pensions vs ISAs - a bad media article

dunstonh

We had the ISA vs Pension thread recently and most of us here share the same view that for basic rate taxpayers that using a pension to utilise the personal allowances is the best thing with the ISAs being used for the amount above. And that spouse should be included to "double up" the allowances.

However, read the following BBC article today:
http://news.bbc.co.uk/1/hi/business/6525587.stm

Now look at the flaws:

It used the example of two basic rate tax payers each contributing the after-tax relief equivalent of £200 per month, one into an ISA and the other into a personal pension.

After 20 years the pension holder had a larger fund than the ISA saver.

This would be correct. If you invest in the same funds in an ISA and a pension then the growth and charges would be the same so the only difference would be the tax relief. Nothing wrong there but.....

However, when the pension fund was used to buy an annuity - a retirement income for life - it was roughly equivalent to what the ISA saver could earn through keeping their money invested in an account paying 4.5% interest.

Flaw 1
An annuity at 65 on level basis would be in excess of 6% p.a.

Flaw 2
An ISA invested in funds matching the pension cannot be converted to a cash ISA so you wouldnt get cash ISA treatment. You would be on a savings account which is taxable.

Flaw 3
If you used a cash ISA to get you to retirement the value of the fund would typically be significantly lower than the pension which would have been invested. Far more than the tax relief difference

Flaw 4
25% lump sum ignored on pension.

Flaw 5
Interest rates fluctuate but annuity income is guaranteed.

The BBC have focused on the research being flawed, to their credit. However, it just goes to show how easy it is for the subject to be "subjected" to bias and I bet you that this biased and inaccurate research will be picked up by one of the papers and used, without the flaws mentioned, in some anti pension article.

michaels

I thought the conclusion was that money in an isa was more flexible and given the removal on limits that could be paid in to a pension in a single year could be exactly equivalent financially - obviously only up to the isa limit per annum.

The flexibility can be a plus or minus depending on personal responsibility I guess.

cheerfulcat

Hi, dh,

Sadly the BBC is not unknown to the world of spin and I would love to have seen the original article. And Tom McPhail is not exactly an independent observer!

wotsthat

Yes this report seems to be written in a very superficial way.

The most dangerous thing is that they seem to imply that people have to choose between pensions and ISA's when it's perfectly reasonable to use the tax benefits of both vehicles to best effect.

dunstonh

Tom McPhail was on the news the other day and was a called financial analyst for the UK watchdog!

cheerfulcat

Good grief, what next. You might be interested to know that TMcP was named " Personality of the Year " in 2006 -

Scottish Widows Awards

" The judges agreed that Tom has been everywhere this year and has been a prominent spokesperson in the trade and consumer media across a broad range of issues. "

They might say that, I couldn't possibly etc., etc. ...

EdInvestor

The report is IMHO beneficial as it highlights two aspects of pensions vs ISAs that people often miss: the fact that pension tax relief is in many cases only deferred tax, as pension income is taxed in retirement at your highest rate; and the fact that you lose the capital in the pension fund when you take an annuity income.By compariosn ISAs are not taxed in retirement and you can do what you like,when you like, with the capital.

But the article missed one important aspect that strengthens the case for ISAs: the change in the A-day rules which enables you to contribute large lump sums to a pension right up to retirement under the "lifetime allowance".

Whereas the ISA is an annual "use it or lose it" tax perk.

Because of this change, young basic rate taxpayers with no company pension are much better contributing to ISAs at first, because they then have the option of taking that ISA fund when they are older ( and perhaps paying higher rate tax) and putting it in a pension to get the better tax relief at the much higher rate.Thus they get the best of both worlds - the benefits of early tax free saving in the wrapper, but mainitianing flexibility, with the chance of higher tax relief later.

It is sensible to use pensions to soak up the tax free personal (age) allowances, which are scheduled to rise to 10k a year quite soon.But the 2 state pensions will take up much of that allowance for many people: and most people won't really know how much they should have in their pension until much closer to their retirement date.So there is a danger of oversaving in pensions if you start young.There are also concerns about whether the tax free lump sum will survive.

Better to stay flexible with ISAs, and then you can fine tune the amount in your pension when you know what the allowances and regulations are at the time.

dunstonh

But the article missed one important aspect that strengthens the case for ISAs: the change in the A-day rules which enables you to contribute large lump sums to a pension right up to retirement under the "lifetime allowance".

There is a risk with that. If you are made redundant or leave work for any reason, you lose the ability to pay lump sums in and get tax relief above £3600.

EdInvestor

dunstonh wrote: »

There is a risk with that. If you are made redundant or leave work for any reason, you lose the ability to pay lump sums in and get tax relief above £3600.

True, but since you can pay in lump sums equivalent to your entire annual salary per year, it's not too much of a risk.In any case you would still have the fund tax protected in your ISA.Indeed some people might regard it as a blessing in disguise, as you would still retain control of the capital.

If you did want to convert the ISA fund (or part of it) to a guaranteed income for life, you can still do so - and you would get a higher income from a voluntary annuity because it has better tax treatment.

dunstonh

True, but since you can pay in lump sums equivalent to your entire annual salary per year, it's not too much of a risk

made redundant in May and you only have 2 months income.

It is a small risk but if it was an advice case and that occured, it would almost certainly be upheld if there was a complaint. So, it is worth noting that using ISAs with the intention to probably feed a pension later does carry a small degree of risk.

If you did want to convert the ISA fund (or part of it) to a guaranteed income for life, you can still do so - and you would get a higher income from a voluntary annuity because it has better tax treatment.

a purchase life annuity does pay more but not more than 22% whcih would get by the enhancement of the tax relief.

EdInvestor

dunstonh wrote: »

a purchase life annuity does pay more but not more than 22% whcih would get by the enhancement of the tax relief.

What is the actual comparison now that the pension annuity tax relief has fallen to 20%?