Pension Vs ISA

Firegirl

My first time posting about retirement planning, I’ve been a regular in the mortgage free wannabe space!!! I’m fairly  finance savvy but for some reason pension planning is getting me in a twist so I’ve spent time reading the threads and thought it was time I asked for your opinions!

I live in Scotland and when I earn over £43663 I move to a higher tax rate of 42%.  My salary is approx 100k per year and I don’t spend that much at all. ( I know how lucky I am)

I’m really not sure why I’m struggling to wrap my head around this but I think it’s because there are unknowns such as the govt could change rules at any time!  Also with pension I get tax relief now but then I’ll have to pay tax on it when I withdraw from it.  Uncertain health condition in the mix.

Ok getting to the point - My general question is should I save to my pension or my ISA or a bit of both. 

Some info:

I’m 45ish

Current ISA approx £80k

Current pension pot approx £160k

Mortgage Neutral (not worried about mortgage small mortgage as with other savings am mortgage  neutral)

I spent many years blasting the mortgage but when I got a job with a significantly higher salary I started paying into pension because my mortgage rate was so low and pension gave me tax relief.  Nice seeing 25% tax relief get added for each deposit!  Note I am working PAYE and my company do not match any pension contributions so I have a private pension.  HMRC have said I can do a simple assessment and I don’t need to complete a self assessment, which I thought was strange but perhaps that depends on the amount I pay to pension…. Maybe that’s a question for another day!

Due to a health condition that is not life threatening but also will gradually get worse over time I will def retire early and am aiming to have the choice at 55, so I have 10 years to plan.

What do you think Pension Vs ISA or any tips!

BoGoF

Given the fact you will be liable to the new 45% tax rate next year then I would be looking to mitigate this as far as possible.

Do also remember you will be able to take out 25% tax free from your private pension which would be at 57 for your age under current rules. Given that you would be getting 42%/45% relief on your contributions and would.likely only be paying 21% on any future pension then the pension looks more attractive but if you want the flexibility of accessing early then nothing stopping you doing an ISA as well. You need to ascertain what you need to live on in retirement and plan based on that.

jamesd

The pension annual allowance is now £60k gross so I suggest that you start by using all of that and add stocks & shares ISA investing with any additional money. Given your current pot size and ten years to go I think you'll stay clear of the potential of extra tax on taking more than the lifetime allowance that Labour says they will reintroduce. Catch for you is you probably have an age 57 minimum access age but your scheme might be one with a protected 55 age, ask.

When making personal pension contributions 25% is added to the pot to give you the basic rate relief. To get the higher rate reliefs you tell HMRC your expected gross pension contribution for the year & they issue a new tax code. No need to wait for the tax return. They work it out by increasing your basic rate band by the gross contribution.

A good core investment is a global equity tracker fund. Maybe add 10% for a global small cap fund if you can handle a 60% bad year drop vs the 40% for the standard one.

You could instead target an after pension gross of £43,633 to allow more ISA adding.

Main role of the ISA is going to be bridging a few years so you can wait to add to that. You probably already have enough.

25% of your pension pot is likely to be tax free, assuming you don't go over the roughly million combined limit. The remaining 75% is taxable when you withdraw it, so plan to withdraw at a tax efficient rate.

For greater overall tax efficiency you might look into Venture Capital Trust investing. VCTs get 30% initial tax relief from HMRC and tax exempt dividends, typically 5% a year, with no CGT. The 30% is capped at your otherwise payable tax for the year. It's easy to buy enough to eliminate your lower rate tax liability. You have to repay the 30% if you sell within five years. You can recycle the same money every five years or take the ongoing dividends or some of each, up to you. With around £25k a year to cover most if the tax liability a five year plan would accumulate about £87,500 in VCTs net cost with around 5% of £125,000 in annual dividends, £6,250. About 7.1% of your net cost. 5% isn't guaranteed, it's just a common policy.

I'm currently using this approach to extract my pension pot with about nil net tax cost. Taxable.. but you can mitigate the tax with VCTs if you want to and I do.

Your large surplus income is part of why I think VCTs might be suitable for you.

hugheskevi

I live in Scotland and when I earn over £43663 I move to a higher tax rate of 42%.  My salary is approx 100k per year and I don’t spend that much at all. 

....

Current ISA approx £80k

...

Mortgage Neutral (not worried about mortgage small mortgage as with other savings am mortgage  neutral)

So you have no immediate nor foreseeable need for liquid assets given you have other savings and ISAs in addition.

You could plan to repay the mortgage from pension lump sum perhaps, which would be very tax efficient.

I’m really not sure why I’m struggling to wrap my head around this but I think it’s because there are unknowns such as the govt could change rules at any time!  

Political uncertainty applies to all financial products, albeit to a greater extent with some. Concern over such things generally would lead you to take advantage of incentives available at the current time, in fear that they will be removed or curtailed.

Also with pension I get tax relief now but then I’ll have to pay tax on it when I withdraw from it.  

From 2024/25 you will be paying 45% income tax on taxable income in excess of £75,000 (and 67.5% on any taxable income between £100,000 to £125,140). 

You can obtain relief at 45% (more if you have access to salary sacrifice or taxable income exceeds £100,000). When you draw this, you will get 25% tax-free.

Assuming your income in retirement is under £43,662 you will be paying 21% in retirement on the remaining 75% (and 0% on the income within your Personal Allowance). Hence the effective tax rate you pay is (25% x 0%) + (75% x 21%) = 15.75%. 

Hence every £1 of your income over £75,000 you put into a pension costs you 55p (possibly less) and you will get out 84.25p - a tax gain in excess of 50% on that 55p you put into a pension.

You can contribute up to £60,000 per year into a pension, plus use carry-forward from previous years if you would contribute more than this. That would enable you to avoid all of your higher-rate tax liability potentially.

Uncertain health condition in the mix.

Does this have any bearing on your plans, ie, does it mean you prefer to have access to your savings rather than tying them up in a pension until age 57/58? Would you qualify for early ill-health access to a pension from the condition were it to be an issue?

I spent many years blasting the mortgage but when I got a job with a significantly higher salary I started paying into pension because my mortgage rate was so low and pension gave me tax relief.  

You are reclaiming higher rate relief if this is a Relief-at-Source scheme?

Note I am working PAYE and my company do not match any pension contributions so I have a private pension.  

The company does not provide you with access to salary-sacrifice?

Due to a health condition that is not life threatening but also will gradually get worse over time I will def retire early and am aiming to have the choice at 55, so I have 10 years to plan.

The earliest you will be able to access the pension is age 57, unless you have a protected minimum pension age or qualify for early access through ill-health. ISAs are probably appropriate to fund the years between 55-57.

What do you think Pension Vs ISA or any tips!

Pension seems fairly compelling, given you have savings to cover your outstanding mortgage, a decent ISA already and more income than you need for your expenditure.

Firegirl

Wow! Thanks so much for the info!

BoGoF, I think you hit the nail on the head saying that I need to ascertain what I need to live on in retirement!  It’s really hard to know and I’ve rethought this several times based on number of holidays!  25% tax free, I knew this but forgot….that is significant.

Jamesd, I’ll check if my pension has protected age 55. I didn’t know this so thanks.  I’ve told HMRC my current planned contribution for this tax year but as I am likely to up this I’ll call them again. Struggling to understand your paragraph on VCTs so I’ll def look into that further! Sounds interesting and very tax efficient.

Hugheskevi, thanks for those tax calcs! It’s really cleared up my spinning head.  Early ill health access. I’ll look into this! This would take away the concern re using ISA to cover years before 57.

I’m a contractor and the agency pay me paye.  The agency pay some of my salary to a nest pension but that hasn’t much in it and they don’t offer any matching.  I will double check this again though!

Thanks again, lots to think about!

Fermion

Firegirl said:

I’m a contractor and the agency pay me paye.  The agency pay some of my salary to a nest pension but that hasn’t much in it and they don’t offer any matching.  I will double check this again though!

Presumably the Agency is paying you as, or through, an Umbrella company? Has the end client mandated this or did you have the option to set up your own limited company? The latter might be more tax efficient for you as you can choose how and when you pay yourself dividends and this would also allow you to pay employer Sipp contributions if you wanted. If it is an umbrella company just check that you are contracted for holiday and sick pay.

I agree with Jamesd regarding VCTs- these could be tax efficient in your situation, although you need to select VCTs that offer regular VCT share buyback options so you can exit after you have held them for 5 years. (Selling VCTs can sometimes be a problem). Also VCT that invest in lower risk startups to reduce your risk exposure. When I was in a similar situation to yourself some years ago I invested in Foresight Enterprise VCTs and held them in my HL Share Account. I only recently cashed in my last VCT investment after holding for 5 years - they performed well - apart from the 30% initial tax relief they paid tax free dividends of about 5% per annum gave a Nett investment return of about 10%. 

jamesd

Nest doesn't offer any investments that I'd call good so best to use somewhere else for most of your money. They also tend to put people in low growth options for ages so I suggest turning off lifestyling and picking their Sharia fund, which looks like their least bad option.

VCTs trade on the London stock exchange just like their much older companions investment trusts. But the tax structure means there are relatively few buyers and it's routine to tell the VCT company that you'd like to sell when they next offer to buy back shares from investors. Policies on this vary by VCT and over time. Some do it monthly, some around once a year and sometimes they can decide not to do it for a while. There's also a discount policy, how much below the current price they will do this at. It varies by VCT but around 10% is typical.

VCTs generally look to give most investment returns as dividends, not share price growth. That reduces the effect of the discount. It's routine for VCTs to pay special dividends after selling their interest in one of the companies they invested in. Back in 2021 Albion VCT paid out around 30% of its total value in special dividends after selling several care homes that had done well.
 
I've been choosing to hold mine for the dividends so Fermion and others can share more about the selling experience.

Firegirl

Fermion, I used to have limited company and did exactly as you suggest but now I’m inside IR35 so the agency pay me PAYE. I signed up for pension but it’s not great so I have a private pension too.  I get holiday pay and I usually just take holidays if I’m sick…..ironically I’m rarely sick even with a long term health condition….my general health is good.

Jamesd, agree Nest pension isn’t the best so the amount I have there is very small.  I should actually check if I should just stop that.  I can’t remember if it comes out of my wage or if the agency pay it and I’ll look at the fund choice.

Been reading up on the VCTs, I def like the sound of it as it feels like supporting small businesses. 

Thanks again for your input, much appreciated even if my jobs list is growing 😆

amanda1024

Just to add, you might want to double check whether your employer (the agency?) *ought* to be making employer pension contributions even if they aren’t currently - I thought there was a 3% minimum employer contribution under the auto-enrolment rules (https://www.gov.uk/workplace-pensions/what-you-your-employer-and-the-government-pay) - i.e. not only do you make the significant tax savings described above by avoiding the new 45% rate, your 5% is bumped up to 8% by the employer

Firegirl

Great minds Amanda1024.  I’ve just checked and the current contributions are made by the agency. I’m not putting any contributions so I’ve dropped them an email to see if there is any matching if I put a percentage in.  I’m sure I checked this before but worth double checking!  I’ve also asked what percentage they are contributing.

response already!
Strange though cause I can see that this tax year I haven’t contributed anything on the nest portal, I better check
my payslips!

‘As your employer we contribute 3% into your pension pot, it is not matching contributions, your deposit consists of 5% unless you opt to increase this by reaching out to our pensions team.’

Update again….looks like Nest aren’t separating the split between company contributions and my contribution's.  This investigation into pensions is uncovering more every step of the way!

NoMore

Firegirl said:

Update again….looks like Nest aren’t separating the split between company contributions and my contribution's.  This investigation into pensions is uncovering more every step of the way!

That sounds like its a salary sacrifice arrangement, basically you give up some of your salary and the employer increases their contribution, saves you NI and income tax this way, rather than via relief at source which only saves you income tax.