AVC's VS Stakeholder Post April 2006

dunstonh

Pension contributions should be deducted from your salary when you give the figure to the childrens tax credit people. I dont know about past years but you could check in the cutting tax forum as there is a regular contributer in there that is linked with the tax office who should be able to answer you.

Paul_Varjak

dunstonh:

What about someone who is a basic rate taxpayer now and will be a basic rate taxpayer upon retirement? What is the balanced choice of ISA or pension then? Does it depend on how many years to retirement? (i.e. more time for grossing-up to take effect)

I am also thinking, in part, about the loss of the ability to reclaim the 10% tax credit on dividends in an ISA. You may remember that you told me it was some years ago that pension funds lost the ability to reclaim tax credits on dividends, whereas ISAs only lost this last year.

DavidLaGuardia

dunstonh wrote:

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.

Dunstonh, I agree with most of what you say, but if charges were equal (which they can be) and (as the poster EDITOR sayswe ignire the Tax Free Cash) then the difference between the ISA and Pension fund would be 66% (or 66.66% to 2DP). IF this were all taxed at 40% the resulting return would be the same as the ISA.
If one were to be a higher rate tax payer in retirment then it is whether or not the Tax Free Cash is sufficient to compensate for any restrictions the pension has (Accepted death benefits are an a peripheral additional benefit as is protection from bankruptcy)
And this is where I really support your defence of pensions.
If 25% of the Gross Result is just like an ISA then this is effectively achieved from 25%/60% of the Gross Premium = 41.67%. The other 58.33% of the net premium goes towards the taxable income element which is 75% of 166.66% which is 124.50%. After 40% tax this is 74.70%
Hence using the RELEVANT part for comparison there is a net increase of 28.06%.
If they end up as a basic rate taxpayer the 124.50% after tax is 97.11% then the net increase is 66.47%
Is this worth the restrictions and the annuity- I would say so.