ISAs v Pensions: The Official Retirement Debate

wotsthat

wotsthat, the odds are that the NHS pension doesn't allow doing that ISA to pension shift and the benefits of that pension are so generous compared to normal personal pensions that it's not worth using a personal pension instead.

Sorry I was answering two different points. Yes I agree the NHS pension cannot be beaten by ISA's or private pensions.

The ISA vs. pension comment was intended was aimed at those who were considering the merits of either route. The ISA and pension saving route are both poor relations to a decent company or public sector scheme.

scrooge38

dunstonh wrote: »

Disadvantages of ISA

2 - For the first £10k of income in retirement, the income from the ISA would be lower than what the pension would have provided.

Please can you explain why this is so? I'm assuming that state pensions mop up basic tax allowance.

Paul_Herring

scrooge38 wrote: »

Please can you explain why this is so? I'm assuming that state pensions mop up basic tax allowance.

When you reach 65, your nil-rate band goes up to about £10k. You should plan for any personal pension provision to provide the difference between state pension and £10k (in today's money of course)

dunstonh

Basic state pension is £4300 a year. Personal allowance at 65 plus 10% band (or new allowance from next year) is 10k. So, you may as well use pensions to utilise the tax free income. With a couple, that is 20k of tax free income in retirement and from an income only point of view, the pension will pay the best income.

EdInvestor

Of course most people retiring in the future can expect the second state pension to top up the state total to something like 7-8k, so there won't be much left for other pension saving.

Check here for a forecast of what you might get from the state pensions:
http://www.thepensionservice.gov.uk/atoz/atozdetailed/rpforecast.asp

scrooge38

dunstonh wrote: »

Basic state pension is £4300 a year. Personal allowance at 65 plus 10% band (or new allowance from next year) is 10k. So, you may as well use pensions to utilise the tax free income. With a couple, that is 20k of tax free income in retirement and from an income only point of view, the pension will pay the best income.

Wouldn't argue with that, but as there is no tax on ISA income, so how can it be more heavily taxed than pension income?

And you are making the rather large assumption that people don't have other income to mop up these allowances.

Scrooge

dunstonh

Wouldn't argue with that, but as there is no tax on ISA income, so how can it be more heavily taxed than pension income?

There is no personal liability for income tax on ISAs but if you keep the pensions below the personal allowance then there is no tax on those either. So, the tax relief on the contributions make a difference.

And you are making the rather large assumption that people don't have other income to mop up these allowances.

The aim then is to use ISAs for the amount above the personal allowances. So, you balance the pensions and the ISAs. That reduces the amount you have in taxable income from other sources.

Of course most people retiring in the future can expect the second state pension to top up the state total to something like 7-8k, so there won't be much left for other pension saving.

It's something that needs to be considered but it is unusual for someone to get the full amount of basic AND S2P. Self employed individuals get no S2P so they stand to gain the most out by making pension contribtuions.

jamesd

scrooge38, you get tax relief on pension contributions and when you take the money 25% of the 20, 22 or 40% relief is available as part of the tax free lump sum, money not available from the ISA route. That's a net tax advantage of 5, 5.5 or 10% of the money. Also the portion below about 10,000 may be in the personal and age allowance range and not be taxable on receipt even though relief was provided on the contributions.

Once you get above 10,000 the only pension benefit is the part from the tax free lump sum. Still enough to be helpful for someone who is trying hard to increase their pension in the last few years before retirement and intends to buy an annuity. They can put the money in the pension then take the lump sum and put that into ISA investments, effectively getting some tax relief on the ISA contributions via the pension.

Age allowance reduction more than eliminates the benefit of the lump sum for the pension income which is in that range.

Better investment performance can overcome these advantages but since you can use income drawdown in a pension you get quite a bit of investment flexibility there until you get into ASP or forced annuity purchase territory at age 75.

Hence you end up with the pretty routine basic suggestion here: pension until your expected taxable income reaches 10,000, ISA beyond that.

EdInvestor

dunstonh wrote: »

It's something that needs to be considered but it is unusual for someone to get the full amount of basic AND S2P.

It may be unusual at present, but that's mainly because people only started accumulating SERPS/S2P entitlement from 1978 when it was introduced, so they missed contributing in early working years. But as time goes by, more and more people will be retiring with a full record - or a combination of a partial record and a contracted out pension adding up to much the same amount.

So the amount of tax free allowance 'left over' is not likely to be high - say 2 or 3k's worth of annual income.At current rates,that translates into a pension fund of around 50k.

Unless there is free employer money around, IMHO it would be better for most people to save this money in ISAs in the first instance. Under the new rules it wouldn't take a person in their 50s very long to acquire a 50k pension fund, and at that stage it's far more likely he or she will be paying higher rate tax and thus able to get even higher tax free benefits.

scrooge38

dunstonh, in my original post I said I assumed that state pensions would mop up these nil-rate allowances, so your statement is incorrect. Pension income is NOT more tax efficient that ISA income. Pension income is taxed at your highest marginal rate. If that's 0%, fine, but that's not what I asked.

And jamesd, I am well aware of how pensions tax deferral works, and the tiny tax advantage that one does retain IMHO in no way compensates for the confiscation of capital and general lack of flexibility these foul products carry with them. And remember that it is extremely unlikely that in most cases all the money that went into a pension was tax-deferred at 40%; most people only hit higher rate later in life, so the average rate of deferral will be something between basic & higher rates. You're better off paying the tax & keeping control IMHO.

Scrooge