ISAs v Pensions: The Official Retirement Debate

EdInvestor

Scotsman calculates that someone who saved first in an ISA as a basic rate taxpayer and then fed the money into a pension when paying higher rate would be up to 100k better off in the end.

dunstonh

EdInvestor wrote: »

Scotsman calculates that someone who saved first in an ISA as a basic rate taxpayer and then fed the money into a pension when paying higher rate would be up to 100k better off in the end.

The article is flawed in some areas as it fails to state what income figures were used for the ISA and pension. It appears to have ignored increased personal allowances at age 65 and not taken into account that the annuity rate is usually higher than the yield on the ISA.

I would stick to the comments on this thread which state you should use pensions where there is free money (from employer) and if not, use pensions upto the level where the income the pension will provide will use up the personal allowance. Above that use an ISA.

The NPSS introduction from 2012 will improve the situation as all employees will receive an employer contribution which will make pensions better than ISAs again.

EdInvestor

dunstonh wrote: »

The NPSS introduction from 2012 will improve the situation as all employees will receive an employer contribution which will make pensions better than ISAs again.

...but only for those who don't mind losing all their capital through being forced to buy an annuity.

dunstonh

...but only for those who don't mind losing all their capital through being forced to buy an annuity.

Not a problem because you wont have to pay as much into the pension allowing you to put more money into the growth side of your investments.

The pensions will provide a higher income in retirement, even with tax, than an ISA. So as long as you contribute enough to meet your income needs into the pension, you put the rest into growth and you will be better off than picking one or the other exclusively.

The article also fails to take into account that those that are in receipt of working/childrens tax credits can get higher tax credits by making pension contributions which they do not with ISAs.

EdInvestor

Many people think it's a problem to have to lose hundreds of thousands of pounds in capital which has accumulated in a pension.An income which is taxable and around the same as bank interest rates is no compensation even if it is guaranteed for life.

dunstonh

EdInvestor wrote: »

Many people think it's a problem to have to lose hundreds of thousands of pounds in capital which has accumulated in a pension.An income which is taxable and around the same as bank interest rates is no compensation even if it is guaranteed for life.

Well those people are silly then. They have to put aside more money to provide an income to the day they die then they would with a pension.

Also assuming that bank interest rates are the same as annuity rates is a risky assumption to make. Just a few years ago savings rates were half annuity rates.

And again, you are assuming tax is paid on the whole amount

Rich1976

dunstonh wrote: »

Well those people are silly then. They have to put aside more money to provide an income to the day they die then they would with a pension.

Also assuming that bank interest rates are the same as annuity rates is a risky assumption to make. Just a few years ago savings rates were half annuity rates.

And again, you are assuming tax is paid on the whole amount

What about the risk for those who save everything into a pension, only to find that annuity rates when they retire is less then they could achieve from income funds/savings accounts? Isn't that a possibility with the prospect that annuity rates could fall even further over the next couple of decades?

dunstonh

What about the risk for those who save everything into a pension, only to find that annuity rates when they retire is less then they could achieve from income funds/savings accounts?

Not a lot different to the risk that savings accounts are paying half what they are now or that investment returns dont return what you expect.

Also, you need to put it in perspective. If you ignore growth on both (as that is the same if you use the same investments in a pension or an ISA) and use 5% yield for the ISA and 7.31% annuity rate (single male) then on a contribution of £100k, the ISA will pay £5000 a year.

If you pay £100,000 into a pension as a basic rate taxpayer then its gets increased to £128,205. You can then take 25% back tax free (£32051). So, the net cost to you is £67,949. After tax free cash taken the rest purchases an annuity at 7.31% which gives an income of £7028 p.a. Tax it at 20% and that gives you a net guaranteed for life income of £5623.

However, that £5623 is against an net outlay of £67,949 whereas the ISA would need £112,460 dedicated to income to pay the same amount.

You can use the £44,511 difference to put into ISAs and that can be your capital pot.

Simple question, Which would you prefer?:

1 -an income of £5623 from a pot of £112,460 which you cannot spend because it will reduce your income but could be passed to your children on death?
2 -an income of £5623 and a pot of £44,511 that you can spend but only that £44,511 can go to your children on death?

Isn't that a possibility with the prospect that annuity rates could fall even further over the next couple of decades?

Annuity rates have been increasing in the last few years. Whilst mortality has been an issue that has caused them to reduce, so has the over payments in the 80s and 90s and as those people are beginning to die, that side of things is being priced out and rates are rising again.

Annuity rates are currently at their highest since 2002.

I will repeat that personally, I like prefer a combination of ISAs and pensions and going 100% into one or the other is usually the weaker option. Doing a bit of both is the strongest option.

EdInvestor

dunstonh wrote: »

Annuity rates have been increasing in the last few years.

Not so as you'd notice - and with longevity continuing to rise and inflation remaining low, there's little likelihood of much improvement .

http://www.annuity-bureau.co.uk/Annuity+Rates/Historic+annuity+rates/

The problem with annuities is that you are locked into a gilt-based low income at a young age.If you have 20 or 30 years to live in retirement, you actually need to remain invested so that your funds will grow and your income can beat inflation long term.

An annuity was never a good idea - when people only lived for a few years, they lost their capital and got nothing like a big enough return. Now they get locked into an inappropriate straitjacket at too young an age, and still lose their capital - and are likely to run out of money due to inflation because they are living so long.

Annuities are well past their sell-by date.

dunstonh

Not so as you'd notice - and with longevity continuing to rise and inflation remaining low, there's little likelihood of much improvement .

They havent improved much but they have improved.

£100k single life wtihout proportion, no guarantees payable yearly in arrears (you wouldnt take it on that basis but it was the same basis each year and thats what matters).

2003 £7422
2004 £7352
2005 £7302
2006 £7356
2007 £7549

That was at 8th May 07 (taxbriefs Pen/31). In the last few weeks emails from providers have been flooding in with increases happening. So, the trend for 2008 is to be higher than 2007.

An annuity was never a good idea

In the 90s you would get £14,430 for 100k. Thats 14.4% guaranteed for life. Like it or not, that sort of rate was very attractive for a guaranteed income.

and are likely to run out of money due to inflation because they are living so long.

If that is a concern then go index linked.

Annuities are well past their sell-by date.

They are not ideal but whenever we discuss this issue you never mention an alterantive that can provide a higher guaranteed income for life.

Its all very well slagging off the annuity option but lets hear the alternatives for providing a guaranteed income?