Tax and asset types in pensions and ISAs

david_c_6

There was a passing reference to this in the great pension vs ISA debate, but it's a slightly separate question so I thought I'd start a new thread.

The question is, if you're going to use both a personal pension of some kind and ISAs for your retirement planning, and have a mix of assets (e.g. cash, equity funds, bond funds, property funds, anything I haven't thought of...), is there any tax reason to having any of them in one wrapper rather than the other? For example, I believe that UK share dividends are taxed at source whether they're going into an ISA or a pension, but interest in a cash ISA is paid without tax deducted. I seem to get tax credits for the bond funds in my ISA, but not for the equity funds. Would this be the same in a personal pension? And what about property funds?

EdInvestor

You can hold equities direct without paying tax quite easily if you are a basic rate taxpayer - dividends come with a notional tax credit which pays the tax on them and the CGT allowance is high. So bonds and property funds may be higher priorities for the pension and ISA.[This would assume however that you had a lot to invest...]

There's a much larger selection of property funds available in pensions than in ISAs, as traditionally they are run by the big lifecos (who also are traditionally better at running bond funds). The fund management companies tend to be better at equities.

But this line is blurring somewhat as most pensions now offer "external funds" and there are also a growing number of property unit trusts (thought they may be of the riskier kind which invest in shares, not bricks and mortar). Also, the appearance of SIPPs as a mass market product basically means that you can more or less invest in anything in either wrapper these days.

david_c_6

Do I understand you correctly? You're saying that there isn't a significant difference between an ISA wrapper or a pensions wrapper in the tax treatment of equity, bond and property funds? So it doesn't matter how I allocate assets between an ISA and a pension *from the tax point of view* (it obviously makes a difference from the point of view of the risk and the timescales).

Are you also saying there is some way that I've overlooked for a basic rate taxpayer to avoid paying tax on dividends on shares held outside any sort of wrapper? I thought that a basic rate of dividend tax was deducted "at source", and you get sent a tax voucher, but that simply proves to the taxman that you've already been taxed on that income. Also, there used to be a way for pension funds to reclaim that dividend tax, and a lot of hoohah when the Chancellor withdrew it, and that he'd done the same thing to equities (possibly only UK equities?) in ISAs. Perhaps I've missed your point here, or maybe firmly grasped the wrong end of the stick...

EdInvestor

david_c wrote:

Do I understand you correctly? You're saying that there isn't a significant difference between an ISA wrapper or a pensions wrapper in the tax treatment of equity, bond and property funds? So it doesn't matter how I allocate assets between an ISA and a pension *from the tax point of view* (it obviously makes a difference from the point of view of the risk and the timescales).

Correct.

Are you also saying there is some way that I've overlooked for a basic rate taxpayer to avoid paying tax on dividends on shares held outside any sort of wrapper?

Yes.The dividend is taxable, but comes with a notional tax credit ( no tax is actually paid.) This tax credit pays the full liability for someone on basic rate. You also have an annual capital gains tax allowance of c 9k, so there is no need to pay tax there either.Thus a basic rate taxpayer can usually hold equities tax free directly.

I thought that a basic rate of dividend tax was deducted "at source", and you get sent a tax voucher, but that simply proves to the taxman that you've already been taxed on that income. Also, there used to be a way for pension funds to reclaim that dividend tax, and a lot of hoohah when the Chancellor withdrew it, and that he'd done the same thing to equities (possibly only UK equities?) in ISAs. Perhaps I've missed your point here, or maybe firmly grasped the wrong end of the stick...

This confusion results from changes to the system in 1999.It used to be the case that a dividend tax was deducted and the previous system involved real tax credits - i.e. actual money paid to the taxman by the company as a result of paying the dividends.This was reclaimable by non-taxpayers such as ISAs, pension funds and charities.

In 1999 companies stopped paying dividend tax and switched to paying corporation tax and the credits were withdrawn . But there was a transition period, during which people with ISAs could continue "reclaiming" what was now only a notional tax credit (no actual tax being paid). The transitional periods ran out in 2004 for ISAs and PEPs.