ISAs v Pensions: The Official Retirement Debate

stefanf

So far there has been conflicting advice for the average earnings 37 yr-old basic rate tax payer that I am, but on the whole the received wisdom is in favour of employers' schemes comapred to ISAs.

I have a dilemma though: I am in a Final Salary type (career averaged)employer's pension scheme which I feel I am right in contributing to. The standard contribution for 1/60ths is 5% from gross earnings. There is an option however for increased accrual rates and the cost for 1/45ths is 9.6%. Ideally I'd like to go for the 1/45ths so that I can build up the maximum two-thirds pension by about 65, but the contribution rate is quite high and will get higher.

Can anyone advise whether it is best to pay the difference in cost of the two accrual rates into ISAs and the like, or should I persist with the 45ths?

mrken30

People should also think about investing in property and if property is too much think about investing in gold coins as this dont have CGT associated with them

dunstonh

mrken30 wrote:

People should also think about investing in property and if property is too much think about investing in gold coins as this dont have CGT associated with them

Property is an asset class and not a tax wrapper. You can invest in property inside an ISA or pension.

Coins are not liquid enough to be suitable for retirement planning generally and it is really a niche area and not something for the average person to even consider.

Happiness71

stefanf wrote:

So far there has been conflicting advice for the average earnings 37 yr-old basic rate tax payer that I am, but on the whole the received wisdom is in favour of employers' schemes comapred to ISAs.

I have a dilemma though: I am in a Final Salary type (career averaged)employer's pension scheme which I feel I am right in contributing to. The standard contribution for 1/60ths is 5% from gross earnings. There is an option however for increased accrual rates and the cost for 1/45ths is 9.6%. Ideally I'd like to go for the 1/45ths so that I can build up the maximum two-thirds pension by about 65, but the contribution rate is quite high and will get higher.

Can anyone advise whether it is best to pay the difference in cost of the two accrual rates into ISAs and the like, or should I persist with the 45ths?

The option of 1/45th seems good to me despite the cost. My final salary scheme shifted us all to earning 1/80th salary per year from 1/60th per year when I started work to save money before they sold us to another company. The final salary pension already accrued was safe however. Thats why I like the idea of 1/45th, get as much of that as you can before they change their minds!!

Neil_Lovatt

Things changed with A-day for pensions. These days it really doesn't make a lot of sense to pay into a pension until you have exhausted all your other tax-free roll-up options; ISA, TESP and investments within your CGT allowance where possible.

The benefit of the fact that ISAs/TESPs and Pensions all roll up at the same rate means that from an overall financial perspective it doesn’t matter if you get tax relief at the beginning or the end of your investment term. However timing of tax-relief does make a huge difference depending on your current tax rate.

As there is effectively no annual limit on contributions (other than your annual salary) with a bit of planning you can invest in a more flexible investment (above) without all the tax downside of income withdrawals that you get with a pension, and then "time" your payments into a pension at a date that suits you.

The big advantage of this is that by doing so you can ensure that you only invest in a pension in those years you are a higher rate taxpayer (thereby maximising your tax-relief or reducing your tax bill) but you can invest in a pension at a date much closer to your retirement which should mean you can work out whether the balance between tax relief going in is worth the tax penalties on income withdrawals which come with a pension.

I’ve put a number of articles together on this post A-day change in pensions and basically now refer to them as the retirement investment of last resort. Personally I think that’s an apt description for pensions in this day and age and would use them as retirement vehicles but for now I’d only use them until I’d exhausted my other options.

stphnstevey

People are trying to compare oranges with apples just because they both come from Tesco's!! Yes, they both have tax advantages, but in as many ways as they are similar, they are very different.

I think the most important difference is that pensions allow you to invest with pre-tax pounds where as ISA's only with post-tax pounds. So for a basic rate tax payer they could receive 22% tax rebate on the entire contribution to a pension. Were as an ISA you receive 22% tax back only on the interest paid on your contribution.

Eg
£100 pension contribution you would need to contribute £78 and receive a £22 tax rebate or for every £78 pounds invested you receive £22 tax break

£78 ISA contribution at say 6% interest you would receive a tax rebate of ((78x6%)x20%=) 93p or for every £78 invested you would receive a 93p tax break

I know in a pension this is tax deffered till when you receive an income, but the point is that the fund starts with considerably more money and that will compound (the power of compound interest!) to a massively larger amount than you could ever achieve with post-tax pounds.

However, as much as I thought I understood pensions and ISA's this has made me wonder one thing - how best to take advantage of my wife's tax allowance either through an ISA or pension. We are both working, but my wife doesn't get an employer's pension - can I contribute to a pension for her?

nobodieshero

My current plan, as a 22% tax payer with prospects, is to save an ISA till such a time I become a Higher rate tax payer. Under the current rules I can then contribute my equivalent entire salary upto the annual allowance, as I understand it and get 40% relief on this. I realise that potentially I am losing growth on 22% of the original however feel more confident in this overall, I am Mid 20's. What are peoples opinions on this?

Mortgage_&_debt_free

dunstonh wrote:

And the Govt can wipe out the tax free status of ISAs overnight if they wanted.



Andy says it well in his response.

You are willing to throw all that free money away for a guaranteed pension that you mistakenly believe will be beaten by tracker funds which rarely if ever go above sector average performance?

Unless you are paying around 15%-20% of your income into these trackers, you wont come close to what the occ scheme would give you.

The LGPS allows you to take 25% tax free of the entire pension (final pension x 20 + 3/80ths lump sum + AVC). Paying into AVCs adds to this total and so increases the tax free lump sum.

I am 42 and paying in 18% of my salary to an AVC. I have constructed a spreadsheet that shows if I maintain this payment in line with inflation/wages, and working on the AVC averaging 5%p.a. growth, I stand to gain a tax free lump sum of around £213,000 + another £73,000 to purchase extra LGPS pension on top of my FS Scheme. To put it in perpective I estimate the lump sum to be just under 6 yrs gross salary tax free, plus a pension of 50% of my final salary + an additional pension bought from the AVC surplus (you can "only" take out up to 100% of the AVC as tax free cash).

I would suggest your kids may be quite happy with a slice of this, in fact don't tell them or you may find the odd rollerskate placed at the top of the stairs.

Yes, legislation may change, but it's a risk that I am very happy to take considering the potential of the investment. In almost all cases government backed pension reforms are not applied retrospectively so you are still likely to be able to get the benefit credited up to when the rules change.

Choosing not to pay into LGPS AVCs requires careful consideration due to the potential benefits.

Choosing not to pay into the LGPS Final Salary Scheme requires (please don't take this personally) a lobotomy.

Madiba_2

I am doing both S&S ISA and Stakeholder Pension scheme through work.

I have 3% of my salary contributed to my pension by my employer, rising to 5% when I turn 26 later this year. Currently its all in a Cautiously managed fund, however I am looking to get it spread across multiple funds this year.

I put £8k into S&S ISAs through HargreavesLandsdown each tax year (£4k in mine, £4k in my wife's) but this gets spread across loads of different things, UK equity, South American funds, China, Japan, Eastern Europe.

I want to invest in some property funds at some point too.

I think if you have the stakeholder option, its good to take.

Judwin

nobodieshero wrote:

My current plan, as a 22% tax payer with prospects, is to save an ISA till such a time I become a Higher rate tax payer. Under the current rules I can then contribute my equivalent entire salary upto the annual allowance, as I understand it and get 40% relief on this. I realise that potentially I am losing growth on 22% of the original however feel more confident in this overall, I am Mid 20's. What are peoples opinions on this?

Not quite correct. You only get 40% relief on contributions paid from the 40% tax portion of your income. Everything else gets relief at 22%.

Say in the first year you get into the 40% tax bracket you earn £40,000. You're single, and don't get any Dividends and other interst. You tax bill would be :

Personal allowance £5035 @ 0% = £0
Lower band £2150 @10% = £215
Middle band £31150 @ 22% = £6853
Upper band £1665 @40% = £666

So on £40,000 Gross you'd pay £7734 tax, and something like £2600 in NI, giving you a take home pay of £29666.

If you wrote a cheque out for £29666, and gave it to your pension provider, the government would make this up to £38033 (+22%). What then happens is the tax office extend the middle tax band (@22%) from £31150 by the gross amount of your pension payments. So your tax bill would change to :

Personal allowance £5035 @ 0% = £0
Lower band £2150 @10% = £215
Middle band £32815 @ 22% = £7219
Upper band £0 @40% = £0

So your tax bill would drop by approx £514 - or more likely if you're on PAYE you'd be refunded £514 as a result of your tax return.

Or put another way, if you're paying from post tax-post NI money to reclaim the 40% tax, there is no point in writing a cheque out for more than £1665 Gross (£1298 Nett@22%) on a 40kp/a income. If your wages go up to £50Kp/a, then a one off £11665 Gross (£9098 Nett@22%) payment into the pension fund will negate all your 40% tax liability.

It's not true that if you earn £1 into the 40% tax bracket that the government will refund all your pension payments at 40%. That's what the man from the Pru told me when I took out my personal pension, and he was wrong then, and he would still be wrong now.

:beer:
Judwin