Pension or isa?

Terry_Towelling · 21 June 2018 at 8:47PM

This title comes up often but I haven't found one that matches what I need to understand.

I am 55, have taken an inflation-linked final-salary pension early and have another income source (largely inflation-linked but not a wage) that brings me within a few pounds of the personal allowance. Going forward, my 'other' income will soon disappear to be replaced by inheriting 50% of another inflation-linked final-salary pension. My income will then still be around the personal allowance level - maybe a little more. Of course I don't know exactly how the personal allowance will change after next year.

I can get the same investment opportunity within an ISA as I can in a pension but without the tax-relief. From my savings I can put £2880 (net) into a pension each year for a few years - I could also do the same (or more) into an ISA.

Because the pension method essentially takes the tax-relief back off me when I draw it, the only way to really 'profit' from the tax-relief is to take the 25% lump sum. That way I actually get my hands on some of the tax-relief and I end up a few hundred pounds better off. The rest of my pension income would then be taxed at 20% (could be more if tax rates go up in the future). I believe the pension does not form part of an estate upon death, so avoids the possibility of IHT. If the IHT threshold doesn't increase and property prices do, IHT may become an issue but I can't be sure.

In an ISA my cash will have the same investment opportunity/risk as the pension and drawing from it will be tax free but it will form part of my estate.

Seems like swings and roundabouts but does the pension have any real advantage over the ISA for someone in my position?

I have seen the 'wheeze' which suggests putting £2880 (net) into a pension, leave it as cash, wait for the tax-relief, take an immediate lump sum followed by a few pounds per month to keep the income still under the personal allowance and claim back any tax which has been deducted by the provider. That would produce a short-term gain but, soon, any drawing of income would likely take me over my personal allowance.

Is an investment ISA therefore a better direction take or have I overlooked something?

dunstonh · 21 June 2018 at 9:58PM

Because the pension method essentially takes the tax-relief back off me when I draw it, the only way to really 'profit' from the tax-relief is to take the 25% lump sum.

That is still tax free on 25% of it. Plus, pensions are outside of your estate as you mentioned. Also, if you die before 75, your beneficiary gets a lump sum or income for life tax free.

I have seen the 'wheeze' which suggests putting £2880 (net) into a pension, leave it as cash, wait for the tax-relief, take an immediate lump sum followed by a few pounds per month to keep the income still under the personal allowance and claim back any tax which has been deducted by the provider. That would produce a short-term gain but, soon, any drawing of income would likely take me over my personal allowance.

You dont have to immediately crystalise it. That is really for people that are short of money. it is very common for people to do £3600 a year every year and not take any money out.

Is an investment ISA therefore a better direction take or have I overlooked something?

Pension is likely to be the financially better option based on what you have said.

Audaxer · 21 June 2018 at 10:30PM

Terry_Towelling wrote: »

I have seen the 'wheeze' which suggests putting £2880 (net) into a pension, leave it as cash, wait for the tax-relief, take an immediate lump sum followed by a few pounds per month to keep the income still under the personal allowance and claim back any tax which has been deducted by the provider. That would produce a short-term gain but, soon, any drawing of income would likely take me over my personal allowance.

I don't understand the part I highlighted above. If you are under the personal tax allowance you can put in £2,880 each year, leave as cash to gross to £3,600, then take out £2,600 the first year, leaving £1,000 in to keep the SIPP open. In subsequent years you pay in £2,880 to take cash balance up to £4,600 after the tax relief is added, and then take out £3,600 and you make a £720 gain each year providing your income is under the personal tax allowance. For the money you want to actually invest, best to put it in an S&S ISA so that you do not get taxed on any gains.

kidmugsy · 21 June 2018 at 10:54PM

The pension is more attractive as long as you are happy that the TFLS will survive and that basic rate tax won't rise above 26% or so. In a decade's time those might well be true. The pension gains enormously if you think you'll die before age 75, though the gain goes to your beneficiary. Personally I'd be astonished if the IHT break on pensions survived another decade.

There are also small but potentially helpful considerations. (i) Some investments can he held in a pension but not an ISA. (ii) If, greatly daring, you hold actual shares from the US or Canada, the pension can claim back some of the withholding tax on the dividends. For all I know that may be true of bonds too.

There is also a case for holding some investments outside a tax shelter. (i) Some things can't be held in an ISA or a pension, or can't easily be held. For example if I want some gold sovereigns in a safety deposit, that's what I want. A gold ETC isn't the same thing. Perhaps I'd like to buy a patch of woodland. Maybe I'd like to buy a cottage, or a caravan, as a holiday let. And so on. (ii) Some things might give a higher return outside a shelter, cash being the example I have in mind. I treat any cash that pays interest exceeding CPI inflation as a useful, conservative investment. If that means current accounts and regular savers, so be it. The fact that the money is (almost all) still cash-like - i.e. instantly accessible and with no risk of a loss in nominal value - is a wonderful bonus. We have far more savings allowance than we can use: there's no prospect of our having to pay tax on that interest.

Terry_Towelling · 22 June 2018 at 2:44PM

Audaxer wrote: »

I don't understand the part I highlighted above. If you are under the personal tax allowance you can put in £2,880 each year, leave as cash to gross to £3,600, then take out £2,600 the first year, leaving £1,000 in to keep the SIPP open. In subsequent years you pay in £2,880 to take cash balance up to £4,600 after the tax relief is added, and then take out £3,600 and you make a £720 gain each year providing your income is under the personal tax allowance. For the money you want to actually invest, best to put it in an S&S ISA so that you do not get taxed on any gains.

I understand what you say. My issue is that my current income is only just shy of the personal allowance, so, after I have taken the TFLS in year 1, anything else I extract that year (apart from a few pounds) will take me over the personal allowance and I'll lose 20% to tax - thus the benefit (to me) of the tax-relief is eroded considerably and I will gain £180 at most. Still that seems a good return for 1 year.

If I make maximum contributions each year for, say, 4 years leave it all as cash, and extract everything at the end of year 4 with the 25% TFLS, I will have made £180 each year. That is a 6.25% gain on the year 1 input (£2880) a 3.13% gain after 2 years net input, 2.08% after 3 years net input and 1.56% after 4.

Also, because I am recycling savings to do this I can also make interest on the money waiting to be paid in. There are so many options with how to treat the 'waiting' cash but it is important to look at things in the round.

The reason I say that is because I could just stick the whole £11520 into a 4 year fixed rate cash ISA and make about £100 more than the pension route. On the face of it, the cash ISA would then look better value but that ignores the return I can make on the 'waiting cash' before it gets put in the pension.

I think the maths is right (somebody shout if it isn't), so I guess the pension is the best option (but probably not by that much overall) regardless of investment and regardless of the fact that it seems slightly 'immoral' to treat the system that way. Surely HMRC will close the door on this soon.

kidmugsy · 22 June 2018 at 4:46PM

Your 6.25% is spot on: I tell myself that money added to a SIPP is worth 6.25% more than the same money added to an ISA. As long as the 25% TFLS survives, basic rate tax (if that's what you would pay) would need to rise to higher than 26% before the two were equally valuable.

If you die before 75 then (currently) your SIPP money is available tax-free to whomever you nominated to receive it. You could look at that advantage several ways - perhaps look on it as a splendid free life insurance.

Terry_Towelling · 22 June 2018 at 5:08PM

kidmugsy wrote: »

Your 6.25% is spot on: I tell myself that money added to a SIPP is worth 6.25% more than the same money added to an ISA. As long as the 25% TFLS survives, basic rate tax (if that's what you would pay) would need to rise to higher than 26% before the two were equally valuable.

If you die before 75 then (currently) your SIPP money is available tax-free to whomever you nominated to receive it. You could look at that advantage several ways - perhaps look on it as a splendid free life insurance.

Just altered my earlier post. Because the effective £180 annual gain is only applicable once to that year's contribution, doing things for multiple years has the effect of eroding the annual gain percentagewise. You'll see what I mean if you read my heavily-edited post - if you've got nowt better to do that is.

kidmugsy · 22 June 2018 at 5:50PM

Terry_Towelling wrote: »

if you've got nowt better to do that is.

Time for my afternoon nap.

Terry_Towelling · 22 June 2018 at 8:31PM

kidmugsy wrote: »

Time for my afternoon nap.

I wish! Time for me to get 'back on my head' (if you know the old joke) - that's why I get the other income I mentioned.

Pension or isa?

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