ISAs - A Useful Alternative

When you start to plan for your retirement, you do not have to do all your saving through a pension. Individual Savings Accounts - or ISAs - provide a useful alternative.

ISAs (Individual Savings Accounts) were introduced by the government in 1999 to replace PEPs and TESSAs. They represent one of the few tax-breaks available to savers who pay income tax.

You can take out EITHER one maxi ISA, in which you can invest up to £7,000 all in stocks and shares or split between the three components with a maximum of £3,000 in cash and £1,000 in life insurance, OR up to three mini ISAs with up to £3,000 in one mini cash ISA, up to £3,000 in one mini shares ISA and up to £1,000 in a mini insurance ISA.

You cannot take out both a maxi ISA and a mini ISA in the same tax year, nor can you have two mini ISAs of the same type (such as two mini cash ISAs).

Mini cash ISAs provide combined benefits of tax exempt interest and instant access. Maxi equity or 'stocks and shares' ISAs provide the opportunity to invest in the stockmarket with returns which are free of tax.

ISAs for retirement

One key difference between a conventional pension and saving via an ISA is when you get your tax benefit. With a pension, you make contributions out of your pre-tax earnings, but get taxed on the income when you draw your pension. With an ISA, you contribute out of your post-tax earnings, but get tax benefits on any income that you take from it. However, in most cases your income (and therefore tax rate) in retirement is likely to be lower. So, if you are a higher rate taxpayer now but expect to be a basic rate taxpayer in retirement, the pension route has a slight tax advantage. Also, if you lost your job, you would have to use up most of your non-pension savings before you qualified for any welfare benefits. The contribution levels for pensions are also higher than for ISAs.

On the plus side, ISAs often have lower charges than pensions, although stakeholder pensions have bridged this gap. There is also the key issue of access to your money. With a traditional pension you cannot touch the cash that you pay into it until you reach the age of 50 (gradually rising to 55 with effect from April 2006). Most of the fund then has to be used to buy an annuity which provides you with annual income for life. Once you have taken out an annuity, you cannot pass your pension fund onto your heirs. However, had you saved in ISAs, whatever remained upon your death could be passed on. Of course you need to exercise discipline if you put retirement savings into an ISA - make sure easy access does lead you to spend the lot.

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