposit or retirement. Brian Byrnes, head of personal finance at Moneybox, notes: “A Lifetime ISA can be especially advantageous for retirement if you’ve already maximized your employer pension contributions, are self-employed, or fall within the nil-rate or basic-rate tax bracket. While pensions provide tax relief on contributions, LISA withdrawals are completely tax-free—unlike pension income, which is taxable.”
When considering a Lifetime ISA for retirement, opting for a stocks and shares LISA is advisable due to the long investment horizon and the potential for higher returns.
