should i pay into a pension now with auto enrolment coming in?

jamesd

A way a PLA can be useful in conjunction with a pension that you already have is by taking the 25% tax free lump sum and buying a PLA. The catch there is that the PLA annuity rate might be sufficiently below the pension lifetime annuity rate that leaving 100% in the pension and buying a pension annuity still comes out ahead. The advantage in this case is more likely to shift in the direction of the PLA if the income would be taxed at 40%.

The text book exam answer to buy annuities with 100% of the value of a pension pot is take the pension 25% lump sum and buy a PLA with it but that's not so likely to be the correct real world answer because of the difference in market competitiveness.

grey_gym_sock

Saving into a S&S isa is all well and good, but for every 80 you put into an ISA you will have 80. for every 80 you put into a pension, you will have ......

... how much?

well, the correct answer is: it depends.

the best simple answer is (i reckon): 85.

that's obtained by assuming you'll take 25% tax free and pay 20% tax on the rest.

atush

100 is the answer. as we don't know how much if any tax would be paid as everyone has a personal allowance.

Everyone should have a pension if just to give income that would take up the personal allowance. If you relied on ISA income only, you would waste your TF allowance

grey_gym_sock

no, the answer is we don't know.

it's only 100 in very limited circumstances - when your pension is covered by your personal allowance - i.e. you don't already have other income using the allowance, and the pension doesn't take you over the allowance.

it's misleading to say: it is 100 because there's 100 inside the pension fund ... when you're never actually going to get all of it into your dirty hands.

it's like saying: i have an income of X (before tax), so i can spend all that money! ... in fact, it's exactly like that, since a pension is a tax deferral scheme.

FatherAbraham

jamesd wrote: »

Pension, pay in £80, get £100 in the pension pot, take 25% tax free lump sum and you now have £75 in the pension for a net cost of £55.

Put the same net £55 into an ISA and you have £55 in the ISA.

Because you've used a free loan of £25 in the pensions case, to be able to pay £80 in with only £55 of net money, you've geared the tax advantage by 1.45 (£80/£55), and therefore overstated it.

jamesd wrote: »

So you need to compare the income you can get from £55 in an ISA with the income you can get from £75 in a pension.

Lets pretend that all of the pension income is taxed at basic rate because the whole personal allowance for income tax is used. That reduces the effective value of the £75 in the pension to £75 * 0.8 = £60. Lets also pretend that the ISA is fully tax free for income generation.

That in turn means that you need to somehow generate 9.1% more income from the ISA than the pension to break even ((60 / 55 - 1) * 100).

Removing the gearing, we can see a more accurate approximation.

Pay £80 into pension, grosses up to £100, tax-free take is £25, plus 80% of £75 taxable (which is £60), giving total "after tax" of £85.

Pay £80 into ISA, giving total "after tax" of £80.

The pensions tax advantage (given the taxation assumptions made, which are generous to the ISA) is "only" 6.25%. not 9.1%

jamesd wrote: »

You can't even break even with the purchased life annuities you can buy outside a pension because they are a less competitive market with lower payment rates than pension lifetime annuities. And of course the ISA PLA isn't really 100% tax free and for many at least part of the pension income is.

Agreed.

Warmest regards,
FA

jamesd

Say I'm 55 years old, pay £80 into a pension on 4 May and take a 25% tax free lump sum on 5 May. I ensure that at no time do lump sums taken within any 12 month period exceed 1% of the lifetime allowance. Meanwhile on 4 May I pay £80 into an ISA and withdraw £25 on 5 May. On 6 May I spend the tax free lump sum and £25 ISA money. I now have the extra amount of money in the pension to produce income and the funding for ISA and pension has been the same throughout. Both the ISA and pension got a little growth on the extra money while it was there.

Are you more comfortable with the calculation with these circumstances specified? If you are, how many years younger than 55 must you be before you consider it to be unfair?

Usually I use the calculation you used, looking at it from the taking money out end. But the calculation with gearing can be more useful when considering where to pay in the money. Say in cases where you have money for mortgage capital repayment that you could pay into a pension or an ISA. Then the pension gets the income leverage. Or viewed alternatively, you get tax relief on your mortgage capital payments.

The gearing is interesting. Sometimes it's not so useful to use it in the calculations but it's really useful if you have dual purposes like that mortgage case or just happen to be 55 or older and able to get the 25% quite quickly, though more realistically in a month or two rather than days. If you don't allow for the gearing in those situations you end up understating the advantage delivered by the pension. In both cases there's investment growth on the money and the 25% ends up being used for capital repayment, leaving the leveraged amount of capital in the pension to compare to the unleveraged ISA remainder once the ISa portion is used for the capital repayment.

stinktankcynic

With so much uncertainty now with low interest rates, means testing and increased longevity, who knows what annuity rates will be in 30 years time, what will the retirement age be etc.

If you have a job with a company pension. Final salary etc, or good % defined contribution then a pension is probably a real good option, with the tax relief too.

If you don't have this, then your stuck with personal pensions, stakeholders etc and tax relief. With the uncertainties above, if you could afford to put away £5000 away a year, should this be into a cheap, discounted stakeholder, cash is a, stocks is a?

Is there anything wrong with saving into ISA's for years, then if the tax rate has increased' annuities are good etc, putting a load of cash into a pension then, or I'd annuities are better, using cash to buy one instead of a pension?

When your hand is on the cheque book, paying into the isa seems more sensible compared to the pension, despite the tax relief.

Will the next couple of budgets see any big changes?

I intend to be auto-enrolled next year, just I cannot get my head around paying into a stakeholder again rather than an isa.

atush

ISAs are good, but should be used alongside any pension. Pension, after the TFLS will give you an income that Could be taxed if it is over your personal allowance. So make sure you have some pension at least.

AS ISA income, being tax free, is best to be used After you use up your personal allowance.

Means testing will have no affect on annuity rates. And you no longer Have to use annuities.

jamesd

stinktankcynic wrote: »

With the uncertainties above, if you could afford to put away £5000 away a year, should this be into a cheap, discounted stakeholder, cash is a, stocks is a?

For a one year horizon only savings accounts or other non-investment options are appropriate, generally. Possibly some exceptions for a few investment types where the potential drop value is acceptable if it happens within the year.

stinktankcynic wrote: »

Is there anything wrong with saving into ISA's for years, then if the tax rate has increased' annuities are good etc, putting a load of cash into a pension then

That can be a useful approach but when it comes to ISAs it's worth remembering that their payouts are free of income tax, while pension income is subject to income tax. This means that if you are providing for a higher income tax rate you'd want to pay into a pension first, then transfer the tax free lump sum from the pension into ISA investments to reduce the tax on income. Possibly also take the income from the pension and move that into ISA (or VCT if appropriate) to protect against future income tax rate increases.

One way using ISA first can be rewarding is if it is anticipated that later you'll be a higher rate tax payer or in a job with a salary sacrifice pension scheme. In either case you can get the growth in the ISA, then later benefit from more generous income and/or NI tax relief on the pension contributions.

stinktankcynic wrote: »

I'd annuities are better, using cash to buy one instead of a pension?

The market for this type of annuity is less competitive and except for someone subject to higher rate income tax it's unlikely to be beneficial to buy outside a pension pot instead of within one. There can be exceptions, but as a general guide this is about right.

stinktankcynic wrote: »

When your hand is on the cheque book, paying into the isa seems more sensible compared to the pension, despite the tax relief.

The ISA has the advantage and disadvantage that the money is available with little notice, so it's available for contingencies like longer term unemployment, while also counting against the savings cap for means tested benefits.

The unlimited capital drawing rate also makes the ISA a good option for topping up pension payouts during retirement before state pension age, since you can take money out faster and drain the capital. The higher drawing rate has to be compared to the higher money value accumulated in the pension, particularly for higher rate tax payers or those using salary sacrifice. The ISA still has the drawing rate edge but it has a longer term cost of lowered income once the high drawing need is over. Commencement of state pensions or work pensions is how that is dealt with - the need was only temporary, so it's OK to be less efficient using the ISA than the pension to cover the shorter term need.

stinktankcynic wrote: »

Will the next couple of budgets see any big changes?

No way to tell but probably not. This one seems unlikely to do anything dramatic, there's little scope for money giveaways and an election is not that far away.

On the pension side, some protection against GAD limit drops and GAD volatility in drawdown via some smoothing or minimum drawing rates would be nice but doesn't seem really likely. In general the GAD limit variation based on capital market and gilt volatility is short-termism when a retired person needs to be doing long term money planning, not short term and shouldn't be dropping income based solely on short term market fluctuations. It doesn't help that you can't put aside a cash pot within the pension to smooth, then draw out by depleting that, because the GAD limit applies to the final withdrawing rate.

grey_gym_sock

if you don't have employer contributions, and won't get higher-rate income tax relief on contributions, and don't have a salary sacrifice scheme (which saves NI as well as income tax on contributions), then i'd usually be inclined to use an S&S ISA (not a cash ISA!) in preference to a pension.

you'll probably get access to 1 of those 3 things later on, if you don't have them now, so you can build up a pension then.