ISAs v Pensions: The Official Retirement Debate

jamesd

dunstonh, thanks, yes I should have been specific that I was referring to stocks and shares ISA use. Cash ISA's are inadequate for retirement income or lump sum growth because they grow at far lower after inflation rates than can be expected from investments in a stocks and shares ISA.

kgarcia

I think it's best to have both personally. Dunstonh, you really know your stuff.

farhad1965

I would go for both, and in fact have both. Ofcourse it depends on what you can afford. I use the £7k maxi isa annual allowance for both the mrs and I, and contribute £700/month to a Scottish Widows private pension plan.

LouLou_S

Wow - so much information!
Forgive me, I'm new to this and you may have already answered this questions but if i were to have and ISA to sustain me during retirement and became ill or infirm and my family had to put me in a home, would my ISA (depending on what is in it) cause me to have to pay for my care? Would this also appy to a Pension?
Thanks

jamesd

Both the ISA capital and income and the pension income are assets that are available to pay for care fees. Access to the capital lump sum in the ISA can let you purchase care payment plans that may be more efficient to pay for the care. That access to capital is one of their significant advantages compared to a pension.

Investment bonds have been one of the main ways of shielding assets from this but they are likely to become significantly less efficient as investment tools after the pending change to capital gains tax.

dizzie

As long as you can be self-disciplined then there are advantages to both ISAs and Pensions. Here is what my plan is:

1. As a higher rate taxpayer (expecting to be a basic rate taxpayer in retirement), I'm paying into a personal pension for the tax relief benefits.
2. But if my pension grows too large (if my total taxable income (including basic state pension, savigs interest etc) is over about £20,900), under today's rules I would be penalised by reduced age-related personal allowances. I suspect it will be similar in the future, so I want to try to keep it under that limit. From past experience I think the system usually punishes those who have worked hard and been frugal.
3. So I'm contributing into an ISA, on which I can draw tax-free income when I retire (income from this would not affect my age-related personal allowance). Another advantage is that I can draw out the capital, so it gives me a bit more flexibility.
4. I'm self employed, so my income can vary. I am only contributing sums of money to my pension fund on which I get the 40% tax relief. If my income drops, I will put extra money in my ISA (rather than only get 22% (soon to be 20%)) tax relief). Then, I'll top up my pension fund (from my ISA) in years when my annual income is up (i.e.when I can get the full 40% tax relief on it).
5. There is an 11 year age gap between hubbie and I, so we are aiming for pension funds in our own right that will be roughly the same size (If he aims to make provision for a 50% widdows pension, his annuity rates will be rubbish).

In theory my plan is to use these two tax wrappers to minimise tax in retirement and yet give me as much flexibility about how and when I want to draw on my pension/isa funds - hopefully that theory won't go belly up and it'll work out in practice.:T

michaels

So if I could afford it, could I put say 75% of my income next year in to my pension fund and qualify for maximum tax credits plus live off my savings and then pay less in to my pension thereafter to rebuild my savings pot and have benefited by the amount of tax credits that I normally don't qualify for?

dizzie

Sorry Michael - you've lost me...

What I mean by getting the maximum tax benefits is this:

Last year, my income was around £49k and I had paid £6000 gross into my pension fund (all of which attracted the 40% tax relief - taxman pays 22% to my pension fund and I reclaim the other 18% on my tax return)

But say next year, my income drops to £42k - if I pay in £6000 that year, then I am not going to get 40% tax relief on it all, therefore I will only put in the proportion that will qualify for that higher rate (i.e the bit of my income that is above the 40% threshold), and the rest, I will stick in an ISA

Then say I get a year where I am into the 40% tax bracket by £10,000 or more, I could use my ISA reserves to fund a bigger contribution that year.

Let me take another example:

If as a taxpayer, I acquired some savings, I would probably proceed as follows:

1. I would have some in cash assets for short-term needs (e.g cash isa)
2. I would be paying into my pension (for my long term needs)
3. I would be considering a stocks/shares ISA on the basis that I am going to save up for long term needs but I still might require access to the cash earlier.
4. I would review how my investments were performing and hopefully when the stocks and shares ISA is growing, I can keeping splitting it and putting some into my pension fund and get the applicable rate of tax relief on that extra contribution (as described above).

If I was only a basic rate taxpayer, I would get basic rate relief. If I was a higher rate taxpayer, it would depend on what contribution I was making and what my income was (as described above).

Hope that makes sense.

jamesd

michaels, you appear to be correct in theory. However, do note that "income you may have deprived yourself of for the purpose of getting a tax credit or more tax credit" may be counted. I don't have the experience of how this is applied in practice to know if say a single person with a before pension salary of 40,000 could put 32,000 after tax relief into a pension and get working tax credits. I also don't know if higher rate tax relief would be counted for the income calculation for someone earning say 60,000 before pension contributions of 52,000 after tax relief.

Do note that most savings interest, dividends and rental income will be included when calculating your income for working tax credit eligibility. The items that don't count which are most interesting for your purpose include:

• pension contributions
• income from ISAs or PEPs
• income from tax-exempt National Savings products
• income from rent-a-room
• non-taxable benefits including housing benefit, council tax benefit, child benefit, attentance allowance, disability living allowance.

Taking income from the ISAs will reduce the remaining amount in the ISAs so that's probably not the best source of income. Taking income from NS&I products and rent-a-room looks most beneficial.

Also interesting is that when the income is increased in the next year the first 25,000 of the increase is ignored, so you could also benefit in the following year.

Up_the_Creek_4

Just a thought:

By the age of 35, 250 out of 100,000 people suffer mortality to cancer, by the age of 55 (the pensionable age) this increases to 1,750 per 100,000 (cancer research site stats). In the UK in 2005 153,491 people died from cancer. Our new concern, obesity, shows that 61% of men and 54% of women are overweight or obese, at the age of 16-24 about 285 of the population is classified at riak of obesity, by the age of 55-64 (the time we should be spending that hard saved pension fund) 78% of men and 68% of women are obese - we all know the increased risk factors of obesity and mortality, I won't even go into the heart statistics as it gets too depressing. So I would go ISA any day and protect the family, with maybe the ability to have a little private health care if needed.