ISAs v Pensions: The Official Retirement Debate

dunstonh

I have reported the above spam. It is also a breach of FSA finanical promotion guidelines. So, if you do happen to see the post before the board remove it, then do remember that if the breach guidelines trying to obtain business, what are they going to be like with the rest of it.

ceejayblue

I've also reported it, definitely advertising.

atush

He posted on the Can I cash in my pension thread too, so report him there. I have.

mickeypops

I'm struggling to understand why most people would consider ISAs to be an effective alternative to Pensions for retirement savings purposes.

Firstly, if you a higher rate tax payer during your working life, and likely to be a lower rate payer in retirement (which is my likely status) then there is no debate. The tax advantages of the Pension are huge and dwarf any other consideration.

But even if you are a lower rate tax payer, both prior to and after retirement, which I think will be the majority of people, I just can;'t make the ISA option add up.

(Keeping the arithmetic simple for illustration's sake.) Let's first consider cash savings. If I put £10K into an ISA, and say it gathered interest worth 20% before I retired, I now have £12K which at 3% would raise me £360 per year.

If I put the same £10K into a pension, and pick up 20% tax relief on the way in, I now have £12,500. With the same 20% growth I now have £15K. At any age after 55, I retire and take the 25% lump sum tax free (£3730), and THEN put THAT into an ISA.

My remaining £11,250 at 3% earns me £337.50, I pay 20% tax and so net £270 from that. My other £3,750 in my new ISA earns me £111.90 tax free. I now have a total of £381.90 income.

I'm now generating 6.25% more income than I would have done had I pursued the ISA option at the outset.

If your money is invested not in cash, but in a balance of investment funds of different types, as would be the case in most pension funds, and stocks and shares ISA, the benefits are even more starkly in the favour of pensions I think, which I will post about later.

Andy_L

Only about 15% of people pay higher rate tax so most people wont get the big bonus of HRT vs BRT

As you've shown pensions are better for income, however ISAs are better for lump sums.

The general consensus of this thread/board isn't that ISAs are an "alternative to pensions", its that they compliment each other and that a mix is the best option. The precise ratio of that mix being very dependant on personal circumstances

mickeypops

Hi Andy L.

I might be missing a trick with my own plans, so I'm interested in knowing in what way ISAs are better with a lump sum?

Thanks in advance.

M

Andy_L

mickeypops wrote: »

Hi Andy L.

I might be missing a trick with my own plans, so I'm interested in knowing in what way ISAs are better with a lump sum?

Thanks in advance.

M

ISAs are better at providing a lump sum in that you have access to 100% of the capital whilst with the pension you can only get at 25% of the capital whilst the rest is trapped/protected (depending on your point of view) by the pension wrapper

jamesd

You can draw 100% of the ISA money, not being limited by the GAD limit on pension withdrawing.

Say you are 40 and want to provide for yourself if you are unable to work. You can't use any pension money because you're not 55 yet. So you have to have ISA or other money to last you until you're 55 and can get at pension money. More viable as you get closer to 55 and the number of years you need to pay for decreases.

Now you're 55 and want to retire. You can get at pension money but you want the same income now as when you get the state pensions. The GAD limit blocks you from taking enough from a pension so you need ISA money to top the income up by withdrawing capital until the state pensions start.

The ability to draw the capital is a key reason why you may find it very useful to have an ISA component as well as a pension component.

For higher rate tax payers aged 55 or over the pension disadvantage is less because more of the contribution can be taken out, after allowing for the benefit of the tax relief on the way in. Same for basic rate and salary sacrifice. But they still can't get out as much capital as from an ISA.

mickeypops

ISAs v Pensions - Part 2.

Here's my (non-professional) take on the debate, following on the illustration I posted above which focussed upon cash or cash-like savings for retirement.

In practice, I think that the majority of people's retirement planning will involve sime cash, but a greater proportion would normally be invested in investment funds via either their employers' scheme or a personal pension fund e.g. SIPP. These would contain a mix of equities (shares) and other asset types - bonds, gilts, maybe some specialist stuff like commidities etc.

Anyone can mirror, or very closely mirror, their chosen, or advised, portfolio mix in a Stocks and Shaers ISA up to the annual limit, instead of a Pension. The benefits of Pension v. ISA is of course the basis of the very intersting thread.

As we know, the tax benefits of a Pension fund, up to the new reduced limits, are that for every £10K a standard rate payer puts in, he actually gets £12.5K invested. HRT payers of course do even better.

Fairly recent changes to Dividend taxes, which seem to be rarely mentioned, mean that dividends from shares paid into Pension Funds and ISAs are both treated the same by the taxman. You may have thought that your dividends from shares, and from funds that invest in shares, were paid tax free into your ISA. They are not. The government levies a 10% "tax credit" on share dividends at source, and this cannot be reclaimed by the ISA holder, even if the holder pays no income tax. Remember, this applies just the same if your ISA houses individual shares, or funds such Unit Trusts etc.

From this perspective, S&S ISAs invested in equities, have no income tax benefit for standard rate tax payers at all. Higher rate payers benefit, as there is no further tax to pay on divdends for them for inside an ISA, whereas there is outside this wrapper.

ISAs, just like Pension funds, attract no Capital Gains tax.

As a brief aside, we all have a £10.6K CGT annual allowance, so it would be a very hefty gain to be realised before any CGT was payable in any year. (Don't forget that CGT is payable only when the capital gain is "realised", i.e. cashed in, not when it's a "paper" gain.) Really, it is only in a minority of cases, I believe, that S&S ISAs hold any real benefit over making the same investments outside an ISA.

So, there are no tax advantages for holding your investments within an S&S ISA than in a pension fund. Your pension fund immediately inflates your investment because of the tax relief. And, just as above as the above example I describe a couple of posts above, the ability to take a 25% lump sum tax free upon retirement, which can be immediately re-invested into ISAs (up to the limit) make the Pension fund, by and large, the better option I think, as it produces more income.

mickeypops

jamesd wrote: »

You can draw 100% of the ISA money, not being limited by the GAD limit on pension withdrawing.

Say you are 40 and want to provide for yourself if you are unable to work. You can't use any pension money because you're not 55 yet. So you have to have ISA or other money to last you until you're 55 and can get at pension money. More viable as you get closer to 55 and the number of years you need to pay for decreases.

Now you're 55 and want to retire. You can get at pension money but you want the same income now as when you get the state pensions. The GAD limit blocks you from taking enough from a pension so you need ISA money to top the income up by withdrawing capital until the state pensions start.

The ability to draw the capital is a key reason why you may find it very useful to have an ISA component as well as a pension component.

For higher rate tax payers aged 55 or over the pension disadvantage is less because more of the contribution can be taken out, after allowing for the benefit of the tax relief on the way in. Same for basic rate and salary sacrifice. But they still can't get out as much capital as from an ISA.

Thanks Andy L, I can see where you're coming from. your examples are quite feasible real life circumstances and so deserve serious consideration.

I would suggest though that you are describing methods of saving cash to deal with adverse life circumstances. I was talking about saving for retirement, which isn't quite the same thing.

ISAs will always be a better medium for saving cash which may be needed before retirement. This is the essential trade off that is at the core of the ISA v Pension debate. The government gives extensive tax breaks for us to save for our retirement (specifically), the downside being that it then defines the terms and conditions upon how and when we get access the pension funds. Money that may be needed earlier than your planned retirement should NOT be invested in pension funds.

As someone put it earlier in this thread, I think (I'm paraphasing.)

- the advantage of an ISA is that you can get access to your money whenever you want
- the disadvantage of an ISA is that you can get access to you money whenever you want.

In a nutshell, an ISA wrapper gives you greater flexibilty and puts you fully in control. A pension fund, though, in general, will fund your retirement with greater income.

Thanks for your replies.


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