ISAs v Pensions: The Official Retirement Debate

jamesd

I don't know but doubt it because the pension scheme rules are generally written to pretend that there are no other assets, to protect the tax relief within the pension.

I'd certainly like to be able to take a higher income from a drawdown pension between any particular age (not just 55, earlier) and state retirement age to compensate for the eventual availability of the state pension income. It'd increase the sensible amount of use I could make of a pension.

fairleads

jamesd wrote: »

One effect of the change to the GAD limit is to make it particularly rewarding to start taking pension benefits as soon as you reach 55, so you can accumulate a lump sum to make up for the lower GAD income level. That also offers to option to recycle the pension income to get more tax relief and another tax free lump sum, potentially significantly increasing he benefit of a pension compared to an ISA.

Only some one who has a vested interest in the financial services industry would label a 40 % drop in annuity/GAD limited income as 'change'.

aw4428

I may be wrong in my calculations, but I'm looking to retire in 35 years time and am currently a basic rate tax payer. If I expect to be a higher rate income tax payer in the next 25 years, doesn't it make more sense to save in an ISA or outside and then cash-in and enter as a lump sum into a pension when I'm a higher rate tax payer to get 40% tax relief on it?

jamesd

As a higher rate tax payer you only get higher rate tax relief on the money that you'd pay higher rate tax on. So you probably couldn't transfer all of the money as a lump sum and get 40% tax relief on it all in a single year. Other than that, you're right that there is benefit to waiting for higher rate tax relief.

As a basic rate tax payer you could check whether you have an employer who operates a salary sacrifice scheme for pension contributions. That would get you 20% income tax plus 12% national insurance saving, for a total of 32%. Some employers will also share part of their 13.8%, often half of it, which would take you to 38.9% tax and NI saving. That's easily sufficient incentive to make the pension better than the ISA, provided you can live with the restrictions in the pension.

Do remember that the ISA money is subject to benefit means tests, so until you can get to a point where you could sustain yourself from your investments it's more vulnerable than money in a pension pot to long term inability to work.

Some years back I spent many tens of thousands in accumulated savings while not working but not generating enough income from them to live on. That provided the incentive that caused me to commit myself to rapidly getting to my current situation where I do now have enough capital to have a high chance of being able to sustain myself indefinitely.

fairleads

jamesd wrote: »

Do remember that the ISA money is subject to benefit means tests, so until you can get to a point where you could sustain yourself from your investments it's more vulnerable than money in a pension pot to long term inability to work.

Whereas the isa saver who,temporarily, falls on hard times can use their discretionary savings to maintain their credit rating (and self esteem) and standard of living with out applying for benefits. And if, by living to a ripe old age, they use up their retirement savings, they have the protection of the benefit cushion to fall back on.

jamesd

For convenience here's a table of illustrative GAD limits for drawdown pension income.

The limit is recalculated every three years and things will hopefully be normal in three years. A recalculation can also be done when more drawdown money is added to a pension pot and that's a trick that can be used to get updated limits if things have improved a year or two years from now. You can see the effect using this GAD limit calculator. There's also one from Prudential in spreadsheet form that includes a table of past gilt yields so you can experiment with the varying rates to see the effect.

For some examples here's how £1,000 in a pension pot would have its income cap set for a man at various gilt yields and ages:

3.5% 55:£51 57:£53 58:£54 60:£56 65:£63 70:£72 75:£87 80:£111 85+:£150
4.0% 55:£55 57:£56 58:£57 60:£59 65:£66 70:£75 75:£90 80:£115 85+:£154
4.5% 55:£58 57:£60 58:£61 60:£63 65:£70 70:£79 75:£93 80:£118 85+:£158
5.0% 55:£62 57:£63 58:£64 60:£66 65:£73 70:£82 75:£97 80:£122 85+:£161

4.5% is a pretty typical gilt yield over the last twelve years but it's currently 3.5%. On the 4.5 line the 65:£70 entry means that at a 4.5% gilt yield a man would be able to take up to £70 income a year per £1000 in the pension pot.

And an old post from many pages back that compares pension and ISA income, without regulating the pension income according to the GAD limit, which needs to be done using the limit at the time the income is to be taken.

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Lets take a more realistic example, one I've fully worked and which pays the same net amount of money into pension and ISA.

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.

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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.

Income assumption is 5% for both pension and ISA, drawdown used for both. For convenience I've assumed that the whole pension lump sum can be placed in an ISA at commencement; really phased drawdown or several years would be needed for the larger amounts.

doshwatcher

One advantage of an ISA, is that you can get your hands on it before age 55.
One disadvantage of an ISA, is that you can get your hands on it before age 55.

Assuming charges are identical (which they can be), the Pension has the edge over the ISA tax wise, even if you are only a Basic Rate tax payer.

To invest £100 into an ISA, you need to earn £125 before basic rate tax.
To invest £100 into an Pension, you need to earn £100 before basic rate tax.

Sometime between 1 October 2012 and Oct 2016, you won't have such an easy choice between a Pension or an ISA, because your employer will be obliged to automatically enrol you in a new Government sponsored scheme call "NEST", where you will invest 4% of your income into a private pension plan (see nestpensions.org.uk ).

Paul_Herring

doshwatcher wrote: »

Sometime between 1 October 2012 and Oct 2016, you won't have such an easy choice between a Pension or an ISA, because your employer will be obliged to automatically enrol you in a new Government sponsored scheme call "NEST", where you will invest 4% of your income into a private pension plan (see nestpensions.org.uk ).

Wrong.

1) They are obliged to offer at least that, and
2) you are entirely at liberty to opt out of it.

NEST is only 'compulsory' in the sense that employers must offer some pension provision, and employees will be enrolled unless they decide otherwise.

cagney123

i am in a slight dilemma and hoping that some of you guys can point me in the right direction.
I have a private pension plan with legal and general,i have been in this plan since 1989,and my selected retirement age was 60,i am now 54.

My monthly payment is £133,with gross contribution £166,so the most extra money that i am going to put into the plan is £9576.

On my last statement the buying power of my projected pension is £1590
per year which is rubbish.

My dilemma is this,i am due to inherit my father's house at some point in the future and my plan is to buy out my brothers share and rent the house out for my retirement,should i freeze my pension plan and keep paying the same money into an isa to put towards the cost of the house,because it seems that the pension fund just isn't rising enough to give me a decent pension,after all these years of paying into it.

Thank you in advance David.

Paul_Herring

cagney123 wrote: »

On my last statement the buying power of my projected pension is £1590 per year which is rubbish.

Making a pot of around £30,000? Sounds about right given your current level of contributions.

My dilemma is this,i am due to inherit my father's house at some point in the future and my plan is to buy out my brothers share and rent the house out for my retirement,should i freeze my pension plan and keep paying the same money into an isa to put towards the cost of the house,

Do you have any other savings at the moment? Any debts? (Mortgage, credit cards, any debt your're carrying over from month to month.)

Any other forms of income when you retire?

because it seems that the pension fund just isn't rising enough to give me a decent pension,after all these years of paying into it.

I'm guessing you haven't been increasing your contributions (enough) each year.

Unless your gross wage is currently less than around £20K/yr, £166 seems an awfully small amount for someone who's been contributing for more than 20 years, thus the small value of the annuity.