ISAs v Pensions: The Official Retirement Debate

htkm18

I have read the majority of the postings on here and I must admit had not even thought of an ISA to save for my retirement! I also did not realise that I would be taxed on a private pension income. (I have only just starting looking into pensions)
I recently did my online estimate for when I would recieve my state pension, providing there still is one, and it scared me! I am turning 28 soon and already have a company pension but do not wish to solely rely on this. I have seen sites that will tell you that this alone will be enough. I have been putting 50 pounds into Premium bonds monthly for some time now. I am now wondering what to do about a private pension? Do I save in an ISA and at the end of the year stash it in my premium bonds? I realise this will eventually have a limit. Or do I save privately....if so where?? I cant afford 14 percent of my salary just yet as I already contribute to the company pension. I looked into Virgin, recommended by a friend, but the whole tax issue has really thrown me now! Help please!
Thank You!

jem16

Zebra wrote: »

I appreciate that this quote is going back abit (Feb 2007 to be exact) but is it still relevant and how do you transfer investments into a pension in this way?

You can put a lump sum into your pension any time you want. However it will only attract tax relief at the appropriate rate.

For example if you were £5k into the higher rate tax band and put in a lump sum of £10k, only £5k of it would attract the 40% tax relief - the other £5k would attract 20% tax relief.

jem16

htkm18 wrote: »

I have been putting 50 pounds into Premium bonds monthly for some time now.

Premium bonds are not really investing - they are more like gambling. Basically you are gambling on winning a big prize as you are likely to earn more in a normal savings account.

I am now wondering what to do about a private pension? Do I save in an ISA and at the end of the year stash it in my premium bonds?

That would be a waste of a good ISA.

I looked into Virgin, recommended by a friend, but the whole tax issue has really thrown me now! Help please!
Thank You!

Are you referring to a Virgin pension? It's about the worst pension around.

If you wish to save for retirement, other than in your company pension, use a S&S ISA.

Zebra

jem16 wrote: »

You can put a lump sum into your pension any time you want. However it will only attract tax relief at the appropriate rate.

For example if you were £5k into the higher rate tax band and put in a lump sum of £10k, only £5k of it would attract the 40% tax relief - the other £5k would attract 20% tax relief.

So rather than "transfering" the investments as such, it's more a case of selling the investments and investing the proceeds in the pension fund?

jem16

Zebra wrote: »

So rather than "transfering" the investments as such, it's more a case of selling the investments and investing the proceeds in the pension fund?

Yes it is.

wayoflife

Being sceptical, an ISA looks like the better option if you have more than 10 years until retirement, as by the time you retire Im sure there will be higher taxes and if you have the money tied up in an ISA, at least you have already paid the tax (at the old rate)

LongTermLurker

wayoflife wrote: »

Being sceptical, an ISA looks like the better option if you have more than 10 years until retirement, as by the time you retire Im sure there will be higher taxes and if you have the money tied up in an ISA, at least you have already paid the tax (at the old rate)

But it's not that clear cut - e.g. your pension contributions are tax free and you can take 25% of the combined capital and growth tax free. For any high rate tax payers, a pension is almost a no-brainer, especially if your company doubles your contributions - or offers Salary Sacrifice.

I don't think one is necessarily better than the other, but if you have both you can make tax free contributions (pension), totally free contributions (employer's pension contributions), a lump sum tax free income (pension), a chunk of your regular retirement income tax free (ISA) - and that means you need less "taxed" income (pension), which means you may not actually pay income tax in retirement at all!!

dunstonh

Being sceptical, an ISA looks like the better option if you have more than 10 years until retirement, as by the time you retire Im sure there will be higher taxes and if you have the money tied up in an ISA, at least you have already paid the tax (at the old rate)

To play devils advocate and counter that, the tax relief could be lower in future and ISA contributions cannot increase your working/childrens tax credits but pension contributions can. A lot of people look at the ISA vs pension figures based on tax alone but tax credits need to be considered as well. Those tax credits are unlikely to be at his level in the future.

LongTermLurker

htkm18 wrote: »

I cant afford 14 percent of my salary just yet as I already contribute to the company pension.

I don't know what site you saw, but when they say you should contribute x% of your income, that is the combined gross contribution - take off your 20% or 40% tax relief, your existing gross contribution and those of your employer - if you earned £20000 and your employer matches 5%, that's immediately a 10% contribution that costs you just over £66 pm - to get the full 14% would cost you another £53.

The end result is £2800 invested per year, but it's only cost you £1440, meaning you get £1360 free. If you assumed zero growth and 20% income tax when you retired, you could take £700 tax free and pay £420 tax on the remainder, meaning your £1440 has turned into £2380 after tax without even growing - all you have to worry about then is inflation.

Note that isn't supposed to mean anything specific, but it shows how much can be gained from a small personal contribution..

jamesd

Below are some posts from a pension discussion that seem better in this discussion because they are of general interest.

---

Lets take a more realistic example, one I've fully worked and which pays the same net amount of money into pension and ISA. Send me a PM with an email address if you want me to mail you the spreadsheet.

Basic rate working and in retirement, monthly contributions of 300 increasing with inflation of 3%, growth 7% before inflation, after fees. £7,000 of state pensions, £10,000 personal allowance. Pension lump sum taken and invested in ISA (for simplicity assumed done in one year). 5% of capital available as income (drawdown in both cases). Here's how the two options compare for different numbers of investing years:

10 yrs pen  9609	ISA 9087
15 yrs pen 11286	ISA 10469
20 yrs pen 13063	ISA 12141
25 yrs pen 15213	ISA 14165
30 yrs pen 17813	ISA 16613
35 yrs pen 20960	ISA 19574
40 yrs pen 24767	ISA 23157

Clear enough: the after tax income from the pension is higher than from the ISA if you're putting the same amount of after tax income into each.

More detailed version:

10 yrs taxable pen  8956 net+lump income  9609 lump sum is 13043	ISA income is	9087	lump sum	41737
15 yrs taxable pen 10252 net+lump income 11286 lump sum is 21682	ISA income is	10469	lump sum	69383
20 yrs taxable pen 11820 net+lump income 13063 lump sum is 32134	ISA income is	12141	lump sum	102830
25 yrs taxable pen 13717 net+lump income 15213 lump sum is 44780	ISA income is	14165	lump sum	143295
30 yrs taxable pen 16012 net+lump income 17813 lump sum is 60079	ISA income is	16613	lump sum	192253
35 yrs taxable pen 18788 net+lump income 20960 lump sum is 78589	ISA income is	19574	lump sum	251485
40 yrs taxable pen 22148 net+lump income 24767 lump sum is 100983	ISA income is	23157	lump sum	323147

taxable pen: the taxable pension income from the 75% not taken as lump sum and the state pensions.
net+lump income: after tax pension income + ISA income from investing the lump sum. The full after tax income from the pension route.
lump sum is: the pension lump sum that is taken and invested in an ISA.
ISA income is: the ISA income plus the state pensions. The full after tax income from the ISA route.
lump sum: the ISA lump sum from which income is being taken.

---

For the pension the lump sum can be moved into an ISA. That substitutes some tax free income instead of leaving it all taxable. Since that lump sum is one of the big gains of the pension when tax rates are the same it's really necessary to handle it in the calculation.

1. Pension is: ISA from the lump sum, taxable state pensions and taxable 75% pension pot. ISA is: ISA pot, taxable state pensions (but no tax to pay because below allowance). All taxable income has had the right amount of tax deducted to get comparable after tax figures for pension and ISA.

2. The figures stop before the personal allowance reduction starts, so no. The pension lump sum being taken keeps the pension taxable income below it.

Any money that you put into ISA before pension makes you worse off in income terms before age allowance reduction starts.

Where you can gain from the ISA contributions is if you want to retire early. Then you can draw down 100% of the ISA capital to produce a higher income until the state pensions start. See this early retirement example which illustrates how the ISA part lets you take a higher income before state pensions. The ISA money lowers income longer term but its the way to go to boost income for the few years until the state pensions start.