ISAs v Pensions: The Official Retirement Debate

deadparrot · 13 February 2007 at 9:34PM

moneyandmountains wrote:

This depends on whether the company that they work for pay a contribution to the pension. This is free money that will be lost if they aren't part of the occupational pension scheme.

Yes, but that's no reason not to do both. Always take free money from your employer, but don't necessarily stop there.

EdInvestor · 13 February 2007 at 10:10PM

The really huge downside of the pension is the fact that once the money is in, you can't get it out, except as a (taxed) income according to strict limits and not before age 55.The capital, apart from the tax free cash, is gone forever.You cannot spend it and nor can you pass it on to your heirs.

When you come to think of it, you really do need quite a big bribe of free money to have anything to do with the idea.

peterg1965 · 13 February 2007 at 10:27PM

This has now got me thinking. Being in the very 'comfortable' position of having a variety of pensions (occupational, state and pension) that will put me very much in the higher rate tax bracket, perhaps I should now put all my spare 'investment' cash, which will not quite reach the annual ISA limit of £7000, into ISAs, preferably stocks and shares ISAs. Although I will not get the tax relief at part of a pension investment now, at least I will not be giving it all back in 25 years time as income tax. On reflection the ISA gives me more options and taken as a 'joint' investment with my wife, we can invest £14K a year as and when we can afford it in the future. It would certainly be advantageous for me though if I could 'lock' the ISA investments in for a period of time so that I(we) do not become tempted to withdraw it and spend it!

jamesd · 13 February 2007 at 10:33PM

deadparrot, the trouble with that scenario is that the ISA annual allowances you switch are more valuable then, so the incentive not to switch them is high. Using the full ISA allowance and also putting significant money into the pension becomes increasingly affordable at around that time as well.

If you switch, you get the problem when retired that the ISA allowance you switched would have produced tax free income that doesn't count for reducing age allowance. In a pension it gets the extra tax break but then you lose age allowance in the 20-25k zone so you effectively pay 33% tax on the pension money in that range. That really erodes the benefit of the higher rate tax gain going in.

If you're only just higher rate and likely to stay that way, it looks like a reasonable option to use in the few years before retirement. If you may be well into the higher rate band then it's likely that you can put so much into pension investing that you're going to be trying to avoid taxable income in retirement and keeping the ISA is good for that.

woodhouseian · 14 February 2007 at 1:10AM

I see pensions as you giving your money away to someone else - they pay you an income from it on retirement, but they gat to keep the capital when you die. Whereas an ISA is you saving up your own money for yourself, spending it as you see fit, and able to leave it to your family when you die.

On the face of it the ISA is the much better deal, all things being equal. I'm always amazed by how pathetic the annuity rates are on pensions, eg about 6% or 7% at the age of 60. There are cash savings accounts with almost that level of return.

That means, I think that a pension is only worth doing if someone else (either your employer or the taxman) is going to pay a serious amount into it for you. If you've not got a company scheme, and you're a basic rate taxpayer, it's not worth doing. The only 'benefit' is the tax relief and you pay that back anyway because you have to pay tax on your pension income.

I reckon the best idea for basic-rate taxpayers is, bite the bullet, pay as much as you can into a stocks and shares maxi ISA, including the amount that the taxman would have paid in if it was a pension.

Higher-rate taxpayers, do pretty much the same but pay into a pension as well!

competitionscafe · 14 February 2007 at 1:28AM

dunstonh wrote:

It has nothing to do with the wrapper. Its where you invest the money that is important. If you pick the same investment funds in an ISA and a pension, they will perform exactly the same.

Yes, granted, identical funds will provide the same return regardless of the wrapper - but the charges and the tax rules will also affect what you get back when you cash in those funds.

That's where (for me) it starts to get complicated. At the moment I am self-employed and pay money into both a stakeholder and into an ISA. Obviously I get tax relief (lower rate) on the pension payments and none on the ISA payments. The main concern re the ISA is that because self employed income can fluctuate so much there is no way I could say that some time in the next 10, 15 years I would not be able to resist drawing on the ISA savings, whereas with the pension this is not an option until age 55. As the main aim of either an ISA or a pension would be to provide an income over and above the state basic pension once I retire, that would be the main disadvantage of the ISA only option as far as I can see it?

Otherwise what woodhouseian says above makes a lot of sense - but only if you could guarantee that you would not dip into your ISA and thereby significantly deplete your retirement income. I cannot guarantee that - hence my decision to pay into an ISA and a pension. I don't know if this is the 'correct' decision, hence my interest in this debate, and am no expert on the subject - so i guess in a way I am hedging my bets by sitting on the fence and not going for an either/or option?

McGhie · 14 February 2007 at 1:29AM

A couple of comments:

1. If your employer will make pension contributions for you (via salary sacrifice) and pass all of their savings on to you then paying into a pension is much more tax efficient than paying into an ISA. You end up having the 12.8% employer NI savings passed back to you by your employer and save the employee NI on your sacrificed salary, on top of the tax relief, which you don't even have to claim as the contributions were made before tax. For a higher rate tax payer you save almost 47%.

2. If you are fortunate enough to be able to max out your annual ISA contributions then IMHO the either/or argument is void as you should simply do both. Of course, that won't sway the people who wouldn't touch a pension with a bargepole.

ducky2004 · 14 February 2007 at 2:16AM

dunstonh wrote:

When we talk about ISAs on the pensions front we refer to stocks and shares ISAs.

Cash ISAs are not suitable retirement planning vehicles as they are no good for long term planning.

I disagree that cash ISA is not suitable, epsecially for those who can afford and will stash away 3k per year, Especially at current rate where top paying Cash ISA pays 5.93% AER guaranteed.

With stocks and shares ISA, one is subjected to the whimp of stock market. In the long run, earning growth cannot exceed nominal GDP growth, which is currently around 2.5%. If PE ratio remains the same, stock prices cannot grow at more than 2.5% pa (UK only, or around 5% if the exposure is worldwide) before fund/ISA charges. The historicaly 7% projection was based on high nominal GDP (and also high inflation world) and may or may not be true going forward.

For anyone who takes the stock and shares ISA route, remember to get a discounted broker to reduce your initial charge and annual charge to minimum. One does not usually have to worry about this with pension fund as your employer is likely to negotiate a good deal with the pension company already.

Also, personally, I feel that the real risk of pension is that when most people do live until 100 and the government run out of money, it would have the tendency of carrying out policies that rob the rich paul to pay the poor peter.

p.s. I came across this as well - for those you are more technical. It describe the chance of having enough money to live to end of life in stock and share investment.

http://www.investorsinsight.com/otb_va_print.aspx?EditionID=469

competitionscafe · 14 February 2007 at 3:47AM

ducky2004 wrote:

I disagree that cash ISA is not suitable

I don't see how cash ISA returns will beat equities over the long term - and saving for retirement is a long-term investment (whether via a personal pension or equity ISA wrapper).

As this chart shows, equities have far outperformed cash over the last 3 years, throughout the 90's and over the very long term (since 1900):
http://uk.standardlifeinvestments.com/content/data/press/press_articles/financial_adviser_06_2006.html

"It is worthwhile therefore to examine the very long term, which can smooth out the effects of cycles in business activity or inflation rates. We can compare market returns since 1900; the average annual nominal return for equities, gilts and cash, was 11.5%, 6.0% and 5.1%, respectively."

valmiki · 14 February 2007 at 7:23AM

stocks and shares ISA (via various index trackers) for me all the way baby!

...and I work in local government.

I would rather know what tax I have paid putting money into an ISA, rather than pay money into a pension, for which I won't know what I'll be taxed 30 years in the future.

Also, my employer's scheme is a final salary scheme but I don't know whether I'll still be working in LG when I retire, or what the terms of my retirement (age, etc.) will be. They have tried to change this recently so just because you get a few extra quid from the employer to put into a pension doesn't make it the icing on the cake, as you don't know how it will be taxed when you retire!

Remember, the population is aging, 30 years time, there will be a lot less taxpayers, the Gov will need their income from somewhere, so just be careful. With a pension, they'll be able to tax you how they want, with an ISA it's all tax-free. And I know I'll be leaving my kids a decent inheritance.

So, yes, in the long-term I may be a couple of quid down with an ISA, that's the risk but personally I don't think I will. I know I'd be really annoyed if I dropped dead one week after retirement, and lose the pension capital for an extra half percent return through an annuity!

ISAs v Pensions: The Official Retirement Debate

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