ISAs v Pensions: The Official Retirement Debate

mitchaa

toptrumps wrote: »

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 am new to this so apologies, but what is pension tax contribution?

If say I pay in £200pm gross from my salary then surely it's £200 into my pot and that is it? I am already saving on tax into my pension pot due to the fact that the £200 is taken off as gross rather than net so although I am paying £200 in, im actually only paying £160 or so (In take home value) to do so.

Are you saying that my £160 take home contribution (£200 Gross) is actually £250 into my pot?

How does that work? I feel im getting a little confused now:rotfl:I've not even mentioned company matching contributions.

Paul_Herring

mitchaa wrote: »

I am new to this so apologies, but what is pension tax contribution?

If say I pay in £200pm gross from my salary then surely it's £200 into my pot and that is it?

Indeed. If you make your contribution before tax is taken off.

However most people with personal pensions make the contribution after tax has been taken off (from net pay.)

The 'tax contribution' is a refund of the income tax paid on the sum put into the pension.

I am already saving on tax into my pension pot due to the fact that the £200 is taken off as gross rather than net so although I am paying £200 in, im actually only paying £160 or so (In take home value) to do so.

Are you saying that my £160 take home contribution (£200 Gross) is actually £250 into my pot?

Nope. You don't get the tax rebate, because you haven't paid the tax to begin with.

mitchaa

Paul_Herring wrote: »

Indeed. If you make your contribution before tax is taken off.

However most people with personal pensions make the contribution after tax has been taken off (from net pay.)

The 'tax contribution' is a refund of the income tax paid on the sum put into the pension.

Nope. You don't get the tax rebate, because you haven't paid the tax to begin with.

Got you, thanks.

Is it the norm that employers match employees contributions so for every £200 an employee puts into the pot, the employer does the same?

I was in a FSP but the penny pinching management have just scrapped it. Im now being offered a 6% money purchase scheme with matching contribution from management.

Although not as good as the FSP scheme, it's free money afterall so would be silly not taking advantage of it.

dunstonh

Is it the norm that employers match employees contributions so for every £200 an employee puts into the pot, the employer does the same?

At the moment there is no norm. Some pay nothing. Some pay 10-20%.

I was in a FSP but the penny pinching management have just scrapped it. Im now being offered a 6% money purchase scheme with matching contribution from management.

Correct. 6% is actually quite low for a company that has closed their final salary scheme. You tend to find in those cases the employer contribution is in double digits. However, 6% is higher than the Govt set minimum that will apply in a few years time.

jamesd

Jonbvn wrote: »

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?

As dunstonh wrote, it's because some of the pension money won't be taxed on the way out: the 25% tax free lump sum and the part covered by the personal allowance. I've posted a comparison of the after tax income from ISA and pension contributions assuming identical contributions, investments, fees and income drawdown (not annuity purchase) for both.

The pension gains more if salary sacrifice or higher rate tax are involved when contributing. There's already no requirement to buy an annuity for the pension option, even from age 75, though the deal now for inheritance of that pot beyond age 75 isn't very good, as it's designed not to be to prevent it from being used to retain a lump sum for inheritance planning. The ISA option is better for inheritance planning after taking the pension, worse before.

stphnstevey

Just my mind wandering - if you could control how much of your income you took as salary and were close but below the upper tax threshold, wud it then be more tax efficient to take salary that took you over the upper tax threshold just so you could make personal pension contributions and receive 40% tax relief as opposed to the 20%?

For me, I have been putting all spare cash into a Stocks and Shares ISA and pensions. I estimated the return to be around 12% (before the recession started), but over the past 3yrs I have been doing it, only seen a 2% return - worst than a savings account.

Now guess I have to think what return I might see this year and decide if the money is better off paying off the mortgage?

jamesd

Your choice: 80% into the pension and 20% tax relief, total 100% or 60% into the pension and 40% tax relief, total 100%. There's no gain because you're just changing the mixture between after tax contribution and tax relief, not the net reduction in money that you keep.

A one year time horizon is too short. We're fairly early in what may be a growth part of an economic cycle over a period of five years or so and what will matter for investments is performance through the whole period.

stphnstevey

jamesd wrote: »

Your choice: 80% into the pension and 20% tax relief, total 100% or 60% into the pension and 40% tax relief, total 100%. There's no gain because you're just changing the mixture between after tax contribution and tax relief, not the net reduction in money that you keep.

A one year time horizon is too short. We're fairly early in what may be a growth part of an economic cycle over a period of five years or so and what will matter for investments is performance through the whole period.

Thanks - What were you doing up at 4.30am!

Your right about the longterm perspective - just hard when I started S&S ISA in 2007 and haven't had that much return to date. But the last few years have been bleak for everything and compared to property for example, the returns haven't been that bad.

mradamsmith

I popped my details in to a calculator which I found called 'get a reality check'. Type it into google - it tells you exacly how much you need to put away each month and then how much you'll have when you're 65!

dunstonh

mradamsmith wrote: »

I popped my details in to a calculator which I found called 'get a reality check'. Type it into google - it tells you exacly how much you need to put away each month and then how much you'll have when you're 65!

Problem is that it cant actually do that. It can use assumptions to give you an indication but you need to make sure the assumptions are appropriate for you.

For example, someone that is using a cautious or even a mostly cash based investment shouldnt use the industry standard 7% projected growth figure, let alone the 9% one.

And at the end of the day, it will depend on how the investments perform as you will never get one that gives you x% a year every year without change. So, it will always be an estimate and a guide that you need to review periodically to make sure you are still paying the right amount and still investing the best way for you.