25 years old, join a pension scheme or pay off mortgage?

dunstonh

As already mentioned, the ISA vs pension debate is an old one and both sides have pros and cons.

Whilst the pension income will be taxable above your personal allowances, the rate of income can be higher than what is payable on ISAs. Plus, as the fund will be at least 22% higher than the ISA, you can afford to pay some tax on it and still come out higher.

In reality, a combination of pensions and ISAs is usually the best way. Personally, I tend to recommend pensions to build up a value that should use up at least the personal allowance at 65 and the 10% tax band for both partners (retirement should be looked at with spouse/partner where applicable. Having it all in one name means you just pay extra tax). Above that, I tend to go with ISAs.

However, some people need the tie in that pensions have as they do not have the discipline to use ISAs and leave the money there. Or, they may have special deals through work which give the pension a better rate or have free money. Or a range of other events that could alter the decision on what is best (including children/working tax credits where it is possible to get upto 72% tax relief on pensions in effect).

Chrismaths

If I put £50 out of my gross salary into a pension fund per month and my employer adds a further 12.8% for their part of NI, then the pension fund has increased by £56.40. Alternatively the £50 could be paid directly to me after NI and tax (12.8% and 22%) resulting in £32.6 which I could then put into an ISA.

Your employer doesn't put in 12.8%. They still pay this to HMRC.

Employee NICS are 11% for BR tax payers, not 12.8%. You still have to pay these on pension contributions so it is best to ignore them. For a £50 gross contribution, you actually pay £39 out of taxed income, then the Revenue add the tax relief to the pension fund. So the true comparative figures are pension: £50, ISA: £39.

The pension fund managers take 1% commission pa.
The pension fund is not available to me until I reach 55.
When retirement is reached, 25% of the fund can be taken as tax free.
The remaining 75% of the fund can be used to buy an annuity (after being taxed??) or can be withdrawn in small amounts (limit set by government??) each year.

If you've got a stakeholder, it'll probably be 1.5%pa for first 10 years, followed by 1%.
Your pension fund is not taxed before you buy an annuity, the income from the annuity is taxed as employment income. As you will have retired, there will be no NICs, so you'll get taxed at probably 22/40% on this money, assuming a full state pension.

Hopefully the fund managers can increase the value of the fund by the same percentage as inflation each year + 1% so the value of the fund isn’t reduced.
The ISA has a much lower input per month, but will increase by a bit more than the rate of inflation each year.
The ISA is always accessable should there be a need.

You seemed to have chosen a cash mini ISA, and equity based pension fund investments. You should be comparing a stocks & shares (maxi or mini) ISA. If you have a stakeholder, the choice of funds will be limited by the charging structure. If you chose an ISA, the choice will be unlimited. But let's say the investments in each grow at an identical annual rate, and examine a case where you pay basic rate tax and are 20 years from retirement.

At the end of 20 years, assuming a 7% growth rate after charges (as the tax treatment is more or less the same) in each the ISA and the pension, the pension fund is worth £25,715 and the ISA £20,058.

So assuming you take the 25% tax free cash, when you withdraw the money through the pension by means of an annuity, if this is taxed at the basic rate, you will end up with (effectively) £21,471 as opposed to the £20,058.

Is it still worth the inflexibility?

Tahiti

The only thing that concerns me with salary sacrifice is the lowering of your gross salary figure. Will this not impact on how much you can borrow, and if things went wrong, wouldn't any benefits be based on the lower salary figure (inc life cover, Income Protection, and even redundancy)? Excuse my lack of knowledge.

jem16

This thread has made a very interesting read.

My late husband and I made the decision to pay into our pension schemes when we were in our 20s and I'm so glad that we did. We really didn't notice the amount paid into the pension schemes as it came off our salaries before we ever got the money. Almost 4 years ago my husband was killed in an accident and without his pension scheme my sons and I would have had severe difficulties.

I received a pension of around £11k and they each had a pension of around £5 and will have until they leave university. I also got a lump sum of around 4x his salary.

Widowed Parents' Allowance was paid but only lasted for 2 years until my younger son was 18 then nothing from the government. No such thing as a Widow's Pension now!

Yes he had Life Assurance but that gave us nowhere near what the pension scheme has.

As to using equity release. We worked hard to pay off our mortgage and the house now belongs to me and I'm proud of it. I wouldn't dream of using equity release unless I had absolutely no choice.

In the end I'd still rather have my husband but his decision to pay into a pension scheme meant that his family are well provided for.

I will certainly encourage my 21 yr old son to start his pension as soon as he starts work in October.

claretmatt

The Actuary Profession believes that flawed and outdated calculations could lead to individuals repaying double of what they expected under equity release schemes because of flawed life expenctancy calculations used.

They believe that the basis and method of calculating life expectancy under the mortgage conduct of business rules seriously understates the true average life expectancy.

The FSA does not take into account future mortality improvements which will increase repayments.

The FSA have no plans to alter the formula.

A warning to those who are considering equity release would be to get quotes over and above the average life expectancy that probably would be quoted.