Mortgage free 1st,Pension later?

dunstonh

I feel that pensions are just a euphemism for stock market investment. Look at the FTSE - it's in the same place it was 12 years ago! .

What about the income generated by the companies in the FTSE? The index doesn't include that. Plus, any decent investment portfolio wouldnt be 100% in the FTSE100 (which has been one of the worst indices to track in the last 14 years). Looking at 12 years then a bog standard balanced managed fund would have doubled its value (assuming single value from 12 years ago). Balanced managed funds are usually the default option. Never that good, never that bad. I wouldnt want my money in one but it is where most people find themselves. However, it highlights your assumption about the FTSE is irrelevant. You dont need to invest in the stockmarket if you dont want to and if you do (in part or in full) then assuming that the FTSE100 is an indicator of stockmarket performance is wrong.

maryjane01

dunstonh, you do make some good points but you are also starting to sound like a salesman for pensions, which I think you might be.

Saying you have control over your pension investments like any other tax wrapper I don't really believe although please correct me if I am wrong because I will admit to being a bit ignorant about pensions. Most people think of ISAs when you use the term tax wrapper and I don't think it is like an ISA at all. I don't want to be forced to buy an annuity when I retire. Granted, my funds in a pension may be worth hundreds of thousands of pounds, but what if I am forced to buy an annuity which is peanuts because when I retire they will calculate my life expectancy to be 140 years? Women are already at a disadvantage because it is expected they will live longer so get lower annuity rates, and that is with in most cases already starting out with smaller pension pots due to child rearing and average lower salaries. I don't have any proof but I don't think I will necessarily see an annuity as good value in 25 years and I don't want to be forced to buy one.

dunstonh

dunstonh, you do make some good points but you are also starting to sound like a salesman for pensions, which I think you might be.

I'm a fee based adviser. Not a pension salesman. Plus, I am not a big fan of the pension tax wrapper. That doesnt mean it doesnt have its uses.

Saying you have control over your pension investments like any other tax wrapper I don't really believe although please correct me if I am wrong because I will admit to being a bit ignorant about pensions.

You are wrong You can have pension funds, unit trusts/oeics/sicavs, ITs & ETFs, shares, cash savings and many more things in a pension. Nowadays, the different tax wrappers can hold most conventional investments.

Most people think of ISAs when you use the term tax wrapper and I don't think it is like an ISA at all.

Its virtually identical apart from the maturity process. Both have access to the same underlying investments. Both have the same tax advantages (except pensions are exempt from IHT, unlike ISAs).

I don't want to be forced to buy an annuity when I retire.

Dont buy one then. Go with income drawdown instead.

Also, dont mistake my comments as being pro pension. I am pro retirement planning. There is a very good ISA vs pension thread in the pensions section which shows that in real life most people are better off with both pensions and ISAs to ensure personal allowances are used up. However, for those that dont make decent retirement provision and need the least money possible to buy the most income in retirement, then the pension is the product that does that. It may have negatives in other areas but as far as income provision goes it is top.

jon3001

dunstonh wrote: »

That is a negative with pensions for sure but the pay off is that pensions will provide the highest income in retirement of all the conventional options available. If you were to use ISAs, for example, you would need to pay more into them to get the same income.

I'm assuming you say you have to pay more into an ISA because to get the same income you don't get the tax relief on contributions? Is that net or gross income? As I understand it withdrawals from a pension fund are taxed whereas withdrawals from an ISA aren't. Everything else being equal shouldn't you get the same net income?

Pensions seems to be particularly advantageous if one is a higher-rate tax payer but is planning to be a lower-rate tax payer after retirement. There's also the 25% tax-free lump sum you can take out.

Leokiss

I thought this would be difficult to answer i guess its down to individual circumstance as to what you do,i may hammer the mortgage as such for 5years n then start paying into a pension.
I'll explain my circumstance better then someone can give me a better idea what to do,hopefully!
I'm a 30year old self-employed(sub-contractor) electrician last year i grossed 40,000 i expect to do the same this year although i guess my income could fluctuate up tp 10,000 either way. Im one year into a 125,000 mortgage which is 100% interest only with NR which is gunna cause me probs when my fixed deal ends so i may have to invest heavily into morgage just to try n get a decent deal.
I have a dependent wife n child, and no pension what so ever n about 2000 in an ISA which i intend to take to 3600 each year.
I currently pay about 1200 a month mortgage including overpayment.
And as of october i will be totally debt free.
So if anyone has any good advice on what would be best for me to do in my situation i would be very gratefull,cheers.

dunstonh

I'm assuming you say you have to pay more into an ISA because to get the same income you don't get the tax relief on contributions? Is that net or gross income? As I understand it withdrawals from a pension fund are taxed whereas withdrawals from an ISA aren't. Everything else being equal shouldn't you get the same net income?

Tax relief is partly clawed back with tax at the other end. However, you can earn nearly double after age 65 due to an increase in the age allowance (its increasing to over £10,000 a year soon). So, the first £10k of your income (each where spouse/partner is included) is tax free. So getting tax relief on your contributions at the start and then using up the outstanding personal allowances is where the pension is strongest. There is also the 25% you can take out which gives a bit of the relief back in your pocket. Once you get past the personal allowance, pensions become less attractive as an option unless you are a basic rate taxpayer and/or get enhanced working/childrens tax credits.

Also, annuity rates or drawdown rates mean that the income you take from a pension, even if taxed, will be higher than an ISA.

And, it is possible to get upto an effective 72% tax relief for some people as pension contributions lower your income for working/childrens tax credit purposes. So, not only can the pension get tax relief but it can also see an increase in your tax credits (if you qualify for them). So, there are still some advantages with pensions.

I'll explain my circumstance better then someone can give me a better idea what to do,hopefully!
I'm a 30year old self-employed(sub-contractor)

Ok, first important thing there is that you are self employed. That means you dont qualify for the full state pensions. You only qualify for the basic. So, your retirement provision will need to be around £100k more in todays terms than an employed person would have to do.

For maximum tax efficiency, you should be utilising a pension to provide you with a pot of around £120k in todays terms (as your income would be totally tax free in retirement then). You should also utilise your wife's personal allownance in retirement so using a pension for her should be done. Anything above that should be placed in ISA.

jon3001

dunstonh wrote: »

Also, annuity rates or drawdown rates mean that the income you take from a pension, even if taxed, will be higher than an ISA.

Is that because a portion is classed as a return of capital? I was just browsing online now but I get the impression that only annuites purchased outside of a pension plan (e.g. with the tax-free lump sum) got that portion tax-free.

I agree that proper planning around your personal allowances is essential for maximizing income.

dunstonh

Is that because a portion is classed as a return of capital? I was just browsing online now but I get the impression that only annuites purchased outside of a pension plan (e.g. with the tax-free lump sum) got that portion tax-free.

No. Lifetime annuities are taxable income fully. Other annuities can get tax advantages due to treatment of capital.

For example, you should never use 100% of the pension fund to buy a lifetime annuity. If you want to maximise income that way the 25% TFC should buy a purchase life annuity with only the 75% buying a lifetime annuity.

The reason why pension income is higher is that the annuity rate is typically higher than savings account rates or the 5% net that it typically safe to take from investments. Drawdown allows a more natural income than annuity that exceed ISA.

When thinking about pensions it is best to think of them purely in the context of income provision. Dont think of them for capital appreciation as they are useless for that. (another reason why pension and ISA is the best solution rather than 100% into either).

jon3001

dunstonh wrote: »

The reason why pension income is higher is that the annuity rate is typically higher than savings account rates or the 5% net that it typically safe to take from investments.

I understand this.

dunstonh wrote: »

Drawdown allows a more natural income than annuity that exceed ISA.

I don't understand this. I thought the income from drawdown was derived from investments held within the pension. If 5% is the safe withdrawal rate from investments (i.e. retains an inflation linked principal?) then how is possible to exceed this?

dunstonh wrote: »

When thinking about pensions it is best to think of them purely in the context of income provision. Dont think of them for capital appreciation as they are useless for that. (another reason why pension and ISA is the best solution rather than 100% into either).

Ok. Some of the strategies I looked at for retirement investing (although I'm a long way from that myself yet) suggested targeting a 8% return with low-volatility. Basically 5% can used for withdrawal whilst the other 3% would be for inflation hedging.

8% wouldn't be sustainable with an all-bonds portfolio. The return would be a mix of income and capital appreciation. So for example you could have a mixture of investment grade bonds (7-10 years worth of income to ride out market lows), junk bonds, property and equity income. Part of the stategy involves rebalancing by selling off your highest appreciating assets to supplement income as necessary.

Is this typical of what one would use in an income-drawdown situation?

dunstonh

I don't understand this. I thought the income from drawdown was derived from investments held within the pension. If 5% is the safe withdrawal rate from investments (i.e. retains an inflation linked principal?) then how is possible to exceed this?

At age 75 you have to buy an annuity. The annuity rate increases every year. So, you can afford to take a little more each year and risk a little capital erosion. Indeed, you could take a fair bit more and use it to fund your £7200 ISA allowance(s) in retirement.

8% wouldn't be sustainable with an all-bonds portfolio. The return would be a mix of income and capital appreciation. So for example you could have a mixture of investment grade bonds (7-10 years worth of income to ride out market lows), junk bonds, property and equity income. Part of the stategy involves rebalancing by selling off your highest appreciating assets to supplement income as necessary.

Is this typical of what one would use in an income-drawdown situation?

Yes. Rebalancing and diversification being very important. Anyone really trying it with a bog standard managed fund isnt likely to get the best from the investments (anyone considering a balanced managed fund or similar should even consider drawdown really ). You seem to have a good grasp of it though.