From Drawdown to ISA

In message , Llewellyn ap Iorwerth writes

Not only that, but I would maximise the ISA allowance during pre-retirement before contributing to a pension.

Always ?

(share) ISA's only protect against capital gains, and the minimal extra tax on dividends.

Pensions allow you to more than double the money you put in almost instantaenously (subject to a few conditions).

In message , Miss L. Toe writes

Not necessarily, I just dont believe in the salesmans maxim 'maximise your pensions'. I think pensions are worth it for those who are 40% tax payers when working and lesser rate in retirement. The trouble is the maxim can often mean that the income in retirement is in the 60% also. This means that after about 10 years or so you pay more tax on the output than was saved on the input. Plus you have inflexibility and (possibly) IHT problems.

Just the same as Pensions.

But heavily taxed and controlled on the way out.. which ISAs arent.

If you are a 40% tax payer then I would suggest maximising your ISAllowance (which isnt all that much) before considering pensions. It gives far more flexibility and doesnt contribute towards the lifetime allowance.

eg. I know some consultant doctors who have a maximum NHS pension plus £200k p.a. private income. Their advisers have told them to maximise pension conts for the reasons you describe. Result ? Over the lifetime allowance.

So, in answer to your question of 'always'? well I have to admit, my answer would have to be 'no'! but I think people should look at 'post retirement planning' rather than 'pensions'.

Why are they good for lesser rate payers in retirement ? I haven't begun to think about that as part of my pension planning :-)

Well pensions give the bonus of full tax relief going in as well and possibly 40% going in and only 22% on 75% of the pot coming out

For people on that level then VCT's are probably better than both. (or were last year). (Making lots of assumptions that they have plenty of other investments).

In message , Miss L. Toe writes

Because if you pay tax at the same rate before & after retirement, when you take the benefits after about 9 - 13 years you will have paid more income tax than you saved.

I agree.

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But the pension payment is then taxable income. You have to balance that. Otherwise if the pension is directly linked to equity performance, taking the same risk with ISAs leaves you with much more flexibility (you can even cash them in and buy an annuity pension).

Toom

Initially, maybe on paper, but really, they are almost as much of a gamble as shares are to those who don't like the thought of investing their money in shares (most pension funds are invested in stocks and shares).

When you consider that: a) you can't get hold of your money until retirement age (the age of which is subject to change); b) considering that you may not make it to retirement age and c) the government and consequently current pension rules will shift and change as you make your way to retirement age, then in conclusion, there's really there's no way of telling how much in reality you may get.

So I would advise anyone of thinking that "pensions allow you to more than double your money" to really think through what has to happen for that to be any more than a just one potential scenario.

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If it is a final salary scheme the main question is really: will it pay out..? The second question is: how much do I have to pay in..?

Another question is: why did we ever have defined benefit schemes..?

60% ?? Are you talking about the lifetime allowance being exceeded? At about 1.5 million and increasing every year with inflation that's not going to apply "often".

Other than the LA being exceeded the only way that can happen is if you only get basic rate relief on contributions but end up in the 33% band in retirement (the band where the age related personal allowance is reduced). Even there, 25% is available tax free so the tax rate would only be 24.75%.

Otherwise, other than changes in tax rates, I can't see how you'd pay more tax through contributing to a pension.

Heavily? Usually far less heavily than it would have been taxed on the way into the ISA.

I would say for high earners it'd be better to contribute just enough to a pension to ensure your that retirement income uses up your basic rate band of income tax in retirement (this is unlikely to take you over the LA), and for not so high earners in the 40% band, as much as they can afford of their 40% taxed income.

Before or after the pension rules were changed?

But you get worse rates with PLA's than with compulsory purchase annuities. This is because the life companies know that only people with good life expectancy with buy a PLA whereas they get a wider range with CPA's.

In message , Andy Pandy writes

No, just a typo, sorry! 40%!

My typo apart, I am not saying you would pay more tax, merely pointing out that the tax paid on the resulting income quickly exceeds the tax saved on the contribution. I only mention this so as to broaden peoples minds away form the salesmens' expression 'A pension is tax free!', because it isnt. As life expectancy increases the amount of tax paid on the income is getting larger and larger. If some funds were in an ISA then of course, subject to you managing the fund so as to last as long as you need it to, there is no tax payable AND capital (albeit potentially reducing) is protected.

You are fallling into the salesman's trap. Dont forget the tax is on the way out, and upon death in drawdown depending on the circs there can be some swingeing taxation charges on the fund.

For the reasons described above I think it was wrong to take this view even before A day.

Only because your money has grown pre-tax! That doesn't make you any worse off. It simply makes no difference. Think about it.

Only because the pre-tax investment has grown (ie the tax you *would have* paid much earlier has grown).

But how do you predict when you're going to die? An annuity is basically insurance against living too long, if you don't buy one then you can't guarantee not running out of cash.

Of course. But with 25% available tax free and the remainder often taxed at a lower rate, the tax advantages can be very significant.

In message , Andy Pandy writes

I never said you were. But it is obviously more beneficial for those higher rate payers who are at a lower rate in retirement. One way to ensure this is to direct your post retirement investment into more than one type of investment vehicle so as to ensure a lower rate band in retirement.

With respect, I dont need to think about it any further.

In message , Andy Pandy writes

Thats right.

I agree. I am not arguing against all pensions, just warning that there is merit in having other forms of post retirement planning.

I note you say 'at the lower rate'.

What about the lack of flexibility and the loss of capital. In real life most people spend less the older they get (inflation apart). If they are lucky enough to have income in excess of £20k-£25k in retirement then they neednt worry about care home fees and only a small proportion go there anyway. IN general, people spend a lot in the early years of retirement, and rightly so.

If the base income is protected by an annuity the excess is far more accessable with ISAs. in retirement an often forgotten benefit is that funds previously invested in equities can switch to fixed interest and regain the tax free element of the interest which can then be paid as quasi income without prejudice to age allowance.. This is just an example of the extra flexibility having some funds in an ISA can provide.

No - 'often taxed at a lower rate'.

Right - so the 25% tax free lump sum can provide extra for the earlier years. For a HRT payer this would work out to 41.7% of the equivalent ISA fund assuming everything else was equal. Also a non index linked annuity can skew greater income towards the earlier years.

Yup. But the extra flexibility costs.

So what was your point when you wrote 'after about 9 - 13 years you will have paid more income tax than you saved' ?

Agreed, it IS a question of getting the balance right, and understanding the circumstances of the person involved, some people might be better protected from themsleves by having an annuity that a big ISA pot - But those sort of people are unlikely to have saved much anywhere.

But SIPPS can easilly be invested soley in cash/gilts etc.

Very true - but we are talking about pension planning - If we were talking about saving for a world cruise in 3 years time a pension is definately the wrong place :-)

But equally you might not live long enough to cash in your ISA's.

If you take inflation into account then you cant tell how much you will get in ANY investment.

By double your money I meant:

10k in your pension pot costs 6k (to a 40% tax payer) 25% tax free (ie 2.5k) at 50 (currently) deducted from both the pot and payment gives a pot of 7.5k (10k-2.5k) for a cost of 3.5k (6k-2.5k)

Hence if you currently pay tax at 40% AND are 50 or more then you can put (net) 3.5k into your pension and see 7.5k in there.

Obviously one can only then get a certain %age out each year.