AVC's VS Stakeholder Post April 2006

elephant_guy

I currently earn in excess of £40,000 and have a around £24,000 in an employer organised AVC arrangement with Standard Life at a reduced management fee. £100 is currently deducted per month from my gross salary.

I have 10 years to work before qualifying for my employers final salary pension.

Following the Pension changes I have heard about due to take place in 2006 will it be possible for higher rate tax payers to transfer to/take up Stakeholder pensions.

If a Stakeholder plan will not be an option in 2006 are there any more flexible/profitable means of saving than the AVC I am currently paying into for my retirement.

Many Thanks

Elephant_Guy

dunstonh

The AVC will have the tax free lump sum payable but will still be tied in with the main scheme as far as commencement date is concerned.

An FSAVC is virtually a dead product now and even more so from A day. The personal pension and stakeholder pension have killed it off.

Currently you cannot transfer your AVC into a SHP/PPP whilst you are still a contributing member of the occupational scheme. I havent read anything to say that is changing but then I havent looked specifically at that and there is an awful lot to read.

The stakeholder/PPP/SIPP should be an option for you from 2006 so I wouldnt worry about other things at this time.

elephant_guy

Thanks Dunstonh for such a quick and informative reply. :T

It sounds like I could freeze the payments on my current AVC and open a Stakeholder pension next year.

I didnt realise that a lump sum could be obtained from the AVC - thats great news.

When I initially took out the AVC (About 15 years ago!!) I was told it could only suppliment income and no lump sum was possible.

Sorry to be a dullard..... But would a new Stakeholder pension in 2006 be likely to offer me more benefits than my existing AVC ?

Elephant_Guy

EdInvestor

The stakeholder would be more flexible - you can take benefits (including tax free cash) any time after 50 at present.

If you were locked into a company scheme/AVC which couldn't be accessed before a certain age and then you lost your job before that, the stakeholder could come in handy by generating some money in the meantime.

But an ISA would be even more flexible - if you haven't maxed out your ISA allowances I'd do that first.

dunstonh

When I initially took out the AVC (About 15 years ago!!) I was told it could only suppliment income and no lump sum was possible.

That is correct. The change comes in from April next year when all pension schemes will have 25% tax free lump sum payable from them. This includes occupational schemes as well.

Sorry to be a dullard..... But would a new Stakeholder pension in 2006 be likely to offer me more benefits than my existing AVC ?

Main difference is that with the AVC, you will be forced to commence it at the same time as the occupational scheme whether you wanted to or not. A stakeholder/personal pension or SIPP would not have that rule and you could commence benefits earlier or later or potentially utilise income drawdown or phased retirement.

I have had 3-4 clients this year who regretted taking out in house AVCs because of that tie in.

In the "old" days, the AVC would have been the cheapest method of the options available. Nowadays that isnt the case. Equally, a stakeholder may no longer be the best option. Most of the major providers are dropping the fund availability on their stakeholders and making them a pure budget product. Indeed, personal pensions can now offer lower charges than a stakeholder.

I just did an illustration a few minutes ago (i know, its sunday but i am busy) and the comparison gave the NU personal pension lower charges than the NU stakeholder.

If the fund is big enough, A SIPP could be cheap as well.

Each of these has pros and cons but its food for thought and you have ample to time to look into these options before you decide what to do.

dunstonh

Editor wrote:

But an ISA would be even more flexible - if you haven't maxed out your ISA allowances I'd do that first.

Elephant Guy mentioned he was a higher rate tax payer. Are you suggesting that he should do an ISA instead of a pension and give up 40% tax relief (possibly more if he has children)?

An ISA cannot come close to a pension for a higher rate tax payer when looking at the amount of retirement income that would be paid.

EdInvestor

dunstonh wrote:

Elephant Guy mentioned he was a higher rate tax payer. Are you suggesting that he should do an ISA instead of a pension and give up 40% tax relief (possibly more if he has children)?

An ISA cannot come close to a pension for a higher rate tax payer when looking at the amount of retirement income that would be paid.

#We always have to remember that the pension income is taxed whereas the ISA proceeds are not, don't we?

If Elephant guy is sure he will be a basic rate taxpayer in retirement then he will certainly benefit more from pension investment than a basic rate taxpayer now and later, who IMHO will hardly benefit at all from pension saving vs ISAs if he has no employer contribution.

But with the new rules coming up there's no need for even higher rate taxpayers to deny themselves flexibility, because they can sweep large amounts of money into the pension wrapper later and pick up the tax relief.

dunstonh

Yes that can be done but then he would lose the investment on the tax relief.

Assumption time ....

£100 pm into an ISA is the same as £166 on a pension (assuming 40% tax relief is paid into the pension via provider and tax form). That extra £66 gets invested every month and has growth on it which improves year on year. By leaving it till later, he would have missed out on years of growth on the tax relief.

So, one way offers potential convenience but a lower amount. The other offers a higher amount without the flexibility of the ISA. Death before retirement would favour the pension as well.

Somoene on deaths door/terminally ill could do a lot worse than pay into a pension to ensure their spouse receives a larger payout. (hmm, that could be used to good effect after A day).

EdInvestor

dunstonh wrote:

£100 pm into an ISA is the same as £166 on a pension (assuming 40% tax relief is paid into the pension via provider and tax form). That extra £66 gets invested every month and has growth on it which improves year on year. By leaving it till later, he would have missed out on years of growth on the tax relief.

There's no extra growth: this is taken by way of tax on the proceeds when you take the income with the pension.22% extra goes in at the contribution stage and then that 22% is taken out in income tax at the payout stage.If you like, the taxman gets a free ride on your investment skills.The tax is not relieved: it's deferred.

[I'm ignoring the 25% tax free cash, but IMHO that's a small benefit for the lock in, the annuity, etc. Higher rate taxpayers who are BRTs in retirement will do better of course.]

Who does lose if the investor uses an ISA not a pension is the life company, which makes extra money from the tax relief.That's why the overall charges are higher for the same fund with a pension than an ISA.

dunstonh

There's no extra growth: this is taken by way of tax on the proceeds when you take the income with the pension.22% extra goes in at the contribution stage and then that 22% is taken out in income tax at the payout stage.If you like, the taxman gets a free ride on your investment skills.The tax is not relieved: it's deferred.

There is extra growth.

On the ISA, the individual is paying in £100. On the Pension, they are still paying £100 (effectively) but £166 is going in (as elephant guy is 40% tax payer so that is kept in this example). That extra £66 grows too. You cannot ignore it as it will have a signficant impact on the final fund value.

Plus, you appear to be totally ignore the personal allowances. As already mentioned, a couple can earn £14000 a year in retirement without paying tax if they split their retirement income planning. So, potentially, they get 40% relief up front and can end up with no tax at the other end. In this case, a higher rate tax payer is likely to eat up much of their tax free allowance with the basic state pension and occupational scheme. That wont apply to everyone though.

Lets try an example. Full charges are included to ensure every consideration is included.

Stakeholder pension (NU)
£166pm for 30 years at 7% = £166,000

ISA (FFN - liontrust first income)
£100pm for 30 years at 7% = £81,100

That NU pension gives £10,700 income minus £2354 tax (assuming full 22%) = £8346 pa net income (ignored tax free lump sum - not taken)

The ISA we shall assume 5% as that could fluctuate with interest rates will give £4055 pa with no tax deduction.

So, yes there is likely to be tax paid on some of the retirement income or possibly all but even if you assume all, the income achievable from an ISA alone cannot touch the pension.


Another think to note now as well is that charges on pension funds are often lower than the equivalent fund with an ISA.

elephant_guy

dunstonh wrote:

Elephant Guy mentioned he was a higher rate tax payer. Are you suggesting that he should do an ISA instead of a pension and give up 40% tax relief (possibly more if he has children)?

Dunstonh,

I have a 14 year old daughter (who costs me a fortune !!!)

Does this mean I could claim additional tax relief on my AVC for her ? Didn't imagine for a second I could do that, being a higher rate tax payer.

How would I go about doing this ?

Could I claim the relief for previous tax years ?

Many Thanks

Elephant_Guy