An integral part of planning for later life is figuring out how to fund your lifestyle once you stop working. For many, the focus naturally falls on workplace and private pension schemes. Pensions offer significant tax benefits to help you save for the future, but the rules dictate that you cannot access the money until you reach a certain age. This restriction can create a significant financial gap for those hoping to retire early, step back from stressful careers, or reduce their working hours.
In this article, we explain how building an 'ISA bridge' can provide the flexibility needed to navigate the years between stopping work and drawing a pension.
What is an ISA bridge?
An ISA bridge is a dedicated pot of savings or investments built within an Individual Savings Account (ISA). Its primary purpose is to fund your living costs during the gap between the day you reduce your working hours or stop working and the date you can legally access your private and/or State Pensions. It is not a specific financial product; instead, it is a wealth-building strategy that utilises tax-efficient accounts, such as a Cash ISA or a Stocks and Shares ISA, to build a reliable income stream for a set period.
Why might you need an ISA bridge?
When planning for later life, individuals typically face three distinct retirement dates:
- The date you want to retire or reduce your working hours.
- The date you can access your private pension.
- The date you receive your State Pension.
For most people, these three dates do not align. The normal minimum pension age - the earliest you can access most private pensions - is currently 55, but this is set to rise to 57 from April 2028. Meanwhile, the State Pension age is gradually increasing, with millions of workers now having to wait until they turn 68 before they can claim their State Pension.
An ISA bridge can produce the capital you need to cover your everyday expenses for the period between stopping work and drawing a pension. As well as early retirement, the strategy can be applied by those looking to move into part-time work in their fifties, prepare for potential redundancy, or take time out to care for family members.
How an ISA bridge can safeguard your retirement savings
Relying on an ISA to fund early retirement can help to protect your long-term pension wealth. If you start drawing taxable income from your private pension while still working or making contributions, you risk triggering the Money Purchase Annual Allowance (MPAA). Bear in mind that simply taking your tax-free cash entitlement from your pension does not trigger the MPAA.
If you trigger the MPAA it significantly reduces the amount you can contribute to your pension tax-free each year going forward. By using an ISA bridge to cover your living costs, you can delay drawing your pension. This can also help you avoid complex tax penalties while leaving your pension pot invested with the potential to grow even further.
Because pension rules and tax limits can be complex to navigate, seeking independent financial advice is a sensible step as it can help to ensure you are making the best decisions for your retirement. If you need additional help with your pension planning, we have an article that explains 'How to find a financial adviser you can trust'.
How to calculate your ISA bridge
Working out how much money you need to save requires a clear understanding of your future living costs and any incoming revenue.
- Calculate your required income - Determine the annual household income needed to comfortably support your desired lifestyle.
- Deduct reliable income - Subtract any guaranteed income you will receive during the bridging period, such as part-time earnings, rental income, or a partner's salary. The remaining figure is your annual shortfall.
- Multiply by the bridging years - Multiply your annual shortfall by the number of years until your pension becomes accessible.
- Factor in inflation and extras - Living costs will naturally rise over time. It is prudent to assume an inflationary increase, such as 3% per year, and add a buffer for significant one-off expenses like buying a car or funding a family wedding.
Important considerations before building an ISA bridge
While financial flexibility is valuable, building an ISA bridge will not be suitable for everyone. It should always be weighed against your other financial priorities.
- Workplace pensions - Do not sacrifice matched employer pension contributions to fund an ISA. Pensions remain the most tax-efficient way to save for retirement, and giving up free employer contributions will harm your long-term wealth.
- Expensive debt - If you have high-interest debt, paying it off should generally take priority over building an investment portfolio.
- Emergency funds - An ISA bridge is designed for retirement planning, not unexpected short-term costs. It is vital to maintain a separate, easily accessible emergency fund for sudden expenses.
- Investment risk - When calculating your target, consider running different scenarios. Factor in the possibility of low investment growth or sudden market crashes just before you retire. Keeping a portion of your bridge in a Cash ISA can help mitigate this risk as your retirement date approaches.
When investing, your capital is at risk and you may get back less than invested. Past performance doesn’t guarantee future results.
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