Many financial advisors will tell you to invest in a Personal Pension Scheme (Stakeholder Pensions) before an Individual Savings Account (ISA). Whilst your financial advisor may have your best interests at heart, this move may not be right for your finances. I am of the opinion that by opening and investing in an ISA first, you are in greater control and much more aware of your finances. read on to find out why.
A personal pension, sometimes also referred to as a private pension involves a person making regular or lump sum contributions to a regulated financial organisation that invests the money on your behalf.
Don’t mistake this with a workplace pension which all companies are required by law by April 2017 to enrol employees above the the age of 22 who earn more than £9,440. Company Pensions usually match your pension contributions. So if you pay in 3% of your salary to your pension pot, they may match this and pay in the same 3%, giving you a total pot of 6% of your salary for each year you pay in.
With the workplace pension, if your company matches your contributions, it would be foolish of you not to contribute up to the matching amount as you are getting ‘free money from your employer.’ But above this amount, it is far more prudent for you to put your money in an ISA.
Why chose an ISA over Non-Contributory Workplace Pensions or Personal Pensions
If you have a personal pension or a workplace pension, you are leaving the investment decisions in other people hands. You are letting your financial advisor or your employer invest on your behalf and I can guarantee that most people don’t have a clue what their money is invested into!
I, as an advocate of personal finance, believe that people should have a more hands-on approach with their investments. By having to open an ISA, it requires you to go out and do research in where the best place is to open an ISA.
You’ll then have to figure out a way to get the money into it, and forced to learn how to choose the investments you place inside it. This way you’ll be forced to learn about YOUR money and investments – even if it means going to have a chat with your financial advisor to make sense of it all.
Essentially, opening an ISA makes you do some work and gets you more interested in your finances. You’ll actually know where your money is invested and by seeing your investments grow as a result of your decisions, you will be willing to save and invest more.
Also, pensions offered by companies tend to hold investments that are more costly and under perform.
many pensions offer a fairly pathetic array of investment funds with high expense ratios. Most people I know just pick “target date funds” or other funds based on the name, with no knowledge of the underlying expense ratio they pay or other potential costs. Most of the time these firms are ‘closet trackers’ so once you include the high expense ratios’, they under perform the market significantly.
What about Taxes?
Now this is the big question, what about the taxes you can claim back when investing in a Pension? Shouldn’t that make a difference?
For a basic rate payer, it shouldn’t make too much of a difference between investing in a Pension Vs an ISA. When you put money into a pension as a basic rate payer, you normally get 20% added back on top but have to pay tax at PAYE when you withdraw money. On the other hand you get no tax rebate when investing in an ISA but you also don’t get taxed when withdrawing money from an ISA. To keep it simple, if you are going to be a basic rate payer of higher rate/additional rate taxpayer, it should not make too much of a difference tax wise whether you invest in an ISA or Pension.
If you are a higher rate or additional rate taxpayer, it makes much more sense to invest through a Pension. At this rate of tax, you get greater tax efficiencies by investing in Pensions. But I am of the opinion that after funding your pension, you should still open an ISA (or even a SIPP) because you have so many more options for investing your money. It also forces you to investigate, learn, and make a conscious choice versus just filled out some paperwork, forwarding it to HR, and then forgetting about the whole thing.
You need to take an more active role with your money because after all, it is your money!