Smart Pensions versus ISA's

fizio

We all know that with most large companies its possible to invest additional amounts of your gross salary into a variety of funds which then forms part of your pension on retirement (SmartPensions/AVC/etc).

The big incentive for higher rate tax payers being you effectivelly get the tax and NI relief so end up paying around around half the price you would have had you bought into the same funds yourself.

So my dilemma is how i decide how much i invest via SmartPensions versus stocks/shares ISA's. Especially if the ISA investments are in smiliar 'ww index tracker' type funds as are available via the SmartPension.

I can see that the ISA option is a good one if I need access to the money prior to retirement and its also better at enabling investment in specialised funds/markets/sectors versus a limited selection in SmartPensions. But for low risk long term investing the SmartPensions option seems the best bet.
I'm currently doing both but have the opportunity in Jan to update my SmartPension contribution and was debating increasing it by a large amount at the expense of the ISA option. Obviously while ensuring I have access to sufficient monies if needed for usual items/emergencies/etc

Given that there really isn't anywhere you can put your money thesedays and get a relatively low-risk return I'm pondering the option of putting all my spare monthly salary into the SmartPension option (trackers/bonds/etc)and not bother with taking the salary as nett and then putting it into savings/isa/etc accounts? Obviously i can make an annual change if I find better places to invest in the future

Whats the thinking from you folks?

middlepuss

If you could let us know what the tax regime will be on pensions and ISAs in each year up to when you retire, and then what your earnings will be in retirement, the income tax bands and thresholds in force at that time and the taxation arrangements for ISAs and pensions at that time, then we can answer your question.

In other words, nobody knows! I have a (very lucky) friend who saved in pensions enjoying the 40% tax relief, only to retire and find their earnings were over the 40% tax threshold: so they pay 40% tax on the pension, pretty much negating the tax advantage of saving in a pension plan.

So do ISAs and pensions, and roll the dice to determine how much you put in each?

xylophone

Under the current tax regime, income from ISAs is not taxable so does not count against the income tax age allowance.

somethingcorporate

middlepuss wrote: »

If you could let us know what the tax regime will be on pensions and ISAs in each year up to when you retire, and then what your earnings will be in retirement, the income tax bands and thresholds in force at that time and the taxation arrangements for ISAs and pensions at that time, then we can answer your question.

In other words, nobody knows! I have a (very lucky) friend who saved in pensions enjoying the 40% tax relief, only to retire and find their earnings were over the 40% tax threshold: so they pay 40% tax on the pension, pretty much negating the tax advantage of saving in a pension plan.

So do ISAs and pensions, and roll the dice to determine how much you put in each?

You do need to consider that they have seen growth over many years on the tax relief they saw on their money paid into the pension.

This would have had a considerable impact on the value of the pension when they took it.

jamesd

The smart pension/salary sacrifice option is a good one for money taxed at higher rate. It's also good for money taxed at basic rate but the catch is that you can get at all of the money in an ISA. That means you can use the ISA money for something like retiring before age 55 or taking an income larger than the capped drawdown limit from a pension.

So you're right that the salary sacrifice option pays most but the flexibility cost is significant.

atush

I think it also depends on your total amt of investments incl cash outside a pension environment. As ISAs can be accessed earlier than 55, they would be essential as part of this but we have no way to know if you have access to enough funds for the medium term for anything you may want or need?

fizio

I appreciate the feedback and the general view is :
- when doing samartpensions aim to have the pension on retiremant around the 40% tax threshold
- ensure i have enough in savings/isa to meet any personal requirements prior to taking a pension
- take note of the flexibility of having savings/isa versus pension

A couple of other points that are makiing me lean towards the samrt pension option
1. My feeling is that sooner or later the 40% tax advantage will be legislated against so may as well maximise the opportunity and save as much as poss.
2. My 'finaly salary' pension has recently been 'frozen' and the current penson structure we have will allow me to take all my 25% pension lumpsum allowance from the smartpension rather than from the final salary pension..
3. I have a variey of other investments so can cope with emergencies and other unforseen requirements.

I'll have to do a few more sums before I make a final decision but the feedback here has been useful so many thanks

property.advert

I constantly look at this, tax free on the way in or tax free on the way out. Then add in the fact that you can access ISAs when you want. I guess the question only presents itself when are saving less than 60k or so (50k max into pension and 10k into ISA).

My thoughts are that they are more likely to tinker with the tax at 50%/40% on inward pension funds before money coming from ISAs which could sway the decision to fill up a pension but that is locking money away for the never never and you have to be sure about that.

DavidLaGuardia

somethingcorporate wrote: »

You do need to consider that they have seen growth over many years on the tax relief they saw on their money paid into the pension.

This would have had a considerable impact on the value of the pension when they took it.

This is often said, but it is completely irrelevant.

ISAs and Pensions have the same tax advanatages within the growth of the fund itself. What the pension does is increase it by one factor going in, but it has it decreased by another factor going out - by virtue of whatever tax is paid.

If you are a basis rate tax payer, assuming all things are equal: every £1 pension is notionally worth £1.25 compared to £1 going into an ISA. If tax is still 20% in retirement then the factor of 1.25 is reduced to (1.25 x 75% x 80%) + (1.25 x 25%) = 1.0625

Some would argue that a boost of 6.25% is not worth it for the restrictions and potential loss on death.

However, the whole point of the original post was that smart pensions can also make use of NI through such things as Salary Sacrifice

Instead of getting 25% ininitially another 47% is added.

If the basic rate tax payer also gets the benefit of the Employer NI (for example if they can divert all the pennies to a pension as part of a package, the initial boost is nearer 66%.

A 40% taxpayer in the same position would increase their pension contribution by 94.5%. Those who pay an effective rate of 60% (over 100k when the personal allowance is removed get an equivalent of 196.8% added!

Either method makes pensions potentially attractive.

atush

generally, your tax is lower for 'on the way out' than on the way in ie baisc rather than higher rate). Which would favor pensions, all other thigs being equal.

fizio

atush wrote: »

generally, your tax is lower for 'on the way out' than on the way in ie baisc rather than higher rate). Which would favor pensions, all other thigs being equal.

I think that is the crux of it for me.. i,e its a definate 46% saving (in my scheme) going in but likely to be 25% on the way out so if its affordable then I should maximise my contributions..