Each investment vehicle, or ‘wrapper,’ has unique features and benefits, with the funds held within them subject to different tax regulations.
Two of the most commonly held investment vehicles are ISAs and pensions.
Both offer favourable tax advantages, with the funds in each benefiting from growth that is exempt from personal income and capital gains taxes.
But could selecting one wrapper over the other result in a greater yield?
ISA vs pension yields
Starting with an ISA, let’s assume the maximum annual allowance of £20,000 is invested.
If the monies were left invested for 10 years, and achieved a net annualised rate of 5%, then it would grow to be worth £32,578.
As already stated, this would all be tax free. This means the initial contribution has grown by 63%.
If the same money was instead invested within a pension, then the initial contribution would receive tax relief of £5,000, resulting in £25,000 being invested.
Again, leaving this for 10 years, growing at a net annualised rate of 5%, then it would grow to be worth £40,722.
Thanks to the tax relief, the initial contribution has grown by 104%!
The scenario improves for a higher-rate taxpayer, who could claim an additional £5,000 in tax relief.
If they invested this further tax relief into an ISA, over the same period and enjoying the same growth. This would result in a further £8,144 being available.
Withdrawals from ISAs and pension
Those who know their wrappers will already have identified that withdrawals from ISAs are completely free of tax, meaning the £32,578 in the above example can be withdrawn in full to the bank.
However, with pensions we need to account for tax when making a withdrawal.
Looking at the £40,722 generated in a pension, we can withdraw 25% by Pension Commencement Lump Sum (PCLS), commonly known as “tax free cash”.
This will yield £10,181. If we assume the remaining 75% is subject to basic rate tax, we end up with a further net amount of £24,433.
Overall therefore, £34,614 could be received from the pension.
Some may think that this additional return isn’t worth the bother, given the pension route has yielded “just” £2,036 more than the ISA.
For context though, this represents more than 10% more from the initial investment, which others would argue is worth it for what is essentially just signing a couple of bits of paper.
For higher rate taxpayers, on top of the additional £2,036 they would have generated above, they also have the returns from investing the further tax relief they received.
This, as you’ll remember, grew to be worth a further £8,144.
Taking that into account, they’ve now achieved an additional return of £10,180 just by making use of the correct wrappers, meaning a net growth of 124% has been achieved.
As the examples above highlight, it’s crucial to choose the right financial ‘wrappers’ for your investments.
By carefully selecting the appropriate investment vehicles, you can maximise your returns and ensure your financial gifts are presented in the best possible way.
That’s why it’s important to work with a trusted financial planning consultant who understands your unique circumstances and objectives, helping you wrap your investments perfectly for the future.
