ISAs v Pensions: The Official Retirement Debate

A question about : ISAs v Pensions: The Official Retirement Debate

Both ISAs and Pensions are tax-free wrappers you can use to invest or save money in to provide a return for your old age.
ISAs In a nutshell you put money in ISAs from your after tax salary, and the returns aren't taxed (very much in a nutshell, its more complex than that, see the ISA guide)
Pensions. In a nutshell the benefit it you get to put your money in a pension from your before tax salary, but the returns once you retire are taxed (again read the pensions guide for more on this)
It's important to remember both these are just wrappers, in other words you can choose what you put in them. In both you can have a savings product or a range of investments.

So which is better for retirement?

Now I'm opening the debate up. There's no strict right or wrong answer only views. I thought it would be interesting to canvas opinions, there are many qualified (and unqualified) money nerds on these boards. Now its time to have your say.

Martin

Best answers:

• The problem with ISAs is the temptation to dip into them before retirement, so I follow the rule - put money into a pension first and then put money into an ISA.
• I just posted this
  https://forums.moneysavingexpert.com/...=374730&page=2
  in reply to someone who was struggling to pay towards either a pension or ISA but was being persuaded towards the ISA route.
  It seems to me that if you can afford to pay the "right" amount now towards retirement savings then ISA's offer much more flexibility - as Paul says, for some maybe too much - but if you're struggling to pay enough then use the tax perk now to ensure more goes in your funds.
  If you do go the pension route initially you can always supplement it with ISAs later instead of increased pension contributions.
  Also where co's offer pensions they often make a significant contribution - and free money is the best there is.
• Does my employer contribute to my avc contributions? I think not? Therefore am I better off going down the ISA route. I pay 9% into the teachers avc with the PRU (apparently not doing too well)
  I have £30K in the fund!!!
  Anyone got a view?
  Thanks in advance.
• You have to be very disciplined not to take money from ISAs before retirement, the temptation is always there. With a pension as an investment wrapper you can claim tax relief on the amount you pay in (within certain limits) and this surely makes it ideal for a higher rate tax payer. The tax relief, in a way, cancels out the tax which you will pay when you take the pension as income in retirement. There are also various options, like lump sum tax free withdrawals, which make the pension investment better. Also if an employer contributes this allows even more money to be invested, which you dont get with a traditional ISA product. However, as always I would assume that a balanced portfolio of investments is the best way to go.
• I would go for an isa because I don't trust pensions.
  That' not a view due to the recent troubles but because money is locked in and there's not a lot you can do if the rules change.
  At least currently with an isa you can take the money out so I feel there's less chance of an unavoidable loss.
  But then I wouldn't keep everything in an isa wrapper either, just in case.
• But you can take 25% out tax free (from the pension) which would put you back in front...
• Easy cases first, where there is little to no disagreement even among those who routinely disagree:
• Get a state pension forecast and arrange enough pension to total at least 8-10,000 income in retirement. This exploits the tax benefit paying in and lower tax taking the money out in the 0% and 10% bands.
• Arrange that 8-10,000 for both partners if you're a couple, to exploit both tax allowances and provide a cheaper pension income for your partner after you die, by avoiding the need for a dual life annuity or long guarantee periods.
• Take any employer matching funds for a pension up to the employer limit.

The rest is down to personal views on various factors:

• A higher rate tax payer who will be basic rate in retirement gets a tax benefit from the pension.
• The 25% tax-free sum is a benefit only available from the pension and it gains from the tax rebated on the way in. It's also unpopular in some government circles so it carries legislative risk of being eliminated.
• The pension can't be taken before 55 soon, while an ISA can be taken at any time.
• The amount that can be taken out of a pension in income drawdown is limited but the amount that can be taken out of an ISA isn't limited.
• Annuities are the government-favored option for retirement income from a pension so alternatively secured pensions available after age 75 have a high legislative risk of going away. Age 75 is also the point at which an annuity is currently expected to be better than income drawdown for an average person, if you ignore inheritance concerns.
• ISAs are fully inheritable across generations. Pension money has major penalties and limitations on inheritance across generations.
• ISAs are savings. Pensions aren't. This is significant for those who may receive means-tested benefits during their working lives.
• The pension rules on what happens to past contributions (but not their value) have routinely been changed by governments and this seems likely to continue in the future. ISAs may be eliminated but their future is probably less subject to legislative risk.
• You can put up to your whole salary into a pension each year so using an ISA first if in doubt is a practical approach that can work even up to a few years before retirement.
• An annuity or income drawdown pays more to those who live longer. Historically, this means that manual workers and those in the north of England and Scotland get less from their annuities than those in desk jobs and from the south. Those who can expect a short retired life may benefit from ISA funds and more rapid withdrawing of them. The problem with this is the chance that you may live longer than expected and may be poorer for a long time after the ISA money is gone.

Place your bet on what future governments will do to pensions and whether the current and possibly greater reduced flexibility of a pension will be more or less costly than the tax treatment.
Those commenting here seem to prefer the greater control of the ISA approach up to the ISA limit.
Note on 18 Feb 2012 in reply to a private comment asking: this is still my current summary. No significant changes to it. Similar for the comment by dunstonh a few posts later, aside from the 22% tax rate mentioned in that one.

• Having always been self employed I have frowned upon pensions as you never know what is round the corner - you may need some of the money in a hurry and/or before retirement. I agree that if you earn enough part ISA and part pension is a good idea.
  While on the subject of retirement, the government are always telling us to save for our retirement but never say how much. Has anyone any idea of a ball park figure to save for an enjoyable retirement?
• Heres something to think about when planning on how to fund retirement...
  2/3rds of all the people who have ever lived to the age of 65 are alive today!
  Also the maximum age of the human body is currently estimated at somewhere between 120-140 years.
  Who reckons any government knows how to deal with this over the next 50 years?
• Personally, I have both ISAs and Pensions.
  Here are my thoughts to add to the debate.
  (a) Take out a pension if your employer makes a contribution to it.
  (b) Although you get tax relief on your pension contributions on the way in, the income you can take when you retire is taxed. Tax is deferred. This may be beneficial because:
  (i) 25% of the Pension fund can be taken tax free
  (ii) You have a personal tax free allowance on income
  (iii) You may be a higher rate tax payer now, but a basic rate tax payer in retirement.
  (c) If you are a basic rate tax payer, consider saving outside of a pension wrapper until you are a higher rate tax payer. Then transfer the investments to a pension to get the maximum tax relief.
  (d) Save in an ISA to build up your tax free lump sum to use in retirement, rather than taking it from your pension fund. Discipline yourself to regard a certain percentage of your ISA fund as "retirement" savings and the rest as other savings.
• What's realistic for a couple?I'd say a retirement income of 20k each, 40k total, would do nicely ( that's compared with the average of 14k for two today.)
  Income made up as follows:
  1.The two state pensions, both index-linked, let's say 6-6.5k average (part of this might include income from a small contracted out "protected rights" pension).
  2. Company or private pension income, either final salary (index linked)or money purchase,or a mixture of the two: 3.5-4k. This would involve a money purchase fund of approx 75-100k to provide for inflation, depending on whether it was annuitised or in income drawdown.
  The income above should be pretty well tax-free as it's within the age allowance and 10% band.
  3.Income from ISAs - 5k. This would be a fund of 100k, invested in a mixture of property funds, bond funds and cash generating a 5% annual tax-free return.[Much of this money,except for the cash, might have been invested in equities earlier while it was growing.]
  4.Income from direct investment 5k - in shares or equity unit trusts. The dividend income is free of additional tax and any top up is covered by the CGT tax free allowance.
  This 20k income will be below the threshold at which you are deemed well-off and start losing your age allowance.
  How might this be accumulated?
  The state pension will grow as you work, and company pensions where employers' contribute should crop up for most people to provide the other chunk.If not use a SIPP.
  The first 100k fund needs to be saved in your ISA, first in cash and then in ideally in equities.
  But the 2nd one could well come from either trading down from your family home into something smaller at retirement, or from cashing in a BTL.[Of course you might want to keep the BTL, but bear in mind that letting income is taxable.]
• Things that are the same:
  1 - both have tax free growth
  2 - both can invest in virtually identical areas
  3 - charges can be exactly the same (although pensions do have a budget option with stakeholder)
  Benefits of pension
  1 - tax relief on contributions
  2 - no inheritance tax to pay if you die before retirement as lump sum is outside of estate
  3 - on death before retirement, the death benefits (value) will be 22% higher than an ISA
  4 - not accessible until 55 (from 2010). Double edged sword for some but some need the tie in.
  5 - contributions can increase your working/childrens tax credits received giving upto a potential equivalent of 72% tax relief
  Benefits of ISA
  1 - flexible. The lump sum is yours to do with as you wish
  2 - income or fixed regular withdrawals in retirement are tax free
  3 - on death after retirement, the lump sum is paid to beneficiaries
  4 - If pensions get improved later or something better comes along, you can move your money into that.
  Negatives of pensions
  1 - Annuity compulsion. You have to purchase an annuity at some point. Ok, we have ASP and USPs but the Govt keeps fiddling with these so at this time, its worth having the mindset that you may be forced to buy an annuity
  2 - income from pension annuities is taxable
  3 - If you die after purchasing the annuity, the income can die with you (subject to spouse benefit and guarantee period)
  4 - If you start the pension income early, the annuity rate is likely to be very low
  5 - If something better comes along later, you cannot take the money out of the pension and put it into that.
  Disadvantages of ISA
  1 - Its too easy to dip in and you need to be disciplined.
  2 - For the first £10k of income in retirement, the income from the ISA would be lower than what the pension would have provided.
  3 - On death, the lump sum forms part of your estate and IHT could be payable.
  4 - means testing can mean that ISAs are taken into account when looking at benefits but pensions are not (until they are commenceable)
  Ideal scenario for a basic rate taxpayer is
  1 - contribute to pensions to aim for a £10k income in retirement as this uses up the £7,280 personal allowance and £2150 10% lower rate band. (the pension tax relief at 22% is valuable in this case as you get 22% going in but pay nothing or just 10% coming out.
  2 - always split your retirement planning equally between couples. You both have that £7280 personal allowance which is nearly £15,000 a year tax free income
  3 - when your pensions are on track to give a real term income in excess of £10k, then switch to ISA
  Notes to be aware of:
  1 - self employed individuals only get the basic state pension of £4381. They do not get SERPS/S2P.
  2 - Taxable income in retirement above £20,100 increases your tax burden. For every £2 above £20,100, your age allowance is reduced by £1. Income from ISAs does not count towards your taxable income. (savings account interest goes towards the £20,100 so dont be too heavy in cash).
  3 - age allowances increase annually. So this £10k target could well be £15k in 10 years time and age allowance reduction £25k. Work in real terms (with inflation taken into account) to keep yourself on track.