Stocks and Shares ISA investments vs Pensions

Anonymous101

I'm currently having a rethink of my retirement plan and would like to hear others opinions of what my strategy should be.

I'm 35 years old and currently earn just over £50k.
I have an existing pension pot of £75k to which I pay 10% of my salary into and also receive a 6% contribution from my employer. I have been told verbally that my salary will rise by 5% in the New Year and I think that this is a good time to further increase my AVC's with a target total contribution of 20% of my salary in total.

I have a stocks and shares ISA with minimal balance which I have been thinking about investing into however I can't get away from the fact that I think pension contributions are a much more tax efficient way to save for retirement given that I'm a 40% tax payer. I almost begrudge paying the 40% and would like to pay as much into my pension as possible in order to minimize the higher rate tax I'm paying.

My dilemma is really around whether this is the best strategy given that I have very little in the way of investments save a 2 months salary "rainy day" buffer. I know that this is a very personal stance and possibly not the wisest so I was wondering if there was an accepted % split between ISA investments and pension contributions which I could take a view on?

I'd welcome any opinions on this.
Thanks, Anon.


**** Sorry posted this in the Pensions section first but it's probably better posted here.*****

ColdIron

ISAs and pensions have their pros and cons but for retirement it's pensions every time for me and especially if you pay higher rate tax. Put all of your earnings into retirement saving or give the tax man £4 in every ten? It's a bit of a no brainer. It's also useful to take yourself out of higher rate tax as it reduces other tax liabilities such as CGT, dividend and savings interest tax etc

Does your employer offer salary sacrifice? If so you pay less NI and it saves you having to reclaim the higher rate portion of the tax rebate via self assessment

Your 2 months salary "rainy day" buffer should be in cash and not an investment ISA

dunstonh

The pensions section had a great ISA vs pension sticky which was highly popular and kept upto date by forum members with some excellent contributions. The thread contained more information about pensions and ISAs than every official article on this site did. The board, in its wisdom, decided to remove stickies and that thread has sadly ended up being neglected.

however I can't get away from the fact that I think pension contributions are a much more tax efficient way to save for retirement given that I'm a 40% tax payer.

Correct.

My dilemma is really around whether this is the best strategy given that I have very little in the way of investments save a 2 months salary "rainy day" buffer.

That does need addressing.

I know that this is a very personal stance and possibly not the wisest so I was wondering if there was an accepted % split between ISA investments and pension contributions which I could take a view on?

Emergency fund would not typically be a risk based investment but personal cash savings.

You are only a 40% taxpayer on part of your income and therefore, only the amount in that tax band will get tax relief. So at least maximising the higher rate band would make sense. If can help ensure you maintain child benefit too if you are over 50k by bringing your effective income under that threshold.

Anonymous101

ColdIron wrote: »

ISAs and pensions have their pros and cons but for retirement it's pensions every time for me and especially if you pay higher rate tax. Put all of your earnings into retirement saving or give the tax man £4 in every ten? It's a bit of a no brainer. It's also useful to take yourself out of higher rate tax as it reduces other tax liabilities such as CGT, dividend and savings interest tax etc

Does your employer offer salary sacrifice? If so you pay less NI and it saves you having to reclaim the higher rate portion of the tax rebate via self assessment

Your 2 months salary "rainy day" buffer should be in cash and not an investment ISA

That's my thinking exactly. I suppose my concern is just that I'm neglecting the short to mid term investments/savings.

All of my current pension contributions are through the salary sacrifice so I get the NI benefit. I don't think I'm able to take myself out of the 40% tax bracket though as I receive other taxable allowances paid as salary which don't count towards my employers contribution percentage.

Sorry wasn't clear about that, the rainy day saving is in cash.
I also overpay on my mortgage slightly.

Anonymous101

dunstonh wrote: »

The pensions section had a great ISA vs pension sticky which was highly popular and kept upto date by forum members with some excellent contributions. The thread contained more information about pensions and ISAs than every official article on this site did. The board, in its wisdom, decided to remove stickies and that thread has sadly ended up being neglected.



Correct.



That does need addressing.



Emergency fund would not typically be a risk based investment but personal cash savings.

You are only a 40% taxpayer on part of your income and therefore, only the amount in that tax band will get tax relief. So at least maximising the higher rate band would make sense. If can help ensure you maintain child benefit too if you are over 50k by bringing your effective income under that threshold.

Thanks that's great. I do have a lot to think about there. I'll have to see if I can stretch my pension contribution to take me out of the higher rate altogether. As I said above though that might be difficult... Depend on this pay rise my total taxable income is likely to be too far away from even the increased threshold.

I think I'm coming to the conclusion that a small increase in pension contributions is prob best as well as starting to invest in a medium term investment. That's all in addition to my rainy day fund which is currently held in cash (sorry that was misleading on the first post).

darkidoe

I would if expenses allow, pay into pension for the entire amount that would get you 40% tax relief, around 8k for you I think, if pay is about 50k, then from there on, focus on S&S ISA contributions.

Bravepants

Hello,

I too pay AVCs as I'm in the 40% bracket. I use AVCs for two reasons:
1. Save 40% tax where I can.
2. Lock money away that I cannot touch until later in my life.

However I try to just skim off the 40% component into my AVCs, so I pay about 10 % of gross of my salary into my AVC account. It depends on how high above a £50k salary you are on, but it might be that by paying 20% into AVCs you are partly down into your 20% allowance. You might want to pay into a S&S ISA to make the money more available, perhaps for retiring BEFORE 55. It depends on whether both my points 1 and 2 above are equally important to you, or just the tax implications.

This is quite a good article on pensions, ISAs and tax implications:

http://monevator.com/pensions-versus-isas/

Read the comments section too though.

Cheers,
P

bowlhead99

If you have £1000 of salary you can:

Put £1000 in a pension and invest it for a decade until it's doubled and is £2000 ; or

Take it as £600 cash net of tax and put it in a S&S ISA for a decade until it's doubled and is £1200. Then use the £1200 to pay for a £2000 gross pension contribution (which costs £1200 net).

Either way you can get to £2000 in a pension in a decade's time. But the latter method gives you some certainty about not locking up all your cash until your late fifties when you might need it back for emergencies (for example you said your emergency fund is only a couple of months salary).

Obviously your ability to make that £2000 contribution in ten years and get 40% tax relief depends on a successive government still offering 40% tax relief and you not already be using it with that year's spare income.

But someone who is already earning £50k at age 35, if kept on a decent career trajectory with pay increases meeting or exceeding inflation, would expect to remain higher rate tax for forseeable future.

Also there is the potential other benefit alluded to by others that if in a few years time you are earning say £60k and getting no child tax credit/benefit due to high earnings, a pension contribution at that point gets you 40% tax saving AND extra benefits. So in that year, if you had a load of spare ISA money, you could be putting away £10k into a pension getting 40%+++ on it, rather than (say) getting 40% this year on £5k and then only being able to afford another £5k at 40%++++

There are a few things worth thinking about. The obvious option is to grab as much tax relief now while you can. But if are confident that you can instead get as good, or almost-as-good, or better, tax relief later, it would allow you to pad out your cash savings (high interest rates available for relatively small amounts) and your medium-long term investments (S&S ISA) and do relatively less pension now because pension is a one-way trip.

Anonymous101

Bravepants wrote: »

Hello,

I too pay AVCs as I'm in the 40% bracket. I use AVCs for two reasons:
1. Save 40% tax where I can.
2. Lock money away that I cannot touch until later in my life.

However I try to just skim off the 40% component into my AVCs, so I pay about 10 % of gross of my salary into my AVC account. It depends on how high above a £50k salary you are on, but it might be that by paying 20% into AVCs you are partly down into your 20% allowance. You might want to pay into a S&S ISA to make the money more available, perhaps for retiring BEFORE 55. It depends on whether both my points 1 and 2 above are equally important to you, or just the tax implications.

This is quite a good article on pensions, ISAs and tax implications:

http://monevator.com/pensions-versus-isas/

Read the comments section too though.

Cheers,
P

Thanks.
I think its likely that i'll be shortly be too far into the 40% for my AVC's to take me totally into the lower tax bracket. I'd think that my pensionable salary will be close to £60k and other income such as car allowance etc will take me over £60k. My current AVC's of 10% will still have me over £50k after deductions.

I'm coming to the conclusion that I'll increase my AVC's to 14% so 20% of my salary in total with my employers contribution will be going into my pension. I'll then look to begin contributions to my S&S ISA for medium term investing whilst still adding a little to my existing cash reserves.

Anonymous101

bowlhead99 wrote: »

If you have £1000 of salary you can:

Put £1000 in a pension and invest it for a decade until it's doubled and is £2000 ; or

Take it as £600 cash net of tax and put it in a S&S ISA for a decade until it's doubled and is £1200. Then use the £1200 to pay for a £2000 gross pension contribution (which costs £1200 net).

Either way you can get to £2000 in a pension in a decade's time. But the latter method gives you some certainty about not locking up all your cash until your late fifties when you might need it back for emergencies (for example you said your emergency fund is only a couple of months salary).

Obviously your ability to make that £2000 contribution in ten years and get 40% tax relief depends on a successive government still offering 40% tax relief and you not already be using it with that year's spare income.

But someone who is already earning £50k at age 35, if kept on a decent career trajectory with pay increases meeting or exceeding inflation, would expect to remain higher rate tax for forseeable future.

Also there is the potential other benefit alluded to by others that if in a few years time you are earning say £60k and getting no child tax credit/benefit due to high earnings, a pension contribution at that point gets you 40% tax saving AND extra benefits. So in that year, if you had a load of spare ISA money, you could be putting away £10k into a pension getting 40%+++ on it, rather than (say) getting 40% this year on £5k and then only being able to afford another £5k at 40%++++

There are a few things worth thinking about. The obvious option is to grab as much tax relief now while you can. But if are confident that you can instead get as good, or almost-as-good, or better, tax relief later, it would allow you to pad out your cash savings (high interest rates available for relatively small amounts) and your medium-long term investments (S&S ISA) and do relatively less pension now because pension is a one-way trip.

That's excellent thanks very much. I hadn't thought of it like that and certainly worth a lot of thinking about.
It hadn't occurred to me that I could make a future AVC from savings. I don't know why as I have done that before! :money:

bowlhead99

You can think of it as using your savings and investments to make a future pension contribution, or you can think of it as using savings and investments to partially live off to allow you to use some salary to make a pension contribution. It gets you to the same place.

The important thing to realise is that your s&s isa can invest in pretty much all the same things that your pension can invest in, delivering the same returns for the same investment risks. And of course that holds true in negative markets too.

For example, imagine if you invested the £600 in a s&s isa and instead of doubling over next decade, it halved over the next half decade, and you planned to make a pension contribution at that point.

"Oh no!" You might cry,"now I can't afford to make that £2k gross pension contribution because I only have £300, and I won't get much tax relief on a £500 gross contribution!". But not to worry. If you had instead invested the £1k gross salary money in the pension in similar investments, it would also have halved, so you would have only got £500 in the pension by that point anyway. So you can still "keep up" with the pension by using the £300 ISA money to afford a £500 gross contribution.

Your only risk using the "pension later" model is tax relief being restricted to below the percentage amount you can get today. Some people prefer the "bird in the hand" approach and want to take the relief ASAP. However, if you don't feel you have the ability to commit it all to a pension just yet, the maths above shows it is not necessarily a big problem, if you are expecting lots of high rate relief capacity in the future through having lots of earnings. And if you don't have lots of earnings, you might be glad of having some cash savings and s&s investments to fund your needs.

The important thing to do if you prefer to do pension later rather than sooner is to keep up an awareness of government announcements and consultations re restrictions on higher rate relief so you don't get caught out too badly if things fundamentally change.