Pension MoneySaving: Buy a different way to boost returns Article Discussion Area

wotsthat

Hi all

This is an interesting one!

There seems to be a consensus that pensions are useful as a means to ensure that a lump sum is built to generate an income to utilise personal tax allowances at retirement but over and above this ISA's can be used to deliver tax free income.

If this is the case what fund size is required as the breakeven point? Is it roughly (personal allowance - state pension) multiplied up by annuity rates?

Also what is the difference does being a higher rate tax payer make? Is there any point at which similar arguments can be made for ISA's?

What I don't understand about the argument of tax relief vs. tax deferral is that I would have thought that the compounding of tax relief over many years would outweigh the tax on an annuity and, of course, a bigger 25% tax free lump sum would be available.

On balance I think I'm still in the pension camp; how many people would be tempted to raid their ISA's pre-retirement? It also seems like a mistake to try and plan with too great an emphasis on tax regimes - anyone who has planned for retirement, by whatever means, will be a target for new and inventive taxes in the future as the people who planned have to pay for the people that didn't or couldn't plan ahead.

EdInvestor

What I don't understand about the argument of tax relief vs. tax deferral is that I would have thought that the compounding of tax relief over many years would outweigh the tax on an annuity

This has no effect.

a bigger 25% tax free lump sum would be available.

This is the case - the difference amounts to about 7% of the value of the whole fund.Not worth all the restrictions, loss of capital etc for a BRT IMHO.

Also what is the difference does being a higher rate tax payer make?

A big difference.An HRT gets an additional 18% tax relief in the form of a cash in hand rebate from the Revenue.There is no requirement to put this money into the restrictive pension wrapper.

This is quite a good perk, and when you add on the tax free cash will justify the restrictions of the wrapper for many especially where they expect to pay basic rate tax after retirement and thus will not have the 18% clawed back.

dunstonh

What I don't understand about the argument of tax relief vs. tax deferral is that I would have thought that the compounding of tax relief over many years would outweigh the tax on an annuity and, of course, a bigger 25% tax free lump sum would be available.

There is no compounding of tax relief. Its a misconception that even I was subject to in the past. Whether you add 22% basic tax relief at the start or add it in at the end, the result comes out the same.

Lets look at £780 in an ISA compared with £1000 in a pension due to tax relief at 22%.

£1000 @5% in 1st year = £1050.
£1050 @5% in 2nd year = £1102.50
£1102.50 @5% in 3rd year = £1157.62

£780@5% in 1st year = £819.
£819 @5% in 2nd year = £859.95
£859.95 @5% in 3rd year = £902.95

Now add 22% tax relief to that ISA value of £902.95 and it comes out as £1157.62. Exactly the same as a pension. It doesnt matter if the tax relief is in year 1 or year 40.

bigger 25% tax free lump sum would be available.

The rumours are increasing that the Govt wants to abolish the 25% pension commencement lump sum.

1 - Its no longer called tax free cash. It is pension commencement lump sum. Is this a prelude to the Govt taxing it?
2 - There is no mention of any lump sum benefit on the NPSS.
3 - It's something that raises it's head periodically and in the past has never happened. However, the rumours have never been stronger and the change in name and the NPSS leaving it out have helped that.

If this is the case what fund size is required as the breakeven point? Is it roughly (personal allowance - state pension) multiplied up by annuity rates?

You would need to be able to calculate some assumptions which would change over the years and require monitoring. Its never going to come out perfect. Any IFA running the better back office software packages can do it easily but if you want to DIY, then you are faced with checking a range of calculations which would need some expertise on excel.

The amount you need would depend on your personal circumstances, state pension entitlement, existing pensions etc.

On balance I think I'm still in the pension camp; how many people would be tempted to raid their ISA's pre-retirement?

That is a very important comment. It is also one of the questions I ask when dealing with retirement planning. If you dont have the self control to leave your ISA alone, then a pension is still the best option to make sure you will have some retirement income.

It also seems like a mistake to try and plan with too great an emphasis on tax regimes

Depends on whether you are doing it yourself or paying someone to do it. I do plan to that level for my clients but thats what you get with advice. Other IFA with servicing clients (rather than one off transactions) would do the same. If you want to do it yourself, you can and the benefits can be enourmous. Just ploughing money into a pension and hoping for the best at the end can create an increased liability for tax costing you thousands of pounds a year. Can you afford to lose thousands of pounds a year income in retirement because you didnt want to do it right in the first place?

anyone who has planned for retirement, by whatever means, will be a target for new and inventive taxes in the future as the people who planned have to pay for the people that didn't or couldn't plan ahead.

Another fair comment. Put your money into pensions and you are stuck in them. Put your money into ISAs and you have the flexibility to change it at a later date.

You still in that pension camp?

wotsthat

Lets look at £780 in an ISA compared with £1000 in a pension due to tax relief at 22%.

£1000 @5% in 1st year = £1050.
£1050 @5% in 2nd year = £1102.50
£1102.50 @5% in 3rd year = £1157.62

£780@5% in 1st year = £819.
£819 @5% in 2nd year = £859.95
£859.95 @5% in 3rd year = £902.95

Now add 22% tax relief to that ISA value of £902.95 and it comes out as £1157.62. Exactly the same as a pension. It doesnt matter if the tax relief is in year 1 or year 40.

Yes this is convincing and I can see that ISA's give you the opportunity to decide later whether or not to transfer some of your saved ISA money into a pension wrapper at a later date (subject to contribution limits). I thought that as the final fund is bigger in the pension wrapper it would give a higher income, which it does, but obviously the tax then reduces it back to ISA levels.

The rumours are increasing that the Govt wants to abolish the 25% pension commencement lump sum.

I agree tax planning is important - I'm just being cynical. As the population ages governments will have to find tax where they can and those "silly" people who saved for retirement will probably have to pay more than they expected. I suppose the easiest taxes are those that are easy to disguise - for instance a government would find it easier to announce that the 25% lump sum is being stopped in 2032, say, rather than saying that ISA benefits were being stopped which makes ISA investing more secure.

You still in that pension camp?

The arguments for a pension wrapper income that takes someone over the personal tax allowances and then ISA's once that target is on track seem pretty convincing. I need to get stuck into excel to do some sums based on my personal circumstances - I pay higher rate tax and, for now at least, I want to build fund that I can't touch in an "emergency".

Thanks Dunstonh and Ed for your thoughts.

fatpigeon_2

HI

I'm 26, a basic rate tax payer, and thinking about using my work's pension scheme. They say they'll match a minimum of 3% to max of 4% of my contributions. Is this a good idea to opt into?
I'm already saving into a mini-cash ISA.

dunstonh

They say they'll match a minimum of 3% to max of 4% of my contributions. Is this a good idea to opt into?

Free money. Always take the free money.

I'm already saving into a mini-cash ISA.

No good for long term planning though.

jestaminnit

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Hello to all
I have just taken voluntary redundancy, and am taking early retirement ase well. My question is the pension will produce a lump sum appx £25k and appx £75 a week. should I reduce the lump sum and increase my income... or take the largest possible lump sum? It's a final salary pension so can I use ALL of it to buy an annuity?

jamesd

What is your total taxable income including all pensions?

There is sometimes merit to reducing the pension income, taking the tax-free lump sum to do that. Two possible cases, one around 8-10000, where it can decrease the amount subject to basic rate tax by taking the pension income below that. The other is around 20-24000 where it can avoid having the age allowance reduced. That age allowance reduction raises the effective tax rate to about 33% between 20000 and 24000 in taxable income.

In a final salary scheme you do not buy an annuity. Are you sure that it is a final salary scheme not a money purchase scheme?

If you meant whether you could take all of the final salary scheme money and then buy an annuity, that would probably be a bad idea and produce lower income than the final salary scheme.

If you can trade reduced pension for higher lump sum, it's necessary to consider the amount of the reduction and the amount of the lump sum. There's no general answer since it depends on how good the individual deal is.

EdInvestor

How old are you? What other pension income can you expect?

Get a forecast for the state pensions here3:

https://www.thepensionservice.gov.uk

jestaminnit

hiyaa and thnx for your reply. I'm 55 no other pension income to receive.
so you suggest getting my state pensioin as well?