Average/benchmark pension returns

dancingfairy

Hi. I am thinking about setting up a pension by investing in stocks and shares within an ISA to supplement a non-contributory pension. I am trying to work out (without including inflation) how much I invest now will affect my final pension so am looking for average/benchmark percentage returns per year for medium risk and high risk portfolios.

So if I contribute £100 a month for 40 years (I am 25 and will retire at 65 ish) what will it be worth invested in a medium aggresive fund versus a highly aggressive fund.

My calculation will be something like this:
yearly contributions x average return ^ (to the power of ) 40

I appreciate that an average is just that, an average so for example if a decent med risk portfolio averaged 8% I could get anywhere from say 3% to 11% or something.

Anyway to summarise the q's are: a) the average/benchamrk returns for med risk/high risk portfolios as a percentage per year.
and b) is my sum roughly right?

Any help will be greatly appreciated
Many Thanks
df

EdInvestor

100 pounds a month for 40 years would give you:

@6% 191,616
@8% 324,180
@10% 559,461

Helpful hint: long term stockmarket returns are made up of 3 components

a)average GDP growth
b)inflation
c)dividends.

So make sure you choose shares that pay decent dividends and then reinvest them. Makes all the difference.:)

dancingfairy

Thanks. Could you tell me what formula you used please as I'd like to have a play around with different monthly figures. Also what rate of returns should I be looking out for for med risk and high risk portfolios?

bondo

Unless you require access to your savings before pension age then using an ISA is not as tax efficient as an additional pension (either as an AVC or a standalone personal pension depending on your circumstances). Although an ISA will grow (almost) tax free you will be missing out on the tax relief on your contributions you would get you went the pension route . The underlying investment choices can be the very similar. Only use an ISA if you want access and only use an additional pension if you have other short- term savings in my opinion.

£100 in ISA = £100 invested
£100 in pension = £125 invested(at basic rate tax) and that £125 would only cost you £80 if you were a higher rate taxpayer.

Over the periods you are considering that is a large difference.

nrsql

Furmula is
P((1+i)^n-1)/i

where
n = number periods (B2)
i = interest rate (C2)
P=investment (D2)

if you use excel and have columns in the above order with the formula in col a then it will be
=D2*(POWER((1+C2),B2)-1)/C2

For the annual interest rate you would need to put in the values
n = number periods (B2) = 40
i = interest rate (C2) = .06
P=investment (D2) = 100*12 =1200

This will compound yearly and so will be a bit low
To compound monthly you will need to calculate the monthly interest rate
=(1+i)^(1/12)-1
i = annual rate
in excel
=POWER((1+C2),1/12)-1
Put this in E2 and use in formula
=D2*(POWER((1+E2),B2)-1)/E2
n = number periods (B2) = 40 * 12 = 480
i = interest rate (E2) = monthly calculated
P=investment (D2) = 100

For your investment at 6% this gives
yearly investment 185,714
Monthly 190,767

Slightly different to EdInvestors figure of 191,616 but not far out. Probably due to rounding or inaccuracies in the formula.

nrsql

bondo wrote: »

Unless you require access to your savings before pension age then using an ISA is not as tax efficient as an additional pension (either as an AVC or a standalone personal pension depending on your circumstances). Although an ISA will grow (almost) tax free you will be missing out on the tax relief on your contributions you would get you went the pension route . The underlying investment choices can be the very similar. Only use an ISA if you want access and only use an additional pension if you have other short- term savings in my opinion.

£100 in ISA = £100 invested
£100 in pension = £125 invested(at basic rate tax) and that £125 would only cost you £80 if you were a higher rate taxpayer.

Over the periods you are considering that is a large difference.

But the pension will be taxed when it's taken out - the ISA will be tax free
(Under current rules). You gain on pensions if you are a higher rate taxpayer now but basic rate when taking the pension though.

Also if the rules change you can take out the ISA whereas the pension is stuck (unless that's the rule change).
I'm waiting for an annual tax raid on pensions (or maybe that should be "another one").

Dithering_Dad

nrsql wrote: »

But the pension will be taxed when it's taken out - the ISA will be tax free

Is it not the case that if the tax is rebated into the pension then the tax rebate also grows at a compounded rate, so that after the OPs 40 years of investment it will be worth significantly more than if the OP paid the same net amount into an ISA?

As you can also remove 25% tax free from a pension, so will only pay tax on the remaining 75% you'll never pay back more tax than is rebated?

I put the following figures in a monthly compound interest calculator at 10% interest rate:
£300 per month Net plus £60 tax rebate = £360 per month, over 480 months (40 years). This gives you a figure of £2314973

If you did the same in an ISA: £300 per month over 480 months, this gives you a figure of £1,929,144.00 which is £385, 829 less than the pension option.

Surely you can't expect to pay £385,829 in tax for the years you retire, especially given that the tax thresholds are much higher in retirment than they are while working???

In fact, if you took the £385,829 out of the pension via the 25% tax free lump sum, you'd then have an identical pension pot as Mr. ISA to fund your retirement, but also have £385,829 to fund a massive world trip, and yatch purchase or other amazing retirement treats!!

Why does anyone advocate ISAs over pensions for retirement planning??? Please explain where I am going wrong??

p.s. This also pre-supposes that you retire in the UK, if you retire in a EU country with lower taxes or higher tax free thresholds for the elderly (or both), then you gain from the UK tax system, but never have to pay any back??

nrsql

Compounding of the tax rebate doesn't make any difference as you will pay all that back when you take it out. If the tax rebate gets compounded and the paid back at the same rate then it's the same as not getting the rebate and not paying tax - any advantage would only be in different rates.
The 25% tax free does make a difference and that's what's you get for locking the money away.
Also have to take into account expenses on running the products.
Also remeber that you will get a basic state pension which will use up tax free allowances in both cases

The main gamble is on how the rules change - I consider pensions to be too vulnerable and hence risky but everyone has to make up their own mind.

p.s. I don't know much about pensions so the above may be wrong - I just think the risk overrides everything else so the details don't really matter.

dunstonh

It is worth noting that you are not automatically taxed on your pension income. You have a personal allowance which allows you to earn an amount tax free. This is increased at age 65 and 75. Pensions are by far the best option when you are looking to provide an income up to your personal allowance limits. After that, the difference in pension and ISA becomes less. Although as far as income provision only goes, the pension beats the ISA. There are certain other pros and cons (such as pension contributions lowering your income which can increase your working/childrens tax credits but not on ISAs). There is a guide to these in the ISAs vs pensions thread.

EdInvestor

The main problems with pensions are that

a)the tax relief is largely illusory as you are taxed on the way out on 75% of the money, and

b) you lose control of the capital, which can never be taken out or passed on to heirs.

The fact that the money is trapped also means it suffers from regulatory risk that the rules may change not in your favour at any time and you can't withdraw the money.

If you are a basic rate taxpayer and have no employer's contribution, IMHo the ISA tax wrapper is the better option to save for retirement. The ISA allowance is 'use it or lose it' on an annual basis, whereas large lump sums can be moved into pensions at any time - so you lose nothing if you choose the ISA, no option is lost.But once money goes into the pension you can't get it out.

And there is no compounding on the tax relief, though it's amazing how many people think there is, because they don't realise pension income is taxed in retirement..Note that a countracted in state pension can be as high as 10k, which means it will take up all the tax relief in retirement, there will be none left for the private pension.

bondo

I have answered a few points in bold.

nrsql wrote: »

Compounding of the tax rebate doesn't make any difference as you will pay all that back when you take it out. If the tax rebate gets compounded and the paid back at the same rate then it's the same as not getting the rebate and not paying tax - any advantage would only be in different rates.
no it's not, you are forgetting up to 40 years tax free growth on the tax relief

The 25% tax free does make a difference and that's what's you get for locking the money away.
Also have to take into account expenses on running the products.
Isas have charges too

Also remeber that you will get a basic state pension which will use up tax free allowances in both cases
I don't know what the tax regime will be in 40 years time. You can only base your planning on current legislation

The main gamble is on how the rules change - I consider pensions to be too vulnerable and hence risky but everyone has to make up their own mind.
A pension is merely a type of tax efficient wrapper that holds an investment. A pension is no more or less risky than an Isa with similar investment funds within it

p.s. I don't know much about pensions so the above may be wrong - I just think the risk overrides everything else so the details don't really matter.
See above