ISAs v Pensions: The Official Retirement Debate

Just_landed

mickeypops wrote: »

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.

Just when you think it's save to come out and play, an Article appears from all places The Guardian. Link and scroll down :-

http://www.guardian.co.uk/money/2013/mar/17/isa-save-retirement

Dorset82

Pensons get grossed up whereas ISAs don't. In effect; free money for you. Also it stops you from dipping into it from time to time like you can with an ISA.

Paul_Herring

Dorset82 wrote: »

Pensons get grossed up whereas ISAs don't. In effect; free money for you.

Until the time comes when you want to withdraw the pension, whereupon it gets taxed. (25% TFC notwithstanding.)

atush

So, the answer is to have both ISAs and Pensions.

All ISAs and you don't use all of your personal allowance. All pensions and you have no access to capital and might pay too much tax.

Paul_Herring

atush wrote: »

So, the answer is to have both ISAs and Pensions.

Wasting yer breath I think - how many times has that been said on this thread? How many times have people come along subsequently and said 100% one or t'other is "the best"?

atush

It may be like beating a dead horse,

but I don't like the 100% into one or t'other to have the last word and influence the poor newbies who come by.

EternallyGrateful

I think there are more in favour of a mix of investments though. I have said before that I have both Stocks and Shares ISA's, Cash ISA's and a pension fund. My circumstances changed dramatically a few years ago and without that mix I would have been up whatsit creek.
Expect the unexpected!

Dorset82

Agree with the above points. A mixture of tax wrappers is optimal.

You should only withdraw from your pension up to your personal allowance as others have said. If you're a Higher Rate Tax Payer currently, and likely to be a Basic Rate in retirement then it makes sense to focus more on your pension funding at present to benefit from the higher rate tax relief.

You cannot argue with the fact that a pension stops you from dipping into the capital from time to time like you can with an ISA. Which is certainly one benefit.

A mixture of tax wrappers gives you options to 'decumulate' effectively.

jamesd

Being restricted from dipping into the capital is also a problem of pensions. There's a need for higher income from starting retirement until state pensions or work pensions start and the GAD limit restricts the ability to do that.

atush

Well, there is the 25% LS, but yes, you need ISAs as well.