ISAs v Pensions: The Official Retirement Debate

EdInvestor

Corrected:

dlevene wrote: »

If you are a BR taxpayer and believe you will continue to be in retirement:
Invest in an ISA

If you are a HR taxpayer but will be a BR taxpayer in retirement:
Invest in a pension (but see below)

If you are a BR taxpayer but will be a HR taxpayer in retirement:
Max out ISA

If you are a HR taxpayer and will continue to be in retirement:
Max out ISA

If, before retirement, you go from a BR to a HR taxpayer:
Reduce income to BR by putting excess in pension but not more than that if you will be a BR in retirement.Other savings in ISA.

In any situation:
Take out company pensions if they will match your contribution (free money!)
Opt-in to S2P
Pay off mortgage by retirement

That's it.The comments in the 'nutshell' a re wrong.

Suggest you ignore the tax band fine tuning as it's obviously a bit too technical.

dunstonh

I disagree with Eds view and will post later.

Suggest you ignore the tax band fine tuning as it's obviously a bit too technical.

Depends on whether you want to do it right or not. If you want simple then you make compromises that may result in you not getting the best approach. It doesnt have to be difficult but you can end up over simplifying it which is what I would suggest Ed has done.

EdInvestor

One problem with the tax band thing is judging the amount of your state pension.As discussed elsewhere many people are retiring now on state pension +S2P of around 9-10k p.a. which will be equivalent to the old age personal allowance when it is uplifted over the next few years.

There is thus no scope for additional tax-free pension saving if someone is contracted in throughout his working life.In any case contracting out for d/c pensions will end in 2012. With the NPSS coming in as well, seems likely to me that basic state pension, S2P and NPSS will soak up the old age allowance in future pretty comprehensively.

It is probably worth mentioning the other 2 bands: c.21k where age allowance starts to be withdrawn and c.33k where HRT kicks in. You don't want to acquire taxable (pension) income in retirement which puts you over these levels.

I may have oversimplified in my earlier post but the OP is so seriously confused that it seemed better to stick to the basic principles.

dunstonh

One problem with the tax band thing is judging the amount of your state pension.

You cannot get it 100% right but you can do a good job with periodic reviews.

As discussed elsewhere many people are retiring now on state pension +S2P of around 9-10k p.a. which will be equivalent to the old age personal allowance when it is uplifted over the next few years.

An many people do not get a penny of S2P leaving them with only basic state pension.

There is thus no scope for additional tax-free pension saving if someone is contracted in throughout his working life.In any case contracting out for d/c pensions will end in 2012. With the NPSS coming in as well, seems likely to me that basic state pension, S2P and NPSS will soak up the old age allowance in future pretty comprehensively.

quite valid points which would be considred. However, they will not apply to everyone.

If you are a BR taxpayer and believe you will continue to be in retirement:
Invest in a pension to supply an income in todays terms of around £10k p.a. inc state and other pensions then use ISAs above that.

If you are a HR taxpayer but will be a BR taxpayer in retirement:
Invest in a pension (tax relief paying in more than tax paid when taken as income). However, dont ignore ISAs. I personally would still put ISA before pension due to capital reasons but from an income only point of view, the pension beats ISA.

If you are a BR taxpayer but will be a HR taxpayer in retirement:
Max out ISAs first and then unit trusts. You can always place the money into investment bonds later and reduce your HR liability to possibly make you a basic rate taxpayer (top slicing relief on investment bonds could be a winner here).

If you are a HR taxpayer and will continue to be in retirement:
Go with ISAs first or other investments. 40% in and 40% out gives no advantage on pensions.

If, before retirement, you go from a BR to a HR taxpayer:
Keep ISAs but switch funding to pension. You could use money in the ISA to fund the pension and get 40% relief but that is a personal opinion.

In any situation:
Take out company pensions if they will match your contribution (free money!)
Opt-in or out of S2P depending on your risk profile (rebates increased for 2007/8 and advantages may be worth contracting out)
Paying off a mortgage is a priority but not making extra payments at the expense of building up a retirement fund.

In a nutshell:
Have your retirement income in pensions as close to 10k as you can (in todays terms)
Join occupational pensions where final salary and have employer contributions
Don't have a mortgage

Remember that for income, no investment alternative beats the pension. However, the pension is no good for capital. So a combination of ISAs and pensions is often best.

If you use up you isa allowances, you can always move onto unit trust/OEICs.

EdInvestor

dunstonh wrote: »

If you are a BR taxpayer and believe you will continue to be in retirement:
Invest in a pension to supply an income in todays terms of around £10k p.a. plus state and other pensions then use ISAs above that.

Don't you mean "including state pensions"?

dunstonh

yes i do. edited accordingly. thank you

Also, there are exceptions to the above. i.e. working/childrens tax credits can be increased by making pension contributions whereas they are not with ISAs. It is possible to get effective tax relief of just over 70% with pensions an tax credits under the right circumstances.

bowlhead99

You say that someone HR now and HR expected in retirement, no point using a pension as its 40% in, 40% out. What about the ability to take 25% tax free lump sum on retirement age? Doesn't that mean that either a BR or HR taxpayer could invest a third more than they really wanted to (ie £100 instead of £75), with the express intention of taking £25 out again ASAP and avoiding tax on it?

I am not going to overinvest in a pension now on the hope that locking in to it for 30 years will allow me to take a little out tax free - but is this something that someone nearer retirement age could use? Thanks in advance.

Paul_Herring

bowlhead99 wrote: »

What about the ability to take 25% tax free lump sum on retirement age?

I'd be wary of relying/depending on this still applying at retirement; since the name of this has changed to "Pension Commencement Lump Sum" the pessimist in me thinks that they'll be removing the "tax free" part.

Depends on how far you are to retirement of course..

Ian_W

Paul_Herring wrote: »

the pessimist in me thinks that they'll be removing the "tax free" part.

There seems to be rather a lot of pessimist in you though Paul!

On another thread "the pessimist" was postulating that there wouldn't be a state retirement pension in years to come IIRC when GB has, albeit reluctantly, agreed to restore the link between SP and average earnings as pointed out by EdInvestor! :rolleyes:

Lets face it - the "they'll tax the pension lump sum next" argument has been in the mind of pessimists for well over 25yrs that I can remember but it hasn't happened. Why not? First AFAIK it will require primary legislation and it's such a big deal to so many people that it would probably need to be in a party election manifesto to have any legitimacy - can you see that as a starter? Not least it would apply to all pensions - and who has the best pension scheme bar none - yup, you guessed - MP's! Christmas and Turkeys spring to mind!

Far more likely, and less painful politically IMO is taxing lumps over a certain level, say £100/150 or 200K or abolishing HR tax relief for pensions and restricting it to BR. Equally, it's stroke of a pen [or publication of a statutory instrument] stuff to further reduce the tax advantages of ISAs.

Hope that hasn't added to the pessimism. I think you need to plan things from what you know, not either as a pessimist or optimist you think may happen in the future.

Ian_W

Now on page 10 of the board - deserves a "psuedo sticky bump" me thinks!