Pension increase or ISA

dunstonh

It's not as simple as that, since you have given up all claim on your capital for the higher income.

Correct. However, that is why you compare. Also, the capital retention is a bit of a red herring. If you spend that capital, it further reduces your income. So, you cannot do anything with it. Plus, if you use a cash ISA you are at risk of interest rate fluctuations (2 years ago rates were half what they were now). If you use investment ISAs, your capital is at risk of fluctuation.

Perhaps you could reveal to us from the tables you show to your clients, how long men and women have to live to lose out by not taking a pension compared to if they invested the money in an ISA?

I am not a big fan of pensions. I prefer ISAs and unit trusts. I will feed most into conventional investments outside of the pension wrapper.

That said, there is a place for pensions and you cannot get away from the fact that when it comes to income provision in retirement, the pension will give the higher income.

If you want to build capital you wouldnt use a pension but if you arent paying enough towards your retirement, then the pension is probably the best option because you get more for your money. After tax relief and return of tax free cash, you will typically be getting a return of around 10% of your net contribution.

baby_boomer

dunstonh wrote: »

After tax relief and return of tax free cash, you will typically be getting a return of around 10% of your net contribution.

There is no "typically" on this site.

Are you referring to a 40% taxpayer or a 20% taxpayer?

dunstonh

There is no "typically" on this site.

Are you referring to a 40% taxpayer or a 20% taxpayer?

basic rate taxpayer

baby_boomer

dunstonh wrote: »

After tax relief and return of tax free cash, you will typically be getting a return of around 10% of your net contribution.

Do you mean a return of 10% ON your net contribution? Or something else entirely?

Is that a 10% return from the date of investment or from retirement?

Your language is strangely vague / imprecise for a financial adviser.

What are the variables?

Investment rate?
Date of investment prior to 60/65 retirement date?

dunstonh

Investment rate?

Forget investment rate. That will be the same on a pension or an ISA as they have identical funds and charges (assuming unit trust here. pension will be cheaper on stakeholder but lets keep charges equal for the comparison).

Look at a basic rate taxpayer in this tax year and assume immediate commencement so we ignore growth.

Pension contribution of £3600 gross = £2808 net. Take 25% tax free cash back which is £900. So, the actual cost is £1908.

Annuity rate of 7% (yes I know women are slightly less but men are slightly more so picked a figure in between) = £189 p.a. on that contribution.

The £3600 invested has cost you £1908 because of tax relief and 25% TFC given back. So, £189 against that £1908 is 9.9%

baby_boomer

Although with Gordon's tax change from April 2008, that 9.9% "return" reduces to 9.5% (and don't forget you no longer have your original investment).

dunstonh

Yes, his tax rate change will hit basic rate taxpayers. Although the over 65s will have a larger personal allowance so that makes up for it.

You may not have your original investment but if you are short of income but heavier on capital, using the pension to get you above 9% return guaranteed is worth considering.

Remember, the capital is only of use if you can spend it without it hitting your income.

The art of retirement planning is balancing your income and capital needs and using the right tax wrappers to meet that need. You cannot assume ISA is best every time and you cannot assume pension is best every time.

ffacoffipawb

dunstonh wrote: »

The £3600 invested has cost you £1908 because of tax relief and 25% TFC given back. So, £189 against that £1908 is 9.9%

Not really, since the fund is £2700 not £3600 because you have taken the tax free cash.

The £2700 fund has cost you £1908.

dunstonh

ffacoffipawb wrote: »

Not really, since the fund is £2700 not £3600 because you have taken the tax free cash.

The £2700 fund has cost you £1908.

The net cost is £1908. So, the income against the net cost is 9.9%

jamesd

dunstonh, your comparison here seems unreasonable since you're comparing drawdown with capital preserved from ISA with the capital spent for extra income in the pension. Should be the same for both: each drawdown or each annuity purchase.