Pension or ISA for Retirement Savings

Secret2ndAccount

Let me make this very simple for you:
I earn £1000. I pay tax, and take home £800
I put £800 in a stocks and shares ISA. Ten years later it has doubled. I take out £1600
I put £800 in a SIPP. Taxman adds £200. Ten years later it has doubled. I have £2000. I can take 25% tax free (£500) and the rest at 20% tax (£1500 x 0.8 = £1200) So I have £1700   £100 more than if I had used an ISA
I can operate the SIPP myself in the same way I would operate the ISA. No financial advice is required to open, operate or close the SIPP.
SIPP fees can be a little bit more than ISA fees. If you are doing all this with £1000 it's not worth it. If you are doing it with £100,000 it is.

The above is a base case. If you are a 40% earner, but only a 20% taxpayer in retirement, the advantage of SIPP grows. If you retire early and have some years when you are not using up your £12,570 tax allowance then you can get money out of the SIPP tax free - again better than the above example.

By using an ISA you are paying the tax up front. You are absolutely commiting to pay that tax right away. If you turn out to have a lower tax rate in retirement - too bad - you already paid the tax. Only in the rare case of a 20% earner who hits the 40% bracket in retirement would a pension lose out to an ISA. Remember, you also get the first 25% tax free out of a pension. That part of the money is that rarest of things - it has never been taxed.

MEM62

Makemydeal said:

Can I start by saying, I'm not in financial services. These are my simple observations of my pension options. I've made a comparison list for debate.
Pensions; Tax Free savings ISA; Tax Free savings.  You omitted to say that pension saving go in before income tax.  ISA savings go in after income tax - so there is a 25% advantage for the pension on day 1.  Also that you might be able to take advantage of employer contributions.        
Pensions; percentage of earnings. ISA; Max £20k p/a
Pensions; Accessed at 67 (Drawdown from 55, but with tax to pay) ISA; Full access.  The whole point of a pension is to provide for retirement.  It is therefore appropriate that you cannot access them at a younger age.    
Pensions; annual management fees. ISA; No fees   Incorrect.  ISA's have fees also.
Pensions; Very Expensive financial advice needed to sort out a maturing pension. ISA; No fees.  Also incorrect
From my experience, the complicated nature and choice of pensions is a problem, deliberately created by the financial institutions. Incorrect again.  The rules are set by legislation and it it not that complicated.  You then need to pay them to advise you how to solve the problems they created.  Now we are in the realms of fantasy  An ISA is very easy to sort, with no hidden fees. As is a pension Your money maybe won't grow as much, but you get it all when ever you want.  Investment choices dictate how your investments grow, not which tax wrapper you put them in.  The same investments in a pension would not grow any more or less than those in a ISA.    
Most people who take the pension option will pay tax on it. This diminishes the better return you may have got.  Again, although, yes, pension income is taxable, overall this statement is correct  ISA is always tax free. Well at least you got that right
The answer may not be as clear cut as you might think? 

Clearly you do not have a proper understanding of pension or how they work.  Doing some more research would serve you well and is highly likely to benefit your future-self.    

Makemydeal

Secret2ndAccount said:

Let me make this very simple for you:
I earn £1000. I pay tax, and take home £800
I put £800 in a stocks and shares ISA. Ten years later it has doubled. I take out £1600
I put £800 in a SIPP. Taxman adds £200. Ten years later it has doubled. I have £2000. I can take 25% tax free (£500) and the rest at 20% tax (£1500 x 0.8 = £1200) So I have £1700   £100 more than if I had used an ISA
I can operate the SIPP myself in the same way I would operate the ISA. No financial advice is required to open, operate or close the SIPP.
SIPP fees can be a little bit more than ISA fees. If you are doing all this with £1000 it's not worth it. If you are doing it with £100,000 it is.

The above is a base case. If you are a 40% earner, but only a 20% taxpayer in retirement, the advantage of SIPP grows. If you retire early and have some years when you are not using up your £12,570 tax allowance then you can get money out of the SIPP tax free - again better than the above example.

By using an ISA you are paying the tax up front. You are absolutely committing to pay that tax right away. If you turn out to have a lower tax rate in retirement - too bad - you already paid the tax. Only in the rare case of a 20% earner who hits the 40% bracket in retirement would a pension lose out to an ISA. Remember, you also get the first 25% tax free out of a pension. That part of the money is that rarest of things - it has never been taxed.

Thanks for your input. I have already retired at 60, and plan to "draw down" 25% tax free and £12,570 tax free each year. I will put the money in a cash ISA. I think the low growth of the cash ISA, would be compensated by the tax saving?

Secret2ndAccount

Yes, a good idea to use up your tax free alowance every year and move the money to ISA.
You can also continue to put 2880 into a SIPP each year if you wish. This tops up to 3600. You gain £200 after tax, less the fees. Some people think it's worth it. Others can't be bothered. If you think you can get it out tax free, then it becomes much more positive (+£700)

eskbanker

Makemydeal said:

Pension or ISA for Retirement Savings

The answer may not be as clear cut as you might think? 

The answer should usually be fairly clear cut but is obviously dependent on accurately defining the question, rather than attempting to a reduce a multi-faceted analysis to a simple one-size-fits-all generalisation!

dunstonh

Thanks for your input. I have already retired at 60, and plan to "draw down" 25% tax free and £12,570 tax free each year. I will put the money in a cash ISA. I think the low growth of the cash ISA, would be compensated by the tax saving?

And that money in the cash ISA is planned to spend within 5 or so years?

Have you factored in shortfall risk and inflation risk?  Especially as interest rates are now falling.

Makemydeal

dunstonh said:

Thanks for your input. I have already retired at 60, and plan to "draw down" 25% tax free and £12,570 tax free each year. I will put the money in a cash ISA. I think the low growth of the cash ISA, would be compensated by the tax saving?

And that money in the cash ISA is planned to spend within 5 or so years?

Have you factored in shortfall risk and inflation risk?  Especially as interest rates are now falling.

Would you believe a Stocks & Shares ISA would be better than a Cash ISA over 5 years?
Or leave the pension alone until 67? The state pension may be the same as the tax free allowance per year? Then I would pay 20% tax on any pension?

dunstonh

Would you believe a Stocks & Shares ISA would be better than a Cash ISA over 5 years?

Statistically, the vast majority of 5-year periods see investments outperform cash.    For terms longer than 5 years, the odds of investments will be better increases.   For most people, a combination of things is best.  i.e. cash for short term and rainy day and investments for medium to long term.    

You could be alive for another 30 years.  Cash would be an awful option for money you intend to spend in 20 years time but its the best option for money you intend to spend in 2 years time.

Or leave the pension alone until 67? The state pension may be the same as the tax free allowance per year? Then I would pay 20% tax on any pension?

You pay a net effective rate of 15% on the pension as 25% is tax free and 75% is taxable.    20% on that 75% chunk equates to 15%.           

This is why earlier posts were making the point that with tax relief on the way in and tax on 75% of it on way out, that equates to pensions being 6.25% better than Cash ISAs if you are a basic rate taxpayer when paying in and when drawing out.

cfw1994

In summary:
With the benefits of the tax top up plus company contributions, especially if one becomes a high rate tax payer paying in and a 20% taxpayer drawing out, the solid answer is “Pension for Retirement Savings” 💪

ISA for building up a fund to help allow an earlier retirement, or for other tax-free savings (but with money that had already been taxed) 👍

Cash ISA (or pension) only for very short term savings that *will* be needed, otherwise inflation will invariably reduce the value of the money saved.
S&S for mid- to long-term.