Retirement funding options

martinpike

Hi,

Myself (40) and my other half (32) took over a business last year, and are now directors and shareholders of a limited company.

We're both taking a small salary (between NI LEL and ET), and our income is topped up by dividends from profits.

I have a reasonable size (six figure) defined contribution pension pot from my previous employments, and my other half has as good as nothing.

As we approach the end of the tax year, we are weighing up our options between contributing to ISA's from post tax income, or to a pension of some sort via company contributions from pre-tax profit.

If the answer is a pension pot, what are our best options? We're not active or particularly knowledgeable investors in any way, but we are fairly astute and appreciate that there are tax breaks here that we should be taking advantage of.

Has anyone got any guidance for us?

Thanks.

shaunrc

Hi Martin

Firstly although I am an IFA please do not take this posting as formal advice as that has a specific meaning for regulated individual's...

Between ISAs and pensions there are two main differences and some similarities. The main plus of an ISA over a pension is access. In an ISA you can take the money when you want tax free whereas there are rules and limits on access to a pension.

A pension's advantage comes from the fact that you can make contributions tax free. So you get more money going in for the same net contribution which if markets grow means that by the laws of compound interest you will get a bigger pot at the end even allowing for most of it being taxable.

For you and your wife you can also boost a pension by paying directly from your company. I do a lot of this for company owners. Why? Employee National Insurance does not become due and nor does employers National Insurance. So compared with paying yourself and investing it in a pension paying in directly is very efficient. Make sure you get your accountant to check with the local Tax Office.

As to the type of pension. it looks like a SIPP would offer you investment choices you do not need. Stakeholders mostly have a restricted investmnet choice but personal pensions these days have sharpened up their act and particularly with your fund value can have low charges and a wide investment choice. I switched to a personal pension myself in similar circumstances recently and it also offers the option to switch to a SIPP later.

Good luck.

martinpike

Many thanks for this feedback. It's pretty much along the lines I was thinking, but it really is good to hear someone competent agree that I'm not barking up a completely wrong tree.

In terms of size of contributions, we are planning for the company to pay 50% of salary into our pensions. We have read elsewhere that up to 100% is not inviting unnecessary attention, but we'll probably be a bit more cautious than that.

Cheers,

Martin.

shaunrc

Hi Martin

Get your accountant to clear it with your local tax office as they have discretion over this. It is in fact a poor system on the Revenue side as tax offices may vary but I wouldn't be surprised if they agreed to 100% so Good Luck!

martinpike

Hi Shaun,

My accountant is using the 50% contribution level themself...

However, I am still assuming that in our circumstances it would be sensible to fully fund an ISA before making pension contributions? I must admit that I don't understand your assertion that 'by the laws of compound interest you will get a bigger pot at the end even allowing for most of it being taxable.'.

As far as I'm concerned I can pay £80 net of 20% tax into an ISA, or £100 gross of tax into a pension, and assuming the underlying investments perform the same, the post tax value of those investments will be the same at the end.

In which case, having ISA funds completely under our control makes them the definite first choice for us...?

Cheers,

Martin.

shaunrc

Hi Martin

Firstly although I am an IFA please do not take this posting as formal advice as that has a specific meaning for regulated individual's...

As your main income is from dividends the national insurance gains from a company pension contribution do not arise in the way they would for someone with a salary. However the numbers were estimated as being 10% better for a pension payment at basic rate tax than an ISA by the Institute of Fiscal Studies. However to do this you have to make various assumptions like for example a value for potential early access which you have in an ISA and not in a pension.

My assertion about compound interest actually probably confuses rather than helps so sorry. Let me put it more in a better way. A pension allows you to take 25% of it at the end as a tax free lump sum. Essentially this is its biggest gain as otherwise the tax treatment of an ISA and a pension are essentially a mirror image of each other.

In a way you could consider the 25% tax free lump sum as the price of not having early access to the pension.

Should you ever be paying 40% tax then the situation moves substantially in a pensions favour.


I hope I have made it a little clearer.

martinpike

Don't worry, I fully understand that you're not giving advice.

I'd overlooked the 25% tax free lump sum thing, so thanks for reminding me of that. It certainly means it should form part of our long term retirement planning. Although I can quite see that perk being plundered by the government before we are eligible for it.

Cheers,

Martin.