Pension: can the capital be ever withdrawn?

money_saver_4

My husband (aged 44) is planning to start a pension plan (SIPP).

However, we understand that (except for the 25% lump sum) we can never withdraw the capital from his pension. To us this is a very significant point against pensions. :mad: Particularly as we are still planning to start a family and I am 15 years younger than my husband.

However, as higher rate tax payers we can not ignore the tax advantages of pensions.

Could someone please confirm that once the money is invested into pensions, the only way to get anything back is through annuities, or live off the interest earned by the pension fund?

I understand that ISAs are much more flexible. However, with the limit of only £7000 a year we would not build up large enough fund. Is there any other type of investment that would offer both tax advantages in our situation (we are both self employed) and have a reasonable return?

Any other advice will be appreciated. Many thanks.

Cook_County

There are various ways that the capital CAN be taken out. However the deal is that you get tax relief on the way in, so the government reckons that after giving you 25% of the value back they'll help themselves to tax for the rest of your life on the remaining 75%. Not all countries do it this way. Some countries give you no tax relief on the contributions, but tax-free growth (like the UK) but tax-free payments when money is withdrawn (unlike the UK). Other countries give you tax relief on the way in (like the UK) but allow lump-sum withdrawals at any time suibject to a special tax rate.

The most obvious occassions that come to mind therefore when potentially tax-free lump sums arise are:
1. On death (given your age and gender differences, this may be "attractive" - although of course not planning one wants to work towards!)
2. On emigration and transfer to a suitable overseas pension fund (currently there are no funds anywhere in the world that fulfill HMRCs post-A Day conditions (i.e. is a Qualifying Recognised Overseas Pension Scheme).
3. After certain other A-Day changes in a few circumstances.
4. For small funds.

Pal

There isn't really any other comparable tax-advantaged investment vehicle.

How about using your ISA allowances to the max, to give you flexibility, and then put any excess into the pension for your eventual retirement? If you ultimately don't need the ISA money you can roll it into the pension as your husband approached retirement.

Alternatively you could consider investing the excess direct into unit trusts or other investment vehicles, and make sure that you plan when you sell them off to maximise your capital gains tax allowances.

You might want to consider speaking to an IFA who can help you plan your finances.

dunstonh

I understand that ISAs are much more flexible.

Yes but they could cost you more in tax if you die. ISAs are added to the estate for IHT purposes. Pensions are not. Also, the income from them would almost certainly be lower than that achieved on a pension. Particulary if you are a higher rate tax payer and/or in receipt of childrens/working tax credits.

However, with the limit of only £7000 a year we would not build up large enough fund. Is there any other type of investment that would offer both tax advantages in our situation (we are both self employed) and have a reasonable return?

Pension is the most tax efficient. Followed by ISA. Then it would be either Investment bond or Unit Trust depending on your tax positition. All these investment tax wrappers can invest in exactly the same funds. The only difference is the taxation and charges and, in the case of pension, how you take the benefits on maturity.

You need to look at what you want. Do you want income or capital? In the real world, most want both and therefore one product is not suitable but two. ISAs and pensions.

You and your husband can earn just over £14000 between you tax free after age 65. So, retirement planning, including state pension, should look to utilise that within a pension. An ISA wouldnt come close to a pension in doing that, let alone beat it. Then you have a further £4k a year which is only taxed at 10%. Again, you may as well use a pension to utilise that. When you start heading towards the 22% tax band, the benefits of taking out a pension become less and start swinging towards an ISA.

EdInvestor

Hi MS

money_saver wrote:

My husband (aged 44) is planning to start a pension plan (SIPP).However, we understand that (except for the 25% lump sum) we can never withdraw the capital from his pension. To us this is a very significant point against pensions. :mad: Particularly as we are still planning to start a family and I am 15 years younger than my husband.

Indeed so: suggest you max out your ISAs ,no such restrictions there.

However, as higher rate tax payers we cannot ignore the tax advantages of pensions.

So just put a little in the Sipp, to reduce the higher rate tax liability.

Could someone please confirm that once the money is invested into pensions, the only way to get anything back is through annuities, or live off the interest earned by the pension fund?

Correct. The irritating additional thing about pension income is that it's taxable, unlike income from ISAs.

I understand that ISAs are much more flexible. However, with the limit of only £7000 a year we would not build up large enough fund.

It's 7k each, 14k in total, does that help?

Is there any other type of investment that would offer both tax advantages in our situation (we are both self employed) and have a reasonable return?

You could invest in shares and take advantage of your annual capital gains tax allowance of 8.5k each, 17k in total.

dunstonh

Correct. The irritating additional thing about pension income is that it's taxable, unlike income from ISAs.

Thats a SPIN which is correct when taken in isolation like that but gives a totally incorrect position on the advantages of the isa compared to pension. Tony Blair would be proud of a SPIN like that.

ISA versus pension

Lets say you have contributed £250,000 into an pension and an ISA. I will ignore growth in this example as growth would be the same in both as exactly the same funds available.

The ISA is therefore £250,000 and giving you 5% return.
The Pension because of tax relief is worth £416,666 and giving you 5% annuity rate.

ISA would give income of £12,500 with no tax to pay
Pension would give income of £20,833 but taxable.

In todays terms, the first £7090 is tax free, the next £2090 is 10% tax and the rest is taxable at 22%. Making a tax liability of £2772. Therefore the pension is really giving you £18,061 income.

The pension beats the ISA by £5561 a year.

If you qualify for a state pension in your own right, that would be taxable so you could deduct £928 extra tax from the above but that still makes the pension £4633 a year better than the ISA.

Cook_County

I hate to say this but I am little distrustful of dunsth's figures because:
a) you are assuming current annuity rates (I guess) but this may change.
b) actual annuity rates may be very different.
c) other goals such as childrens education, house buying etc may need to be met long before pensions are drawn.
d) as I highlighted above, emigration can totally change the picture and potentially enable the withdrawal as a tax-free lump sum of £416,666, BUT subject to QROPs being available and the tax regime of the new country of residence.

dunstonh

a) you are assuming current annuity rates (I guess) but this may change.

No. I understated the annuity rate to avoid such comments. Currently around 6.3% for a non smoker. Using 5% built in a lot of caution.

b) actual annuity rates may be very different.

Yes, they could be lower, they could be higher. ISAs are liable to fluctuate too and not guaranteed to remain tax free beyond 2010.

£250,000 in an ISA would make a big dent in inheritance tax on death. £416k in the pension has no IHT liability.

EdInvestor

But isn't the personal tax allowance usually swallowed up by the state pension(s)?

And of course to get this taxable income via the annuity, you have to give up all the capital to the insurance company.

How do you value the fact that your capital is still in the ISA?I don't really think you can leave it out of the equation completely, just comparing the income.

After all, you can invest the capital and it can grow, while still providing a tax free income.

Not so with the annuity which will be halved in value after 20 years because of inflation, even at current low rates.

whiteflag_3

Yawn! can anything that hasnt been said umpteen times before be added to this tired discussion

ReportInvestor

whiteflag wrote:

Yawn! can anything that hasnt been said umpteen times before be added to this tired discussion

It could all be new to Moneysaver, wf:). Spare a thought for the newbies.