Sole Trader - Savings / Investments / Pension Advice

oysteroyster

Hi all. Have asked a similar question to this in the past, but was hoping I could get a more up-to-date response. Sadly I've not properly acted on things since the last time - I'm generally pretty good with money, but it's easy to put these things off! Anyway, my current situation...

• 32 Years Old (approaching 33) living in Yorkshire.
• Self Employed Sole Trader for 10 years - earning approx £60k-£70k pa.
• Tax obligations accounted for, I have about £85k in savings, which is split between interest paying current accounts, savings accounts, cash ISA, and a small amount with a P2P lender.
• No debt other than mortgage and student loan (nearly paid off the latter).
• Engaged and living with partner who has a salary around £60k pa (marriage fund taken care of)
• No Kids, but a future possibility
• Recently renovated a house with my partner - turning a 500k house into a 700k house - the new valuation means we have likely profited around £125k from it, creating a shared equity of around £280k.

So, here's the dilemma I continue to struggle with: I DON'T have a pension, or pay into a S&S ISA, which I know I need to get a grip on next.

I'm sure everybody is now going to shout at me and tell me to start a pension (a SIPP?) to begin accruing a good retirement through compound interest, as well as reducing my tax bill, but I just can't get excited about it. I really dislike the old-fashioned idea of locking my money away and would much prefer to just manage it myself - and have it readily available for whatever reason. However, I'm also not stupid and appreciate that this may be the only way to maximise returns / reduce my tax burden?

So, can anybody give me any advice of what action to take? Given I'm reasonably financially comfortable in other aspects of my life (I'm self made, it's not parent's money, I should add!), does anyone think I could easily make a good plan without needing a pension? Or not?

Either way, I likely need to dip my toe into a S&S ISA, right? My gut feeling is just to begin funding a higher risk Vanguard fund and forget about it - thoughts? Also, knowing how much of my current savings to allocate to this, and pay in on an ongoing basis, is another big question for me?

Any help would be HUGELY appreciated - I need to get this sorted out once and for all. Big thanks in advance!

oysteroyster

Bump! Can anyone help at all?

Dazed_and_confused

I'm sure everybody is now going to shout at me and tell me to start a pension (a SIPP?) to begin accruing a good retirement through compound interest, as well as reducing my tax bill, but I just can't get excited about it.

You don't need to use a SIPP, standard personal pension or stakeholder are alternatives.

Assuming that the earnings of £60-70k is referring to taxable profit then pension contributions are generally seen as very tax efficient.

If you contributed say £8,000 to a relief at source pension the pension company, courtesy of HMRC, would add £2,000 basic rate tax relief so you have £10,000 in the pension fund.

You show this on your Self Assessment return and this increases the amount of basic rate tax you can pay, which in turn will reduce the amount of higher rate tax payable. Saving you £2,000 off your personal tax liability.

So you end up with £10,000 for a net outlay of £6,000.

However, compound interest will not make you rich in a pension wrapper. In fact you would almost certainly lose money over time as pensions will only usually pay very small amounts of interest so inflation will erode the value over time. At your age pensions are about investing, not saving.

The potential downside to a pension is that 75% of the fund will be taxable so you may pay 20% or 40% tax later on. And you can't access the money until you are 55 (possibly 57 in the future).

ISA's are tax free when money is withdrawn and there is no age restriction but in your situation you wouldn't save any tax in the first place with an ISA.

Maybe a mix of both would be worth considering, to get upfront tax benefits of a pension coupled with flexibility of an ISA.

And have a look at Lifetime ISA's, these might be worth a punt.

SonOf

I'm sure everybody is now going to shout at me and tell me to start a pension (a SIPP?) to begin accruing a good retirement through compound interest, as well as reducing my tax bill, but I just can't get excited about it.

Financial planning is not meant to be exciting.

I really dislike the old-fashioned idea of locking my money away and would much prefer to just manage it myself - and have it readily available for whatever reason.

Being in a pension doesnt prevent you from managing it. The same investment options exist with pensions as they do with other tax wrappers. The Government give the "free" money in the form of tax relief because you are funding your retirement. If you dont want to plan for your retirement then you are not going to get that tax relief.

So, can anybody give me any advice of what action to take?

Any local IFA can give advice.

does anyone think I could easily make a good plan without needing a pension? Or not?

Failure to use a pension means any other solution will not be optimal.

Either way, I likely need to dip my toe into a S&S ISA, right?

Pension massively beats ISA on a like for like basis.

My gut feeling is just to begin funding a higher risk Vanguard fund and forget about it - thoughts?

Its one of 30,000 or so options.

Also, knowing how much of my current savings to allocate to this, and pay in on an ongoing basis, is another big question for me?

That figure will be personal to your circumstances and objectives.

I'm going to be blunt on purpose. Don't take it the wrong way but you need to grow up a bit and realise that you need to fund all phases of your life. Now, short term, medium-term and long term. Ignoring the long term (pension in this case) because you dont like the idea of planning for the long term is daft. You are going to be in your 60s quicker than you realise. Your elder self will consider your younger self a fool for not using a pension when it is so clearly the best option. You are not a teenager or inexperienced 20 year old any more. You are in your 30s. You are self employed and earning well. So, apply your common sense to retirement planning.

oysteroyster

Thanks both. And don't worry, be as blunt as you like - I won't be offended. And yes, I think you're right to suggest talking to an IFA as there's a lot of consider and I can't proclaim to fully understand the system or all my options... but the MSE forums are always a good place to start!

You don't need to use a SIPP, standard personal pension or stakeholder are alternatives. However, compound interest will not make you rich in a pension wrapper.

If I SIPP allows me to invest in S&S in the same way as I could in an ISA (except it's taxable), why is there not the potential to make good money just because it's in a pension wrapper?

Don't take it the wrong way but you need to grow up a bit and realise that you need to fund all phases of your life.

Appreciate what you're saying regarding thinking about the future, but I would argue that I most definitely am thinking about the future and am looking for a different, non-traditional method of planning for it - which may, or may not exist - but I'm open to looking at other, potentially more flexible options. I don't feel as though I'm reckless with my money and don't feel as though I should have to lock my money away as an incentive not to spend it - I can do that by myself. Unfortunately it would seem the tax benefits of funding a pension right now are going to be hard to ignore, but am I not just saving on tax payments now, only to be charged later?

Its one of 30,000 or so options.

Appreciate that, but it sounds like a good place to start.

You are not a teenager or inexperienced 20 year old any more. You are in your 30s.

Correct, with plenty of responsibility and experience, but pensions and investments are a very complicated area, not taught in school and conflicting information coming in from all other angles. Don't forget, the vast majority of the population will be blindly paying into a company pension without too much thought for the future and what it all really means. I'm proactive in being careful with my money, saving, investing in my property etc, which all have longer-term goals in mind, but happy to admit I've not yet got my head around pensions and stock market investment. That's why I'm here.

We're talking about pumping large amounts of money either into investments that could go awry or locking money away for years and years - it absolutely has to be right - I'd say these were pretty big life decisions and I'm very cautious of making the wrong decisions. That's why it's easy to put off, not immaturity - it's much easier to focus on long-term things that I'm far more in control of.

Dazed_and_confused

If I SIPP allows me to invest in S&S in the same way as I could in an ISA (except it's taxable), why is there not the potential to make good money just because it's in a pension wrapper?

You could make good money, you can often invest in exactly same things through a SIPP as you can with a S&S ISA. But you were referring to compound interest. That would mean your money was saved, not invested. And interest rates on savings within a pension wrapper are poor. Compounding say 0.10% isnt a great return if you can get say 2% outside a pension.

But post people your age choosing a pension will be investing the money, often in funds. Not leaving it as cash (within the pension wrapper).

Maybe you are getting saving and investing mixed up

bowlhead99

oysteroyster wrote: »

If I SIPP allows me to invest in S&S in the same way as I could in an ISA (except it's taxable), why is there not the potential to make good money just because it's in a pension wrapper?

As they mentioned, you won't make 'good money' if it's put in pension and left as cash rather than put in pension and invested.

But then in terms of SIPP Vs ISA ...

You have £60-70k of income while the threshold for higher rate tax is £50k. So there is £10-£20k of business profits on which you are paying 40% tax.

Let's say the amount is £10k, and you don't use a pension.

You pay tax on the £10k at 40%, so out of the £10k you only have £6k of net cash after paying your taxes.

You put the £6k into an ISA invested in a Vanguard fund or whatever. Over the next three decades it quadruples in value. You are age 62 and now have £24k to spend on whatever you like.

Or, maybe you decide to use a pension. You put £8k cash into your SIPP and the pension provider claims basic rate tax relief from the government, so you have £10k in the pension. When you do your tax return, you tell HMRC that £10k of pension contributions were made, which HMRC knows will have cost you £8k, but as a higher rate taxpayer they should have only cost you £6k really. So HMRC extends the basic rate band for you so that the overall effect is you get £2k off the rest of your tax bill in addition to having received the £2k inside the pension. Your bank balance at the end is £6k lower than if you had not made the pension contribution at all

Overall, the £10k of pension investments cost you the same amount as the £6k ISA investment would have cost you. You invest the pension account in a Vanguard fund or whatever.

Then over the next three decades, the fund value quadruples, just like it would have done in the ISA. You now have £40k of pension assets at age 62, instead of £24k of ISA assets at age £62.

To access the pension assets, you may have to pay some tax. The first 25% can be taken out entirely tax free (£10k), but the remaining 75% (£30k) is taxed as income, at whatever is your marginal rate of tax in the year you take it out. For example, first £12.5k at 0% (annual personal allowance), next £17.5k at 20% (basic rate, £3500 tax to pay on it).

So to recap,
- when you used the ISA to invest in a vanguard fund that quadrupled in value, you turned £6k cash today into £24k cash for retirement.
- when you used the SIPP to invest in a vanguard fund that quadrupled in value, you turned £6k cash today into (£40k less £3.5k tax = ) £36.5k cash for retirement.

As £36.5k net from the SIPP is 52% higher than £24k from the ISA, with exactly the same investment risk being taken, I think I would prefer to use the SIPP.

The above assumes some of the SIPP withdrawal paid tax at basic rate. However, you can take your pension drawings whenever is convenient for you. You may have plenty of capacity to draw out ncome between giving up work (say, age 60) and starting to draw state pension (say, age 70), entirely within your annual personal allowance (£100k+ over a decade) with no tax to pay on it.

You are looking for a different, non traditional way of providing for your retirement. If you are self employed without certainty of income, makes sense you have a big cash buffer, and look at short and medium term investment rather than exclusively long term ones. But you do need to look at long term ones so it makes a lot of sense to try to get your head around the traditional ones first.

SonOf

Unfortunately it would seem the tax benefits of funding a pension right now are going to be hard to ignore, but am I not just saving on tax payments now, only to be charged later?

No. That is a misconception. Although like many misconceptions, there is an element of truth.

In retirement, you are taxed on income just as you are now. You have the personal allowance and anything above that is taxed.

Today, the personal allowance is £12,500. State pension is £8600. So, you have almost £4,000 of income that you can get tax free.

Then the pension itself only has 75% of the amount drawn taxed. 25% of it is tax free. Assuming you are a basic rate taxpayer in retirement and ignoring the personal allowance (you shouldnt but I am for this example) then the effective rate of tax on the pension is 15%.

So, you pay 15% on the way out but you have had 40% tax relief on way in.

Putting that another way, if you paid the same net amount into an ISA and pension you would have the following:

PENSION
£1,000 into the pension, it has only cost you £600 due to tax relief at 40%. Ignoring growth (As that is the same on an ISA or pension) that £1,000 is taxed at 15% on withdrawal. That is £150 which leaves you £850 in your pocket.

ISA
You dont get tax relief on an ISA. So, your £600 stays £600. Ignoring growth (as again, returns are identical) then you end up with £600. No tax to pay which leaves you £600 in yuour pocket.

So, a pension is £850 and ISA is £600 for identical cost after tax reliefs and tax drawn.

Pensions are also outside of the estate for IHT purposes. ISAs are not.

So, the pension beats the ISA significantly in your case.

And that personal allowance difference of nearly £4,000, if used by the pension is the equivalent of having around £133k in the pension. i.e. £133k drawn at the rate of 4% p.gives you around £4000 taxable income which falls fully within your personal allowance (remember its only the 75% bit that is taxable. The 25% is tax free).

oysteroyster

Thanks all - both new and clarification posts. Indeed, some of my points and questions will reflect my lack of understanding and confusion on the subject. Plenty to go on there, though it's remarkable that, even as someone that thinks of themselves as having at least half a brain, just how hard it is to get my head around some of the statements and calculations expressed above. As usual, I don't feel as though I'm going to come away with any clear answers; it's of course a deeply personal decision made upon a very individual set of circumstances - how anybody gets anywhere with these things, I'll never know!

So, to sum up (so far):

• A pension makes sense
• SIPP is probably the way to go
• Being self-employed, I should also consider a separate S&S ISA for short and medium term planning (and continue to keep a good cash buffer too)

That's pretty much what I expected, though part of me is still yearning for something else! I think it's the millennial, digital-native inside me. But figuring out exactly what to fund and what proportion to pump into each is the next dilemma...

badger09

oysteroyster wrote: »

Thanks all - both new and clarification posts. Indeed, some of my points and questions will reflect my lack of understanding and confusion on the subject. Plenty to go on there, though it's remarkable that, even as someone that thinks of themselves as having at least half a brain, just how hard it is to get my head around some of the statements and calculations expressed above. As usual, I don't feel as though I'm going to come away with any clear answers; it's of course a deeply personal decision made upon a very individual set of circumstances - how anybody gets anywhere with these things, I'll never know!

So, to sum up (so far):

• A pension makes sense
• SIPP is probably the way to go
• Being self-employed, I should also consider a separate S&S ISA for short and medium term planning (and continue to keep a good cash buffer too)

That's pretty much what I expected, though part of me is still yearning for something else! I think it's the millennial, digital-native inside me. But figuring out exactly what to fund and what proportion to pump into each is the next dilemma...

No.

S&S ISA not appropriate for short and medium term planning. Obviously, depends on your definitions:cool: but most would advise against stock market based investment unless your horizon is at least 5 years, but probably more like 7 - 10 or longer.

oysteroyster

Sorry yes, I meant more cash for short term, S&S ISA for medium (5-10 years included) and longer.