ISAs v Pensions: The Official Retirement Debate

david78

I am sure. HR tax payers only get 40% relief on the slice of income they pay 40% tax on. This is why it is usually better not pay massive amounts in one year, then nothing the next, you need to "nibble" away at the 40% tax.

For those still pondering the equivalence of the tax treatment of pensions and ISAs, I like to following bit of maths. Take investment A made at 5% growth in 4 years. Assume a basic rate tax payer at the start and in retirement, and a draw-down or income of 5%. Income is:

pension: A X 0.78 X 1.05 X 1.05 X 1.05 X 1.05 X 0.05
ISA: A X 1.05 X 1.05 X 1.05 X 1.05 X 0.05 X 0.78 (the same)

EdInvestor

This post is basically just an expansion of the "use a pension for the first 10,000 per person of retirement income" general rule.

To determine what this means for you, first check your likely income from the 2 state pensions, which for many people will already be making up at least half the 10k. (Note that state pensions are taxable).

Make sure any credits for home responsibilities are recorded and any missing years paid up ( because the state pension is a bargain not to be missed*):

https://www.thepensionservice.co.uk

Deduct the state pension total from 10k.Let's say the remainder is 3k.

How much would you need in your pension to get an income of 3k per year?

This depends on the annuity rate at the time, which depends on whether you are male or female, your age at retirement, whether you want to allow for a spouse's pension, or having the annuity index-linked, and the state of the gilt market, on which annuity rates are based.

The Annuity Bureau has a table of current rates, level and RPI linked.

The cost of inflation indexing almost doubles the price of the annuity - one reason why the state pension is such a bargain.So if you want an index-linked 3k pension, you'll need to save around 100k.If a level annuity will do, expect to save more like 50-60k.

100 pounds a month (which actually means 78 because of the tax relief) over 20 years @7% growth net of charges will get you 51k: double it to 156 pounds for a fund of around 103k.

Don't forget to increase the contribution annually by 3-4% to cover inflation, otherwise you'll be short at the end.

*Note that the minimum number of years for the basic state pension will soon fall to 30 for those retiring after 2010.

tyllwyd

I'm a bit confused about the meaning of the £10K retirement income. I'm 40 now, so I'm not planning to retire for another 25 years. When I look ahead to see what income I need in 2032, do I still use the £10K figure (assuming the legislation hasn't changed, of course) or should I allow for inflation?

Another question ... I've got about £20,000 in my pension at the moment from previous employment, and about £1000 in savings, which are currently in a cash ISA but which I'd like to invest as part of my retirement savings. (I'm working self-employed but very part time so I don't have much cash to add to it at the moment.) My pension is invested in a range of funds, but I'm worried that if I put my £1000 into a S&S ISA rather than the pension, I will only be able to afford to invest in one fund, which seems to go against the opinions on this board. In that situation, does that tip the balance towards putting it with the rest of the money in the pension?

Paul_Herring

I'm a bit confused about the meaning of the £10K retirement income. I'm 40 now, so I'm not planning to retire for another 25 years. When I look ahead to see what income I need in 2032, do I still use the £10K figure (assuming the legislation hasn't changed, of course) or should I allow for inflation?

You allow for inflation. And any changes in the tax situation.

The £10K figure is, I believe, derived from the (0%) Personal allowance for 65-74 + 10% starting rate band which for 2006/7 is £7280+£2150.

What you believe the Government will do to these numbers by the time you retire will naturally affect how you sort your pension income out.

dunstonh

I'm a bit confused about the meaning of the £10K retirement income. I'm 40 now, so I'm not planning to retire for another 25 years. When I look ahead to see what income I need in 2032, do I still use the £10K figure (assuming the legislation hasn't changed, of course) or should I allow for inflation?

Its £7280 personal allowance and £2150 10% band this year. Next year and every year this increases. Usually not far off inflation. So, if you aim to £10,000 in real terms (inflation adjusted) then you should be fine. Then you keep an eye on it. Where you have a spouse/partner, they should be doing the same. Even if you are a higher rate taxpayer and they are not (or vice versa).

My pension is invested in a range of funds, but I'm worried that if I put my £1000 into a S&S ISA rather than the pension, I will only be able to afford to invest in one fund, which seems to go against the opinions on this board.

Pensions do certainly have more flexibility on that front. However, £1000 allows you two funds in an ISA. There is little you can do about that so pick a fund that matches your risk profile and just keep an eye on it.

RRatchet

Hi

I have read all the threads on this topic and I am still very confused, without some serious study I'm not sure that I will ever get it. The number crunching that is.

However I do feel that for many people on a low income that saving for retirement via a pension is counter productive. Yes I believe in theory that saving for retirement is very important as you could find yourself very very poor in retirement if you don't. However you can only save if you have got spare cash to do so. I am not working and my husband is on £19,000 gross, we obivously qualify for child tax credit and child benefit which help greatly. However we spend all that on just living and saving towards building/buying a house for our family to live in. At present we live in a one bedroomed hovel with 3 kids under 6 and no. 4 is due soon (the last I may add). Already we don't take holidays so there isn't the scope to use the holiday money for putting into a retirement fund. My husband is 48, I am 39, so even if we cut back severely on our spending (making ourselves miserable now) we wouldn't be able to save enough to ensure that we weren't miserable in retirement. My husband (a farmworker) will never "retire" unless he is incapable of working. I will return to work when the kids are all at school, however I do not expect that it will be very highly paid as my priority is to see them off to school and welcome them back from school.
I suppose that if I had to choose between a pension and an ISA I would plump for an ISA. My reasoning is that if you had to have access to the money say for eg. a replacement secondhand car or to put a roof over your head then you could, once in a pension it's lost to you until retirement.
The odds are that any money that we could save in a pension would only ammount to what is called a "????", sorry the term escapes me, but it basically means that you take the whole ammount out of the pension and don't have to buy an annuity, because the annuity would ammount to peanuts. Pension credit would also be affected by a very small pension and/or savings

After all that rambling we don't even invest in ISA's as there are much better rates available in ordinary savings accounts especially as I am a non taxpayer and any money saved will be spent very shortly on a house for us to live in.

Once we've got the basics covered then we'll consider retirement provision, it won't be a conventional pension, but whatever is the best scheme ISA's or others available at the time.

For those who know about retirement planning, I and others on low incomes would greatly appreciate advice at what level of income does planing for retirement via a pension or otherwise become a realistic proposition.

Jakaru

Oddly enough I started a thread recently (just before this one was created I think) called 'Do I need a Pension?'. As someone with limited income and a new family (though I have to say, probably in a better position than yourself, so you have my sympathy as I'm finding it difficult enough!), i wanted to know how I should go about putting Something aside as a Pension, as I have little to date.

After a fair few posts here, I ended up with a thread on The Motley Fool ('Pension Planning for the new to investing...?' for those who want to look it up), so that I could get even more advice on the subject.

It's a NIGHTMARE. Every reply from every location brings up new articles, new opinions, new options, clashing opinions on what Is or Isn't good. I've only been able to come up with a few conclusions from it all:

1) It's not the exact amount you can save, its the fact that you Try.

2) As such, if you can get Something put away, do it, in as safe and Profitable way as you Can. Yes, the compound interest difference between 5 and 7% is huge, yada yada, but if you've only got £200 put away, it's not a great concern to you at the moment. Just get that £200 put away, it's all a start. Any interest is better than None.

3) You may be a well off pensioner, you may not be. If you're not a well off Young/Middle-aged person, your chances of being a well off pensioner are low regardless of what you do. Another half a percentage point on your savings is alone not going to help you.

4) The people who post on threads like this wondering how to invest their Many Thousands of pounds free cash per year are likely never to fully appreciate the plight of those who will struggle to put together a few hundred a year. (I've read a lot of posts in many places along the lines of 'Well, can you not just scrape together an extra £50-75 a month. Erm, No, that's the whole problem.'). This isn't their fault. A LOT of people on the investment/pension forums seem to be in the position of having decent savings, a company paid into pension, and a decent salary (often 2 salaries in the household). I applaud their success, but their advice can be of limited use to people in a worse position. As such, don't try to put Too much wieght on any one opinion you get given - their circumstances are likely much different to yours.

4b) Having said that... if you do manage to get Some money together to invest - get advice off the people investing HUGE amounts. They are more likely to be being Very careful about how they are doing it.

5) Pensions are just a long term investment. ISAs are just a long term investment. There are so many advantages and pitfalls in both that nobody, even experts with years of experience and training, can choose 1 for sure. It seems to be summed up though by: 'If the idea of years of Pension payments being tied up away from access by yourself in times of emergency worries you - don't get one - you're income is likely such as you may well need that money. If the idea of an ISA worries you that you are the type to spend the money you have access to frivolously, get a Pension, as you may not have the discipline to Save any other way.'

Once you at least know for sure Isa or Pension - you can at least narrow down the lowest cost or highest interest options in your chosen area. Personally, I think I'll be an ISA.

And finally...

6) A lot of advice, calculations, estimates etc are wrongly based on things staying as they are over the X number of years before retirement. I don't intend to always earn what I do now - I won't always be paying a mortgage - the wife will return to work in a few years - etc etc. My families financial situation will change over time, so I'll do what's best now, and aim to keep it the Best I Can Do for as long as possible. My retirement income will be what it will be.

Paul_Varjak

woodhouseian wrote:

My understanding is that you can claim tax relief on pension contributions equivalent to 100% of your annual earnings. And yet some of those earnings are not subject to tax in the first place (ie they're covered by the personal allowance). I can't believe they'd describe that as 'tax relief' if it was actually 0%, so presumably you'd get 22% tax relief on what is actually un-taxed income?

Actually, you can put money into a pension (£3,600 - including the 22% tax relief) even if you have no earnings or taxable income. That is what I have done for the past four years!

EdInvestor

IMHO

People on low pay with no extra money should

a)Prioritise buying their own home because this is their best hope of obtaining a lump sum later to help fund their retirement at no extra cost

b) Check out what they are going to get from the two, that's TWO, state pensions the basic and the S2P that they are probably BOTH entitled to, (even if they are at home looking after children).

They may already be on target for joint state pensions which they could comfortably live on in retirement if they own their own home with no mortgage and the children have left.

Check it out.

Get your forecast here: https://www.thepensionservice.gov.uk

Re pensions: if there is free money from an employer, try to take up the pension offer.If not, don't bother.Use the ISA allowance to get togather initially a cash emergency fund and then branch out as spare money becomes available into the investment side.

If you have no time to study investment and a very small margin for error, you're probably best at the moment with interest rates being high to just keep saving in cash and perhaps reduce the mortgage, so outgoings are lower.

As long as you have the two state pensions properly funded and ticking away in the background, you can leave retirement until later.

Paul_Varjak

No matter how little you save each month towards a pension, I think the rewards can be sizeable. I am now aged 56 and have not worked for most of my life due to illness and a disability.

When I was 20 I took out an endowment policy with the Pru and have contributed £4.16p each month since then. Despite being on income support for a lot of the time and once living in a hostel where I got just £4 per week over and above my lodgings I always kept up the monthly payments.

The policy is now worth around £25,000 and it should be worth £30,000 - £40,000 (i hope) when it mature in 9 years time. Now that is, I understand, about the current average size pension pot - and all that for just £4.16p /month!

Now, I know that £30,000 in a pension is not very much but each time you follow one of Martin's money-saving tips think to yourself what shall I do with the money? Ah, I know, I will put it towards my retirement!