ISAs v Pensions: The Official Retirement Debate

HarryD

Neil_Lovatt wrote: »

stphnstevey wrote: »

Most importantly of all by using an ISA THEN Pension route you can "time" your contributions into the pension to ensure you maximise your opportunity to get higher rate relief, imagine in the example above if you got 50% releif AND a reduction in your tax bill? Would there be any question of using an ISA over a pension?

Yes, but bear in mind if you pay 40% tax on, say, £20,000 pa (ie you're earning about £60K) you can only get 40% tax relief on pension contributions of £20,000 in any one year.

So if you have built up £100,000 in your ISA it will take you 5 years to switch it into a pension plan and get 40% tax relief. And that assumes you are not already contributing to another pension scheme (eg an employer's pension scheme) - which you probably are.

So, will take some planning. Remember too that once money is in a pension plan you can't get it out whereas with an ISA you can get it out at any time (which may be an advantage or a disadvantage depending upon how sensible you are!)

HarryD

Pension vs ISA. Another factor is capital growth in the ISA after you retire. Your pension will be a fixed income plus RPI indexation (if you're lucky). If you live for 30 years the purchasing power of your pension will be significantly reduced in the later years.

The initial income from a given amount of money in an ISA will be less than the same amount of money in a pension.

But stock markets tend to grow faster than the RPI. An ISA invested in the stock market (say via an index tracking unit trust) should produce an income that increases faster than the RPI (but there's no guarantee it will, indeed the income could go down.)

If your pension is not index linked, high inflation can very quickly erode its real value. An ISA invested in the stock market will tend to maintain its real value, though there is no guarantee of this.

Remember too that you have to pay tax on pension income but there is no higher rate tax on income drawn from an ISA. This is a huge benefit for 40% tax payers (but how many pensioners are?!)

So does all this mean ISAs or Pensions are better? I reckon it's impossible to say. It depends on the security of your pension provider, whether you have full index linking, the rate of inflation, what your ISA is invested in, future stock market performance, changes to the tax position of ISAs and Pensions, etc etc etc.

Personally I would have both: a pension for security of income (one hopes) and an ISA (one hopes, again) for capital growth and therefore income growth.

jamesd

Pensions aren't limited to RPI indexation, only conventional annuities that are one of the things you can do with teh pension money when you retire. Pension money can stay fully invested until your death via income drawdown until you're 75 then an alternatively secured pension until death. Or you could use one of the alternative annuities that are being introduced that retain some investment component.

dunstonh

Pension vs ISA. Another factor is capital growth in the ISA after you retire. Your pension will be a fixed income plus RPI indexation (if you're lucky). If you live for 30 years the purchasing power of your pension will be significantly reduced in the later years.

Only if you buy an annuity. If you do income drawdown on the pension then it remains invested.

Remember too that you have to pay tax on pension income but there is no higher rate tax on income drawn from an ISA. This is a huge benefit for 40% tax payers (but how many pensioners are?!)

That is true. However, even if you pay basic rate tax, the pension income (assuming annuity or drawdown) would be higher than the ISA after tax.

Personally I would have both: a pension for security of income (one hopes) and an ISA (one hopes, again) for capital growth and therefore income growth.

Yes. That is usually the best option.

EdInvestor

In many ways the debate is really about the order in which you accumulate the pension and the ISA .

In the old days pension contributions were tax relieved on an annual basis so they were use it or lose it.Now, you can put large lump sums into pensions at any time, giving the opportunity of using HRT status rather than BRT.

It thus may pay younger investors on BRT with no employers contribution to save in the ISA format (which is now the 'use it or lose it' wrapper) with a view to transferring some of the accumulated savings into a pension later when they are on HRT.

HarryD

Another factor is capital growth in the ISA after you retire. Your pension will be a fixed income plus RPI indexation (if you're lucky). If you live for 30 years the purchasing power of your pension will be significantly reduced in the later years.

dunstonh wrote: »

Only if you buy an annuity. If you do income drawdown on the pension then it remains invested.

Do all pension plans have a drawdown option? I have a stakeholder pension to which I am contributing. It's invested in a unit trust. I had assumed I would need to buy an annuity with it eventually but pension drawdown sounds interesting. Can you suggest a good source of info about pension drawdown?

Also, as I understand it, when you start to draw a stakeholder pension, 25% of it can be withdrawn in cash with no tax penalty. This seems like a good idea particularly as you can invest £3,600 gross in another stakeholder pension and get tax relief on this contribution, even if you are retired and have no "earned" income. Have I got this right?

HarryD

jamesd wrote: »

Pensions aren't limited to RPI indexation, only conventional annuities that are one of the things you can do with teh pension money when you retire. Pension money can stay fully invested until your death via income drawdown until you're 75 then an alternatively secured pension until death. Or you could use one of the alternative annuities that are being introduced that retain some investment component.

James, that is most interesting, thank you. Could you direct me to a source of information about annuities that retain some investment component? That sounds very attractive in an era of low traditional annuity rates.

dunstonh

Do all pension plans have a drawdown option?

Yes and no. All pensions have the option to be transferred into a personal pension, SIPP or drawdown plan. However, pensions themselves dont have to offer the actual option of drawdown.

I have a stakeholder pension to which I am contributing. It's invested in a unit trust.

Its unlikely it is invested in a unit trust. I cannot think of any stakeholder that does that. Unit trusts tend to be only available on a small number of personal pensions (typically fund supermarket versions) and SIPPs. I am going to guess you mean unit linked pension funds. Similar principle behind them but different sort of range. It sounds like you have just one fund though and thats not encourging. Especially if you were to consider drawdown. You would need to improve your investment knowledge before then or use someone that can.

If you did stick with the stakeholder until retirement and then wanted to do drawdown then you transfer the stakeholder at that time. Or you can move into a pension that allows that option now.

Can you suggest a good source of info about pension drawdown?

Google should get you enough basics. It went through a name change not too long ago and is often called unsecured pension now. However, it's old name of income drawdown is still popular.

Also, as I understand it, when you start to draw a stakeholder pension, 25% of it can be withdrawn in cash with no tax penalty. This seems like a good idea particularly as you can invest £3,600 gross in another stakeholder pension and get tax relief on this contribution, even if you are retired and have no "earned" income. Have I got this right?

Correct.

EdInvestor

HarryD wrote: »

Can you suggest a good source of info about pension drawdown?

The specialist retirement IFAs probably have the best info:

https://www.williamburrows.co.uk
https://www.annuitybureau.co.uk
https://www.annuitydirect.co.uk

HarryD

dunstonh wrote: »

Its unlikely it is invested in a unit trust. I cannot think of any stakeholder that does that. Unit trusts tend to be only available on a small number of personal pensions (typically fund supermarket versions) and SIPPs. I am going to guess you mean unit linked pension funds. Similar principle behind them but different sort of range. It sounds like you have just one fund though and thats not encourging. Especially if you were to consider drawdown. You would need to improve your investment knowledge before then or use someone that can.

It is a Stakeholder Pension (just checked the paperwork) with Legal & General invested in their UK Index Tracker Unit Trust. I have other funds. Thank you for the info on income drawdown, sounds just right for me.

Your comment about needing more investment knowledge is a telling one: I'm no expert but have more knowledge than most. For the average person working out if pension or ISA is best is impractically difficult and few are organised enough to save in one then switch to another etc however good the advice.

I have a friend who couldn't decide if pension or ISA was best and as a result did neither.

Which is why if anyone asks me if they should save in pension or ISA I say "yes". Put some in each - advice anyone can grasp!

Right, off to research income drawdown. Thanks again.