How to use ISAs and pensions at different ages

Whatever your age, how you invest should depend on your attitude to risk and whether you have specific requirements for the money you are saving. At any age it is important to ensure you have a well-diversified portfolio which includes holdings in all of the main asset classes.

Generally, people in their 20/30s are prepared to take more risk within their ISA. This age group will be using their ISAs as regular savings accounts - this means they can take advantage of pound cost averaging. Therefore you would expect this group to be invested mainly in equities - with a higher proportion in overseas equities, including high growth emerging markets such as BRIC funds – as well as smaller allocations to commodities and other alternative assets.

Pensions can be used as an alternative to ISAs for saving. The benefits of pensions are the tax treatment of them: you are able to reclaim your marginal tax rate back on all of your contributions.

On the downside, you are unable to access the funds until at least 55. Therefore if the savings are for a specific short to medium-term need, it might be better to hold savings in ISAs to retain access to them. Of course there is nothing stopping placing some - or all - of your ISA savings into your pension at a later date, to take advantage of tax benefits.

In your 40/50s you are generally still saving but also trying to protect your existing savings and starting to prepare for retirement. Also, you typically have less time to repair any damage inflicted on your investments should markets turn against you. This generally means that less risk should be taken as you get closer to retirement, and a continuing reduction in risk as you get older tends to be recommended.

The principle of diversification remains the same for this age group; however the percentage of your funds invested in higher-risk equities should be reduced, with a larger share of your money being held in fixed-interest assets and, within equities, more investments in defensive sectors such as UK utilities, pharmaceutical and telecoms.

Pensions become a more appropriate option for this age group due to the tax benefits, however it must be remembered that with a pension you will be forced take an income from a pension pot whereas within an ISA you retain access to all of the funds at any time.

At retirement age the accumulation of savings normally draws to a close and ISAs are used to provide an income. Growth is now less important and protection of capital, whilst taking an income is generally recommended. Therefore lowering your exposure to equities to more secure assets such as fixed interest, gilts and cash is often appropriate. Within ISAs there are certain funds (like Architas MM Diversified Protector 80, for example) which offer some protection to your money and these should be looked a closely if you are relying on your ISA for income.

If you are still looking to accumulate wealth in retirement, then you should consider issues such as whether you are leaving an inheritance tax liability for your beneficiaries. If this is the case then ISAs are unlikely to be the most tax-efficient way of saving in retirement.

At all times in your life, it is important you have a good understanding of your financial needs and requirements, understand the risk you are prepared to take and the risk that is inherent within your portfolio. To ensure you achieve this you should seek advice from an independent financial adviser.

Andrew Coles is an IFA at Beard & Coles Financial Practice.