salary sacrifice pension or ISA?

jamesd

When your pay increases will you want to pay all higher rate income into the pension regardless of what you decide now? Or will you only pay in some of it if you withdraw it form ISA money you pay in now? In practice it's pretty common to always pay in all higher rate income regardless of what is in the ISA now.

When will you need the income? The ISA money is available as an extended emergency fund before the age 55 minimum for taking pension money. If your objective is to cover yourself against long term loss of income you need the money outside the pension for at least long enough to cover the period until age 55.

Money in an ISA can be used to take a tax free income before age 55. That can be useful in increasing your spendable income while you use pension contributions for all of the higher rate income, potentially reducing the temptation to pay any higher rate income tax instead of putting that money into a pension instead.

Your employer is not matching pension contributions. This is unusual and not compliant with auto-enrolment requirements. This implies that deferring non higher rate pension contributions is likely to get you a better deal with some employee match in the future when your employer is required to comply with those requirements. You should also consider whether you may have an employer in the future that will match more than just the auto-enrolment minimum. These things tend to favour deferring pension contributions for non higher rate income at present.

Given your age and circumstances, notably impending higher rate change and lack of employer match, I suggest that it is currently preferable for you to use ISA investing for all but higher rate income.

If you were to receive historic UK market growth of about 5% plus inflation after fees on your current £65,000 pension pot it would have a value at age 65 of about £281,000. At 5% of capital as income that would provide a taxable income of about £14,000 a year in today's money. Median average pensioner income is about £18,000 a year. This suggests that you are currently doing very well and could be seriously planning to retire well before that sort of age if you wish to do what it takes to fund that sort of objective.

sterlingstash

I can see how pension contribution wins out due to the additional relief - but as kidmugsy implied, my issue is more about profiling of pension contributions.

I've always put in as much as I can into pension, but am only now cottoning on to the fact that I'll need to rely on increasingly high contributions to keep me under the HRT limit going forwards, and whether I should be seeing now as a good time to rebalance a bit and fill up our ISAs while the opportunity cost is lower.

I know the general advice is put away as much as you can, and in terms of pension pot that big is obviously better, but given the uncertainties of tax rates, lump sum rules (and perhaps even lifetime allowance, if it keeps going down?!) in 20+ years, I can see a chance I'll regret not balancing things a little more, and now seems to be an opportune time.

sterlingstash

jamesd wrote: »

When your pay increases will you want to pay all higher rate income into the pension regardless of what you decide now?

The plan would be to carry on putting all income over the threshold into my pension via SS. So the ISA savings wouldn't be used for pension contributions, other than indirectly perhaps by allowing me to still make the required contributions with a fund to dip into to supplement take home income, if ever needed

Yes - in a couple of years the employer will need to meet minimum auto-enrolment requirements, so I expect a 3% contribution in addition, and hopefully they will still offer salary sacrifice alongside the minimum scheme.

sterlingstash

jamesd wrote: »

If you were to receive historic UK market growth of about 5% plus inflation after fees on your current £65,000 pension pot it would have a value at age 65 of about £281,000. At 5% of capital as income that would provide a taxable income of about £14,000 a year in today's money. Median average pensioner income is about £18,000 a year. This suggests that you are currently doing very well and could be seriously planning to retire well before that sort of age if you wish to do what it takes to fund that sort of objective.

The main reason for the starting to think about this, and hence for the post was getting inspired by Monevator and his quest for financial freedom - which he said that if he started earlier, he would have been all over ISAs...

I think I'm clear now that filling up the ISAs while I can, with the commitment/expectation to 'catch up' on pension contributions in future, when relief should be higher, would be a sensible approach.

jamesd

That's sensible. Pensions are very efficient for the post-55 income, while the before 55 part is best done with ISAs. You can use both and just draw down some of the non-pension capital to boost income until you can take the pension portion. That way you can get the tax efficiency of the pension as far as possible without compromising on the pre-55 part of the objective.

kidmugsy

sterlingstash wrote: »

So the ISA savings wouldn't be used for pension contributions, other than indirectly perhaps by allowing me to still make the required contributions with a fund to dip into to supplement take home income, if ever needed

Exactly: just the ticket!