How to retire early: the ISA trick - Times Money Mentor (2024)

If the thought of retiring early or working part-time is an ambition of yours, did you know that Isas can help you achieve it?

An Isa is a tax-efficient way to save or invest up to £20,000 a year. There are different types you can use when it comes to investing for early retirement.

In this article, we explain:

• Which is the best Isa for retirement?
• How much do I need to save to retire early?
• What are the benefits of pension tax relief?
• An Isa or a pension: Which is better for me?
• Should I consider a Lifetime Isa?

Related content: our favourite stocks and shares Isas.

Investing for early retirement

A pension is an excellent way to save for retirement, but you typically need to wait until you are 55 to access your personal or workplace pension. This will rise to 57 in 2028.

You will have to wait even longer before you reach the state pension age. Currently it is 66 for men and women but this is scheduled to rise to 67 between 2026 and 2028.

So if you want to retire early, you will need to find another way to fund your lifestyle beyond a pension — and this is where a stocks and shares Isa comes in.

Using a stocks and shares Isa for retirement

Stocks and shares Isas are a tax-efficient way to invest your money for the long-term. It offers you the freedom to withdraw money when you want it without the age limit.

With an investment Isa, your money grows free from income tax, dividend tax and capital gains tax. You can also withdraw money from your Isa free from tax. This is different to a pension where withdrawals might be subject to tax.

This means that if you’re retiring early a stocks and shares Isa can be used to bridge the gap until you can access your pension.

NOTE: bear in mind that the Lifetime Isa is different from regular Isas. This is because if you want to use the Lifetime Isa money for retirement, you can’t access the money until you are 60.

Read how Times Money Mentor reader Nicola Richardson is working towards retiring at 50

Which is the best Isa for retirement?

While you receive up-front tax relief when depositing into your pension, when you take money out only the first 25% of the pot is tax-free. The rest will be taxed at your marginal income tax rate.

Any cash taken out of an Isa is completely tax-free, which is useful if you want to semi-retire early.

Cash Isas can be useful if you are:

• Close to retiring
• Semi-retired
• Already retired
• Maxed out on your annual pension allowance of £60,000

A cash Isa is a good home for your emergency savings buffer, which is always good to have, but even more so if you want to retire early. You should aim for six months’ worth of your outgoings in an easy access savings account.

However, there are currently no cash Isas paying a rate of interest anywhere near the rate of inflation, meaning your cash is losing its value in the long-term. Find out the top-paying cash Isas.

If you have many years before retirement, and you have your emergency pot of cash built up already, you may want to consider investing the rest in a stocks and shares Isa to give your money a chance of beating inflation.

Here’s our guide for beginner investors. Bear in mind that there are no guarantees that your investments will rise. But you’re more likely to see growth if you spread your risk across different types of investments and invest for at least five years.

Capital at Risk. All investments carry a varying degree of risk and it’s important you understand the nature of these. The value of your investments can go down as well as up and you may get back less than you put in.

Stocks and shares Isas are likely to be a good option if:

• You have at least a five-year time horizon to invest your money, but you want to retire earlier than you can access your pension pot.

See our guide on the top investment Isas.

Lifetime Isas could be an option if you are:

• Planning to withdraw the money after the age of 60
• Self-employed or not working but looking to build pension savings
• Looking to build separate savings beyond a workplace pension
• Saving up for a down payment on your first home

How much do I need to retire early?

How much money you will need really depends on the lifestyle that you want to lead in retirement and how long you are going to live for — and who knows that?

Remember if quitting work altogether isn’t attainable or desirable for you, an Isa could be used supplement part-time work so you can slowly wind down to retirement.

How to take early retirement

Here is an example of Jade, who is 30 now and plans to pay her mortgage off by 55.

She then wants to have a part-time job.

• Jade needs £2,000 a month gross income to cover living costs
• From 55 to 60 her part time work earns her £1,000 a month
• Her Isa savings need to cover the £1,000 a month shortfall before her workplace pension kicks in at 60 (then her state pension at 68)
• She therefore needs £60,000 in Isa savings by 55
• To achieve this, Jade needs to save £120 a month for the next 25 years, assuming:
  • 2% inflation
  • 2% increases in contributions each year
  • 6% investment growth

You could use this investment calculator from Hargreaves Lansdown to work out how much you will have to save each month.

If you are into extreme budgeting to retire early, find out more about the FIRE method.

Pension tax relief need-to-knows

We do not suggest replacing a pension with an Isa for your retirement fund, as each one has advantages depending on your personal circ*mstances.

In terms of value, pensions are important thanks to the upfront tax relief and your employer’s contribution (if you are employed).

Here’s the tax relief on pension contributions:

• If you’re a basic rate taxpayer then for every £80 you put into your pension, the government tops it up by £20
• Higher rate taxpayers get a bigger top-up: for every £60 they pay into their pension, they get £40 tax relief
• Additional rate taxpayers who put £55 in their pension get a £45 top-up

Is it better to have an Isa or a pension?

Investing more in a pension at the outset thanks to tax relief means investments held within a pension will deliver a higher return than the same investment purchased within an Isa.

EXAMPLE: A £10,000 investment put into a fund that grows at 5% per year after costs over 20 years, compounding monthly.

• If invested in an Isa the £10,000 investment would grow to £27,126 after 20 years
• But if invested in a pension, it would grow to £33,908 over the same time period (for basic-rate taxpayers). This is because of the tax relief available on pensions
• That’s a difference of £6,782 purely because of the type of product you have invested in

If you are looking for a ready-made personal pension, check out our independently rated top products

Lifetime Isa for retirement: Is it worth it?

If you are self-employed, then a Lifetime Isa can provide an additional way to save for retirement. It is also not a bad idea if you have maxed out your annual allowance of £60,000 in your workplace pension scheme.

Unlike a regular stocks and shares Isa or cash Isa, which you can withdraw from at any age, you have to wait until age 60 with a Lifetime Isa. If you take out the money for anything other than buying your first home before the age of 60 you face a penalty.

A Lifetime Isa could be useful to supplement your pension income. But if you want to retire early, a Lifetime Isa might not be the most helpful option.

We take a look at the pros and cons of pensions versus Lifetime Isas.

When should you seek financial advice?

If you are serious about retiring early then consulting a financial adviser could be a good idea.

Together, you could work out how much you will likely need in the future and discuss making lifestyle changes now in order to achieve your goals.