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  • FIRST POST
    • noalibi
    • By noalibi 7th Apr 18, 10:21 AM
    • 8Posts
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    noalibi
    Pension contributions or ISA?
    • #1
    • 7th Apr 18, 10:21 AM
    Pension contributions or ISA? 7th Apr 18 at 10:21 AM
    I am 49 years old with a combined DC pension pot of about 800k. I am currently making AVC of 24% of my salary (2% of which is matched by the employer, plus a generous non-matched contribution) so at this rate I'm likely to hit the LTA. I hope to retire (or consider a change in career) at 55.

    With this in mind, I was wondering if I should reduce my AVC contribution and start saving in ISAs. I am a 40% tax payer, so understand that while my pension contributions are tax free going in and taxed on the way out, the opposite is true of an ISA. If I understand this correctly, for every 100 of salary paid into the pension, I can - subject to LTA - withdraw 25% tax free and normal income tax rules on the remaining 75%. Comparing this to the ISA, for every 100 of salary, after tax only 60 is paid into the ISA but I can withdraw 100% tax free.

    Probably worth pointing out that I don't have any other significant savings and hope to be debt (mortgage) free at about the same time I plan to retire.

    I know this should be a simple numbers calculation question, but until the LTA, I've always thought pension contributions were the best way to save. I'm now thinking that I should consider other options.
Page 1
    • kidmugsy
    • By kidmugsy 7th Apr 18, 10:50 AM
    • 10,348 Posts
    • 7,047 Thanks
    kidmugsy
    • #2
    • 7th Apr 18, 10:50 AM
    • #2
    • 7th Apr 18, 10:50 AM
    Cheer up! There might be a huge market crash before your 55th birthday so that the LTA won't matter at all.

    In your shoes I'd be inclined to avoid as much 40% tax as I reasonably could, in fear of the 40% rebate vanishing after (or even before) the next General Election.

    Would it be possible to defer the decision each year until after the Chancellor's Budget Statement in December?
    Free the dunston one next time too.
    • NoMore
    • By NoMore 7th Apr 18, 11:09 AM
    • 173 Posts
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    NoMore
    • #3
    • 7th Apr 18, 11:09 AM
    • #3
    • 7th Apr 18, 11:09 AM
    You pay isa from post tax earning, so every 100 you deposit is a 100 and will be subject to no tax on withdrawal as well as any gain it has made.
    • Brynsam
    • By Brynsam 7th Apr 18, 11:43 AM
    • 740 Posts
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    Brynsam
    • #4
    • 7th Apr 18, 11:43 AM
    • #4
    • 7th Apr 18, 11:43 AM
    Don't let your decision be driven entirely by tax considerations, although those are of course a very big driver. When do you want to access the cash, and how? Capital gains within an ISA roll up tax free and when you draw money from your ISA it is tax free - so if you are still a higher rate tax payer when you need to take a 'top up' of income, it is worth having some ISA savings.

    Also keep in mind that with a flexible ISA, you can take out money and put it back in the same tax year and keep all the same tax advantages.
    • noalibi
    • By noalibi 7th Apr 18, 4:03 PM
    • 8 Posts
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    noalibi
    • #5
    • 7th Apr 18, 4:03 PM
    • #5
    • 7th Apr 18, 4:03 PM
    @kidmugsy. No urgency in making the decision other than I have the opportunity once a year to change my contribution level. It is only because I'm heading towards the LTA that I am considering alternatives. Like you, I think it is only a matter of time before the 40% tax break is removed, so it is difficult not to take advantage of it while it is still available.

    @brynsam. Haven't thought too much about how to draw the money, but I do take your point of using ISA to have a top up fund. Good idea.
    Last edited by noalibi; 07-04-2018 at 4:07 PM.
    • EdSwippet
    • By EdSwippet 7th Apr 18, 5:42 PM
    • 697 Posts
    • 656 Thanks
    EdSwippet
    • #6
    • 7th Apr 18, 5:42 PM
    • #6
    • 7th Apr 18, 5:42 PM
    I know this should be a simple numbers calculation question, but until the LTA, I've always thought pension contributions were the best way to save. I'm now thinking that I should consider other options.
    Originally posted by noalibi
    The words 'simple' and 'LTA' don't really belong together in the same sentence. However, you can put a bit of a numerical framework around the decision, something that might help.

    If you will be a basic rate taxpayer in retirement, then the pension is either better than or, worst case, the same as an ISA. Earn 100, put 60 into an ISA. Or earn 100, put 100 into a pension and then pay 15% blended tax (25% PCLS then 20% of 75%) on withdrawals below the LTA, or 40% blended tax (25% LTA penalty plus 20% of 75%) on withdrawals above the LTA. Any employer match and salary sacrifice uplift that you get with the pension but not the ISA pushes the benefit to the pension every time (albeit smaller once you pass the LTA).

    If you will be a higher rate taxpayer in retirement, the calculus changes. Now you will pay 30% blended tax on withdrawals below the LTA, so still better than the ISA, but 55% tax on withdrawals above the LTA, and so worse than your 40% current tax rate. Again though, bolstered by any employer match and salary sacrifice uplift.

    So the questions to ask are: Will you be a basic rate taxpayer in retirement?, What is the probability that you will exceed the LTA before retiring?, and Does the employer pension match and/or salary sacrifice uplift make up for the LTA penalty if you do?

    The first question might not be as clear cut as you think. To keep from exceeding the LTA at age 75 and facing a steep penalty at that point, you will need to draw from your pension over 20 years (say). For a pension at LTA levels this means drawing around 6% annually (4% real growth and 2% inflation). So 60k with 75% of this taxable is 45k of 'earnings', and already right at the limit of the current 20% band. Any other income you have -- interest, dividends, BTL, part time work, whatever -- will then push some of this pension withdrawal into higher rate tax.

    The second question is obviously tricky to answer, but you can guess by projecting some growth numbers, say 4% real, onto your current 800k and adding in expected new annual contributions up to when you plan to retire. At 4% real growth it looks to me like you might pass LTA in six years even without adding another penny to your current DC pension (1.04 ^ 6 * 800k = 1,012k), but do note that projecting over such a short timescale is going to be pretty guesswork-ish.

    The third question is a bit easier. To equal the ISA you would have to get at least 60 back from the pension. If over the LTA and in higher rate tax, the tax rate on withdrawals is 55%, meaning you need a balance here of 133 to withdraw 60. So the employer match and salary sacrifice uplift on a 100 contribution from you would need to be 33. The best salary sacrifice uplift is perhaps 13% (employer NI), so if your employer can match your own pension contributions by 20% or more then the pension is always the better choice. Otherwise, you have a judgement call to make.

    Of course, there is a fourth question also: How long before the government worsens the rules and/or moves the goalposts yet again? Nobody knows.

    Painful, isn't it?
    • noalibi
    • By noalibi 8th Apr 18, 3:09 PM
    • 8 Posts
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    noalibi
    • #7
    • 8th Apr 18, 3:09 PM
    • #7
    • 8th Apr 18, 3:09 PM
    @EdSwippet. Thank you for your excellent summary. Has given me way more to think about than I had expected.
    • Thrugelmir
    • By Thrugelmir 8th Apr 18, 3:33 PM
    • 58,184 Posts
    • 51,557 Thanks
    Thrugelmir
    • #8
    • 8th Apr 18, 3:33 PM
    • #8
    • 8th Apr 18, 3:33 PM
    Like you, I think it is only a matter of time before the 40% tax break is removed, so it is difficult not to take advantage of it while it is still available.
    Originally posted by noalibi
    Easier to leave the 40k cap in place and let inflation erode the value of the amount that can be saved. By doing so creates no media headlines.

    with a combined DC pension pot of about 800k.
    Recent years capital returns cannot continue indefinately. Long term average after inflation is only 5% (with income reinvested). Has to be a readjustment at some point in time.
    Financial disasters happen when the last person who can remember what went wrong last time has left the building.
    • kidmugsy
    • By kidmugsy 8th Apr 18, 4:44 PM
    • 10,348 Posts
    • 7,047 Thanks
    kidmugsy
    • #9
    • 8th Apr 18, 4:44 PM
    • #9
    • 8th Apr 18, 4:44 PM
    To keep from exceeding the LTA at age 75 and facing a steep penalty at that point ...
    Originally posted by EdSwippet
    Mind you, reaching 75 would itself be a cause of celebration, as long as good health had survived too. And if the OP doesn't reach 75 then the whole of his pension fund will be available tax-free to his nominee - for example his widow, say.

    ... you will need to draw from your pension over 20 years (say). For a pension at LTA levels this means drawing around 6% annually (4% real growth and ...
    Originally posted by EdSwippet
    You're saying that a healthy real growth rate could cause LTA problems. True, no doubt, but then having heaps of money in the pension is his best defence against lower or negative real growth rates.

    There is also the possibility that, particularly as retirement comes closer, he might want to invest in assets that are less likely to produce 4% real but that might bring him substantial security and comfort e.g. index-linked gilts. Since the LTA is linked to CPI inflation, and ILGs to RPI inflation, then there wouldn't be much real growth generated by the part of his portfolio invested in ILGs but there could still be an investment performance that pleased noalibi.
    Free the dunston one next time too.
    • EdSwippet
    • By EdSwippet 8th Apr 18, 6:56 PM
    • 697 Posts
    • 656 Thanks
    EdSwippet
    Mind you, reaching 75 would itself be a cause of celebration, as long as good health had survived too.
    Originally posted by kidmugsy
    Indeed. But a 55% tax bill on a huge proportion of my pension is not the kind of 75th birthday present I have in mind as something to look forward to. I doubt the OP does either.

    And if the OP doesn't reach 75 then the whole of his pension fund will be available tax-free to his nominee - for example his widow, say.
    Originally posted by kidmugsy
    Pensions are certainly a great inheritance tax bypass. However, this is not what they are designed for. I suspect that at some point a future government will find this aspect of pensions inconvenient, and so axe it.

    You're saying that a healthy real growth rate could cause LTA problems ... there wouldn't be much real growth generated by the part of his portfolio invested in ILGs but there could still be an investment performance that pleased noalibi.
    Originally posted by kidmugsy
    That is not quite what I am saying.

    The problem with the age 75 LTA test is that it captures all the investment growth since crystallising. Not just real growth but all nominal growth. Where initial crystallisation uses 100% of the LTA, there is no further protection from the LTA to be had at the age 75 LTA test, and so the entire nominal gain over perhaps two decades gets taxed at 55%.

    The way to defuse this ticking tax time-bomb is to draw income that at least equivalent to the growth in the pension during the years between crystallising and age 75, where one's normal tax rate would be below 55%. More in this paper from Scottish Widows.
    Last edited by EdSwippet; 08-04-2018 at 7:02 PM.
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