ISAs v Pensions: The Official Retirement Debate

Paul_Herring

jamesd wrote: »

You need to take that annuity orange out of the basket. There's no need to buy one with a pension and you're artificially hurting whatever option you select if you make the money be used to buy an annuity.

Sorry, I thought I'd covered that with my parenthetical comment about drawdown and ASPs. Looks like I didn't.

But thanks for taking the metaphor and running with it

LongTermLurker

parenthetical? That has to be worth a prize, whether it's a real word or not :T

zygurat789

LongTermLurker wrote: »

parenthetical? That has to be worth a prize, whether it's a real word or not :T

I thought it was parenthesised

EdInvestor

jamesd wrote: »

You don't lose the capital with a pension. The pension pot can be inherited, after a tax charge if you've started to take benefits.

Under current rules only 18% ofcapital will be left after tax for anyone over 75.

Paul_Herring

zygurat789 wrote: »

I thought it was parenthesised

http://www.thefreedictionary.com/parenthetical

toptrumps

I think I may be missing something. Have a look at my example below:

If you're 25 with no savings/pension and want to retire at 55, that's 30 years, or 360 months of saving.

Let's say you decide to save £200 a month (£250 with the pension tax contribution), and the interest over those 360 months is 5% for both the pension and the ISA. You are also a basic rate tax payer.

I've used the calculator at: math.com/students/calculators/source/compound.htm

ISA: After 360 months you end up with £166,451.72
Pension: After 360 months you end up with £208,064.65

Now, assume you don't take the 25% lump sum for the pension, and you don't pay into or withdraw from the ISA.

I've used the calculator at: moneymadeclear.fsa.gov.uk/tools/pension_calculator.html

ISA: You continue to earn 5% interest which is £693.54 per month
Pension: The calculator tells me you'll get £400/month (I assume this is after tax?)

My first question: Where have I gone wrong in my calculation for this huge disparity to occur?

My second question: When you take the pension, I think you get something called an annuity, which no one can inherit when you die. I can't see why people would do this as from my understanding if you had the ISA instead, and were living off the interest, your beneficiaries would receive the capital.

Thanks!

dunstonh

ISA: You continue to earn 5% interest which is £693.54 per month
Pension: The calculator tells me you'll get £400/month (I assume this is after tax?)

My first question: Where have I gone wrong in my calculation for this huge disparity to occur?

I dont know what the calculator is doing but I suspect its only using one annuity type in the illustration. Probably a joint life one and/or with indexation. There is no reason why you couldnt get 5% out on drawdown.

Remember the FSA site isnt going to give you all options. Its going to give a typical option.

My second question: When you take the pension, I think you get something called an annuity, which no one can inherit when you die. I can't see why people would do this as from my understanding if you had the ISA instead, and were living off the interest, your beneficiaries would receive the capital.

You dont have to buy an annuity. That is just one of the options. It is the conventional method for people that dont save enough. Mainly as at say age 65, you can still get 6.5% (or higher) income guaranteed for life. Annuities tend not to be well priced for under 60s.

If you do go down the annuity route you can buy guarantees that will ensure a minimum payout on death. Value protect for example will pay the value minus the amount paid out in income minus tax to the beneficiary. Or you go with income drawdown instead.

jamesd

toptrumps, your calculation is fine, the FSA page is using these assumptions:

Investment growth: Your pension fund will grow by 7% a year until you retire.
Inflation: The Retail Prices Index (RPI) will rise by 2.5% a year until you retire.
Pension fund charges: The company providing your pension will charge 1.5% of your fund for the first 10 years, and 1% thereafter.
Income tax rebates: The Government will add a tax rebate to your contributions at the basic rate (20%), so that every £1 that goes into your fund consists of 80p from you and 20p from the Government.
Lifetime annuity rates: When you retire, your pension fund is used to buy a pension income, called a lifetime annuity. We have estimated what lifetime annuity rates might be when you retire.
Life expectancy: The average age that people are expected to live to.
The Pension Calculator estimates also assume that:
!You keep up regular monthly payments from now until you retire.
!Each year you increase your monthly payments by a minimum of the estimated rate of inflation (2.5%)

In addition your choices about wanting an inflation-linked pension (RPI annuity), pension for your partner or taking the maximum lump sum will all reduce the payment from an annuity. I get a £400 a month pension if I choose the inflation-linked pension for a 25 year old born in 1985 retiring at 55. If you don't choose the index-linked option the level annuity rate you get is £670 a month.

You can buy an annuity with either the ISA or pension pot of money. You don't need to buy an annuity with either if you don't want to. If you choose an annuity for one of them, that one will be disadvantaged by the choice at early retirement ages, possibly advantaged around age 75 and older.

Jonbvn

jamesd wrote: »

The pension is still are expected to deliver around 8% more income than ISA only for identical contribution levels, investments and income generation method.

Why would a pension deliver more income than an ISA if the contributions are the same, given that one is taxed before paying in, and the other taxed when paying out?

BTW, assuming the Cons get in, and remove the requirement to buy an annuity, then the comparison will be much different.

dunstonh

Why would a pension deliver more income than an ISA if the contributions are the same, given that one is taxed before paying in, and the other taxed when paying out?

20% tax relief going in (assuming for this purpose). Means that fund value will be that much higher. 25% can come out tax free (which you can put into ISA to generate a tax free income) with the rest paying a taxable income. However, you have your personal allowance and at 65 that is getting on close to £10k a year. So, some of the pension income will not be taxable.