While our savings and investment strategies are likely to change drastically based on factors like our financial goals, current circumstances, and future plans, there are a great number of measures you can take to improve your tax efficiency.
Investing wisely is a core component of your financial security, and with this in mind, making use of your Individual Savings Account (ISA) and pension tax efficient allowance can be vital in helping to retain more of your wealth while keeping it away from the taxman at the end of each financial year.
With each tax year running from April 6th to April 5th, we’re entitled to 12 months of new tax efficient allowances for both our ISAs and pensions that we can utilise to great effect.
However, many savers are failing to make the most of the allowances that they’re entitled to, missing out on valuable tax savings in the process.
While pensions have become part and parcel of UK savings and investing, 22.2 million adults have an active ISA account, representing just 42% of the population. Given their well-known tax efficiency and relatively easy access, it’s fair to say that many savers are missing a trick if they’ve failed to look into individual savings accounts.
So, how can you use ISAs, pensions, and your annual tax-free allowances more efficiently? Let’s take a deeper look into smarter tax planning strategies:
Making ISAs Work for Your Taxes
ISAs come in plenty of different forms, including cash ISAs that operate on fixed rate AERs, stocks and shares ISAs that are invested in securities, and Lifetime ISAs that are geared towards one-off purchases like a home.
Crucially, both Cash ISAs and Stocks and Shares ISAs offer an annual tax-free allowance of £20,000 each tax year. This means that between April 6th and April 5th, it’s possible to save £20,000 towards your financial goals with no capital gains tax (CGT) liable to be paid on any profits made.
Because you have no obligation to pay tax on the earnings you make with your individual savings account, it’s possible to make use of Stocks and Shares ISA allowances to compound your investments and build your wealth.
Unlike pensions, ISAs are relatively easy to access in most cases, and many savers who are more cautious about their overall economic health have been known to build their accounts while dipping into their savings if that dreaded rainy day arrives.
Building Tax Efficiency with Pensions
While pensions can’t be accessed until you turn 55, or 57 when new rules come into effect in 2028, many significant tax allowances can help to improve your tax planning.
First of all, you’re entitled to receive tax relief at your highest marginal rate of any contributions you make to pensions. This effectively means that some of what you would have paid in tax can be reallocated to your pension instead, helping to reduce the tax you pay and boost your savings for the future.
However, it’s worth noting that you’re restricted to paying the lower of £40,000 or 100% of your earnings into your pension each year to receive tax relief on the full amount you save, in what is known as the Annual Allowance.
Despite this, pensions offer a significant advantage over ISAs because it’s possible to carry forward unused allowances from the previous years to boost your pension’s tax efficiency further, if you happen to be a high income earner.
Of course, you will be unable to access your pension pot until later in life, so it’s important that your pension savings align with your financial goals, and whether you can afford to lock high portions of your wealth away for many years.
Uniting ISAs and Pensions
When it comes to intelligent tax planning, there’s no rule about choosing between an ISA or a pension, and creating a strategy that involves both can be a great way to save for your financial goals.
Of course, the 20% cash boosts from the government on pension savings make the strategy more tax efficient as a long-term investment, and the far higher annual allowance for pension contributions helps to contribute to building your wealth into retirement.
However, with the Autumn Budget stipulating that, from April 2027, unspent pension pots will be liable to inheritance tax (IHT) as part of your estate after death, focusing solely on building your personal pension could yet incur taxation if you don’t spend it yourself. With this in mind, a more balanced approach can be effective with ISAs.
Given that ISAs offer a £20,000 tax-free allowance each year, it’s entirely possible to balance out your investments over time for more easy-access efficient savings for the near future while building a large pension pot for the more distant future.
Making Your Savings Work for You
If you’re struggling with where to put your tax-free allowances before the April 5th deadline, it’s possible to save your £20,000 allowance for the current tax year into a Stocks and Shares ISA without investing it. Instead, you can hold it as cash in your account before making a decision.
This means you can make your investment decisions at a later date without missing out on reaching your allowance in time.
Getting Smart with Taxation
While only a small percentage of UK adults have opened an ISA to date, Individual Savings Accounts can be a great way to access tax-efficient savings in a more accessible way compared to pensions.
If you’re keen to make the most of your tax allowances each year, uniting both your ISA and pension to help protect your earnings and reach your financial goals can help you to make the best out of your tax efficiency and prepare for your future, no matter what may be lurking around the corner.
Read more:
ISA, Pensions & Allowances: Your Guide to Smarter Tax Planning