How to use your ISA to prepare for retirement ...Middle East

Whatever age you plan to retire, with a pension you won’t be able to access your money until turning 55.

There are generous tax benefits to saving into a pension pot, but it’s not the only option – ISAs are also a great financial tool for your nest egg, providing more flexibility and useful tax breaks.

A pension is the standard route for retirement planning. Both you and your employer will contribute, you can take 25 per cent of the pot tax-free when you retire, and there’s government tax relief, too – 20 per cent for basic-rate taxpayers and 40 per cent for higher-rate taxpayers.

But ISAs are also valuable for retirement savings, providing more flexibility as all withdrawals are tax-free.  

Last year cash ISAs had a bumper year, with almost £50bn deposited into them, according to the Bank of England, while about 60 per cent of the money held within ISAs sits in stocks and shares.

There’s also the Lifetime ISA, launched in 2017 which can be used for a retirement pot or to save for a first home.

Money within an ISA can be accessed when you need it, making it the ideal home for shorter-term financial goals and for retiring early.

Most people won’t receive their state pension until they turn 67, while private pensions can only be accessed from the age of 55 (rising to 57). However, an ISA can top up your income when you stop working and before you start receiving your pension.

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Laura Suter, director of personal finance at AJ Bell, said: “ISAs don’t offer the same up-front tax perks as pensions, but withdrawals are tax-free, making them a great way to top up your retirement income without increasing your tax bill.

“With retirement lasting 30 or more years for many people, investing in stocks and shares ISAs can help protect against inflation, rather than opting for cash. Because the tax-free allowances on dividends and capital gains taxes have been slashed, the tax-free growth in an ISA is more valuable than ever.”

You can save up to £20,000 per tax year into an ISA, and there are several to choose from. For retirement planning, most people choose an investment instead of a cash ISA due to the longer-term nature of retirement saving.

The tax-free allowance is not the only benefit either. ISAs are exempt from income tax, capital gains tax and dividend tax, and the money taken from an ISA is tax-free, too.

They can also help with inheritance planning as even though they are included in your estate, a spouse or civil partner can inherit an ISA allowance without paying tax due to the spousal exemption.

There’s also the elusive “ISA millionaire” status – savers who have maxed out their annual allowance every year and now have at least £1million in their ISA accounts.

The average age of an ISA millionaire with an account at Hargreaves Lansdown is 72 and it says the number of these millionaires has risen 14 per cent in the past six months and is more than double the number seen two years ago.

Find out more about ISAs

It is possible to get to this milestone at an earlier age, too. Someone starting to save into a stocks and shares ISA at the age of 30, could potentially reach the goal by the age of 57 – providing them with a sizeable pension pot. This could happen if they were able to put away £1,666.66 per month, and with a growth of 5 per cent.

Even with a smaller amount, putting away £300 per month from the age of 25 with a 5 per cent growth rate could see them reaching the millionaire status by the age of 70.

Kate Marshall, lead investment analyst for Hargreaves Lansdown, says: “Some people get into investment in the hope of getting rich quick, but the vast majority of ISA millionaires have built a fortune through the far more reliable approach of getting rich slow.

“They don’t necessarily take enormous risks: many consistently invest as much as possible of their annual allowance, in a diverse and balanced portfolio, every year, for decades.”

Lifetime ISAs can benefit people in retirement

The Lifetime ISA (LISA) is not to be overlooked either. In 2022-2023, 755,000 LISAs were paid into with £1.87bn deposited, a 10 per cent annual rise, according to HMRC.

They allow savers to put away up to £4,000 per tax year and there is a 25 per cent government bonus (which would add £1,000 to the pot if the full allowance was used). You can pay into a LISA until you turn 50 and then withdraw the money from the age of 60.

However, it’s only available to open for people under the age of 40 and there are strict rules around when and how money can be accessed. There’s also a 25 per cent penalty if you take your money out early for a reason other than a first home deposit or for retirement. 

Brian Byrnes, head of personal finance at Moneybox, said: “A Lifetime ISA can be particularly beneficial for retirement if you have already maximised your employer pension contributions, are self-employed, or fall into the nil-rate or basic-rate tax bracket.

“While pensions offer tax relief on contributions, withdrawals from a Lifetime ISA are entirely tax-free – unlike pension income, which is subject to taxation.

“If using a Lifetime ISA for retirement, it’s worth considering a stocks and shares Lifetime ISA due to the long investment horizon and potential for higher returns.”

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