Pension vs ISA

HGLTsuperstar

There was an interesting thread somewhere on the forum recently which, despite my best efforts, so I decided to post this and get a (probably similar) range of responses. So I apologise in advance.
The point is, in my 20's, I am thinking about retirement (not anytime soon you get my drift?)
So the question is this: Pension vs ISA, ideally of course a bit each month into both but which to focus more on, especially with the A-Day changes nearly upon us. What are the pros and cons of either, I intend to work for as long as poss (as I get bored easily) but also want to carry on travelling until my legs give way, and as I currently have no kids, am not looking to leave inheritance etc, so please anyone lets get this ball rolling!!!

People's_Will

Assuming you get no additional pension contributions from your employer then...

...a key question is - are you a basic rate taxpayer but expecting to become a higher rate taxpayer later in your career?

If so, then I think you are best saving into an ISA. Later on you can invest in a pension and £1 gross invested in your pension could only cost you 60p nett (instead of 78p nett) because of tax relief if current rules continue.

The advantage of A-Day in April 2006 is that limitations on pension savings per annum rise to the equivalent of a year's salary except for the very rich. So you can put off your decision about pensions until later, as long as you are saving elsewhere.

That said, if you want to go down the pension route then you have to look to save a fund of about £200,000 by age 65 to give you a pension equivalent to £10K pa in today's money, assuming 2% inflation.

EdInvestor

People's_Will wrote:

The advantage of A-Day in April 2006 is that limitations on pension savings per annum rise to the equivalent of a year's salary except for the very rich. So you can put off your decision about pensions until later...

....while the ISA tax allowance is still "use it or lose it" on an annual basis.

So IMHO pensions should be considered

-if there is free money on offer from an employer
-if you are a high rate taxpayer

If neither applies, max out ISAs (both kinds) first - that's 7k a year in savings.

cheerfulcat

HGLTsuperstar wrote:

So the question is this: Pension vs ISA, ideally of course a bit each month into both but which to focus more on, especially with the A-Day changes nearly upon us. What are the pros and cons of either, I intend to work for as long as poss (as I get bored easily) but also want to carry on travelling until my legs give way, and as I currently have no kids, am not looking to leave inheritance etc, so please anyone lets get this ball rolling!!!

The main advantage of ISAs over pensions is that you can get at the cash at any time; this may also be their main *dis*advantage! The main advantage of a pension is that your contribution is enhanced up front by the tax relief. Both wrappers allow you to enjoy capital gains free of tax. Bear in mind that tax regimes can and do change, and that the tax advantages of both may disappear.

If you were to get into financial difficulties, btw, the pension would be off limits to creditors and disregarded for means testing purposes. The ISA would be a sitting duck :-)

HTH

Cheerfulcat

EdInvestor

Just to clarify the tax position:

Your contributions to the pension enjoy tax relief upfront, but the pension income you get at the end is taxable at your normal rate.* 25% of the fund is allowed as tax free cash. The rest of the fund cannot ever be accessed except in the form of an income,the amount of which is regulated.

With the ISA, you save out of taxed income, but the fund itself and any income it generates are tax free and the whole amount can be taken at any time.

*Pensions tend to be favoured by higher rate taxpayers because

a)Their contributions receive tax relief at the 40% rate - 22% of the money goes into the pension, the other 18% is cash in hand rebate back from the Revenue.

b) Most higher rate taxpayers aim to be basic rate taxpayers when they retire, so they pay tax at the lower rate but get the tax relief at the higher rate.

If such perks were available for basic rate taxpayers, perhaps pensions would be more popular.

ffacoffipawb

EdInvestor wrote:

a)Their contributions receive tax relief at the 40% rate - 22% of the money goes into the pension, the other 18% is cash in hand rebate back from the Revenue.

... unless the contribution is deducted from your pay packet, whereby the higher rate taxpayer gets 40% relief straight away (eg employer-provided group pension schemes), i.e. a £500 gross contribution reduces net pay by just £300.

cheerfulcat

EdInvestor wrote:

Just to clarify the tax position:

Your contributions to the pension enjoy tax relief upfront, but the pension income you get at the end is taxable at your normal rate.* 25% of the fund is allowed as tax free cash. The rest of the fund cannot ever be accessed except in the form of an income,the amount of which is regulated.

With the ISA, you save out of taxed income, but the fund itself and any income it generates are tax free and the whole amount can be taken at any time.

The initial boost to the investment, of 22% or 40%, is pretty useful. In any case, on the bird in the hand principle, tax relief now beats tax relief later :-).

To HGLTsuperstar

Another difference between ISAs and SIPPs is that the SIPP can hold cash ( interest paid gross), cash unit trusts and AFAIK short-dated gilts, none of which are allowed in a stocks and shares ISA ( you can hold cash in an ISA if you intend to invest it but you pay savings tax on the interest ). You can also hold AIM listed shares in a SIPP, again not available in an ISA.

HTH

Cheerfulcat