ISA's versus Personal Pension

IFA_to_be

HI :wave:

I have heard some individuals say that ISA's would be a preferred way for non-taxpayers to fund for there retirement over personal pensions.

Can someone give some reasons why this could be the the case?

I'm not saying this is or should be the case but what would be the advantages for doing it this way?

dunstonh

There is a sticky at the top of the board. Do note that its getting on a bit and some of the early posts will have wrong limits and be before recent finance acts.

I have heard some individuals say that ISA's would be a preferred way for non-taxpayers to fund for there retirement over personal pensions.

Actually its more likely that pensions would be better than ISA. a) as they get tax relief on contributions despite not paying income tax b) the pension income is not charged income tax up to their personal allowance

gadgetmind

I no tax payer can put £240 pcm into a pension which HMG then another £60 to so you get £300 into your pension. You can then invest this money in whatever asset classes you like, but with more choice comes more fees. Unless you then build a huge pot, state pension plus this private pension are unlikely to push much/any of your income into a higher tax bracket. 20% tax relief on the way in, despite paying no tax, and (probably) no tax on the way out.

My wife doesn't pay tax but she *does* put £240pcm into a pension. In her case this is an Aviva pension via Cavendish Online.

I'm not saying that you shouldn't also consider an ISA, but do your research and work out the numbers.

LOST

Using ISA's to draw an income are preferrential as they are tax-free and they do not count against any age-related allowances

IFA_to_be

Thanks dunstonh

I have to say i thought that was a valid point regarding the tax on PP, however I did over hear a few IFA's discussing this particular subject and they all seemed to agree that ISA's were better for Non-taxpayers and as a trainee I didn't have the courage to ask why??

dunstonh

I have to say i thought that was a valid point regarding the tax on PP, however I did over hear a few IFA's discussing this particular subject and they all seemed to agree that ISA's were better for Non-taxpayers and as a trainee I didn't have the courage to ask why??

With modern ISAs and pensions, there is no cost difference and the funds available are identical. So, the only difference is the maturity method and tax.

For a non taxpayer:

A contribution of £3600 into a pension costs £2880. So, the ISA equivalent would cost £2880

Growth would be identical on both but for this example, lets say its 100%. So the pension value would be £7200 and the ISA £5760

They now wish to draw an income and 5% is the selected income figure.

Ignoring tax free cash to begin with
Pension: £7200 x 5% = £360
ISA : £5760 x 5% = £288

You would nearly always take the tax free cash on a money purchase pension. It wouldnt affect the figures here as you would put the TFC into the ISA and apply 5% to it. As long as the person is a non-taxpayer, it wouldnt change the figures.

Those figures above are small but you can see the pension beats the ISA. However, lets make the figures bigger but by the same ratios to ensure like for like.

Pension: £72,000 x 5% = £3600
ISA : £57,600 x 5% = £2880

Still under personal allowance so no tax to pay on pension. So, lets go bigger

Pension: £144,000 x 5% = £7200
ISA : £115,200 x 5% = £5760

Now, the chances are that we are getting into the position where tax is going to need to be paid. The personal allowance for a 65 year old is £9940 and lets say there is a £5311 state pension as the person was self employed and got full entitlement.

ISA will still be £5760 as its tax free.

Pension can have 25% taken as a lump sum. So that leaves £108,000 paying 5% which is £5400. There is only £4629 left of personal allowance so £771 has basic rate tax applied to it. So, the net income will be £5400 minus £154 tax = £5246

However, we need to now factor in the £36k tax free cash which we will use up in ISA over the coming few years £36k x 5% = £1800.

So, ISA would be £5760 and pension would be £7046.

IFA_to_be

Thank you so much for your help in understanding this, clearly listening to half the conversation didnt pay well as from your evidence there is little to no advantages to ISA over PP.

Many thanks for your very helpful calculations

However what about fees with PP could this be a benifit for ISAs

zygurat789

dunstonh wrote: »

A contribution of £3600 into a pension costs £2880. So, the ISA equivalent would cost £2880

This is the crux of the matter, you are investing more for longer thanks to the upfront tax relief.
And the level annuity rate for a 65 year old man (6.5%)is somewhat higher than the interest rate on an ISA at the moment (5%)
Even if the pension was wholly taxed it would give a net income of
£5400 X .8 + £4,320 plus interest from the 25% lump sum in an ISA of £1,800 gives a net income of £6,120 as opposed to the ISA option of £5760.

sleepless_saver

If you have to claim income related state benefits at any point, an ISA will count as capital and you will be expected to use the ISA until you reach the capital limits (usually but not always between £6k and £16k).

So if the worst happened, with an ISA you could be left with too small a pot to fund retirement. With a pension, it can't be touched until you can start drawing your pension, which you would be expected to do.

dunstonh

However what about fees with PP could this be a benifit for ISAs

Modern contracts have the same charges irrespective of tax wrapper. Some older style contracts may have differences. However, nowadays there is no reason for that to be the case.

I was also assuming drawdown on my figures. Hence why i kept the withdrawals both at 5% to allow for a like for like income take.

Aegis

IFA_to_be wrote: »

Thank you so much for your help in understanding this, clearly listening to half the conversation didnt pay well as from your evidence there is little to no advantages to ISA over PP.

There are advantages to using an ISA rather than a pension, but they're largely down to access. An ISA can be fully accessed at any time with no problem, so someone saving for the long term without being sure whether that means retirement or something earlier might wish to use an ISA. The other consideration is that a non-taxpayer can put money into an ISA or a direct investment now and then bed-and-pension once they are a higher rate taxpayer, as this will return 40% tax relief rather than 20%

However what about fees with PP could this be a benifit for ISAs

Charges could definitely be an issue, as could fund selection. For ISAs, you can have the full range of investment funds available on a single platform at minimal cost, but this combination of low cost and fund selection doesn't seem to exist for consumers yet. Personal pensions tend to have cheap internal funds (usually without great track records) and fairly expensive mirror funds of external funds with better track records, SIPPs tend to have very high fixed charges to go with their fund selections. The real exception there would be Hargreaves Lansdown, but even there they take the full trail commission for all funds held in their SIPP without ever giving any advice on the funds.

However, IFAs have little excuse as they can access things like Skandia Investment Solutions to get access to most of the funds available in the UK at standard retail terms with commission either paid to the adviser or rebated to the client. The funds there are available on similar terms to ISAs, so the only real barrier to that strategy is the fixed cost for using the platform, which is around £80 a year if memory serves. For smaller pension portfolios this may be too high a charge, but for larger pensions it becomes negligible.