Dan Hawkins
……….a question some, but perhaps not many are asking
In this article designed to deliver simple answers to the questions facing those new to investing Daniel Hawkins weighs up the relative merits of ISA and Pension saving

 

Many investors have strong views on the merits of either or both of these methods of saving, normally combined with a view on investment in property. The TV commentators give some guidance, but are mainly just encouraged to see people are actually looking to save.

If the question were ‘an ISA or a payday loan’ then I think the answer is somewhat easier to articulate. So what is our view on this barely asked but frequently answered question? Simple, have both.

If your boss offers you a workplace pension in which they are going to put some of their money it is rare that this isn’t the best thing to do.

It is, of course, not as simple a decision as to whether you just accept free money, there is normally a catch – most pension arrangements offered by your employer also insist you contribute as well. You may have seen the slightly condescending TV ads the government paid for including the super-rich Theo Paphitis telling us all that “I’m in” to the new pension arrangements to which most will be automatically enrolled.

The normal deal is the boss puts in 3% of your salary, provided you put 5% in; not quite free money, but generally not to be sniffed at.

Most importantly the tax man will increase your contribution by adding basic rate tax relief whilst high rate tax payers can claim the higher rate back as part of self-assessment.

Why not just put 5% of your salary in to an ISA? Well you probably should, there are limits on how much you can put in to an ISA but few of us are lucky enough to earn such huge salaries that 5% would get close to the annual subscription limit (£20,000 2017/18).

Why an ISA?

Accessibility is the key driver here, ISA rules state that even a fixed rate cash ISA has to allow the customer to be able to withdraw their money within 30 days of requesting it; the likelihood is you’ll be penalised for this but you will be able to get hold of your investment should a rainy day occur (definitely a better option than a 3000% APR loan).

‘As a guide at age 20 if you target a retirement fund of £300k and growth is 5% you will need to save £165 per month until your 68th birthday; start 10 years later and it will cost you £275 per month.’

There are now a wide range of ISA account types that differ in terms of contribution allowances and permitted investment types, so there should be one in line with your requirements and preferred investments.

Your pension arrangement isn’t so forgiving if you need to get hold of cash – pensions were designed in a more paternalistic era when the nation couldn’t trust people not to squander their savings (and importantly the extra bit of tax the government gives the pension saver).

Instead your pension money is normally locked away at least until you’re 55, but if you decide to cash in at this point, take a lump sum and pay off the last of the mortgage or buy the Harley, you will probably seriously reduce the amount of regular income your pension will give you when you decide to give up work.

So an ISA is more flexible but easier to fritter away as a result, your pension gives you a bit more security when you retire as it’s harder to blow on a Caribbean cruise or Tarquin’s university fees but raises the problem of annuity versus income drawdown versus any other method of drawing an income from your pension pot.

What I seem to be saying here is what my father always said to me “put 10% of your salary away for a r ainy day”. Realistically saving any less than this will mean you are unlikely to retire on an income close to the one you were enjoying during employment.

As a guide, at age 20 if you target a retirement fund of £300K and growth is 5% you will need to save £165 per month until your 68th birthday, start 10 years later it will cost you £275 per month. However, this seemingly large pot of money will currently buy you little more than an income of £18K per annum.

However, George Osborne’s 2014 Budget speech drove a coach and horses through the annuity business as from April 2015 pensioners were able to take their entire pot to do as they wish with, thereby avoiding the pitifully low annuity rates that have resulted from five years of rock-bottom base rates.

 

How do you buy your pension income?

 

What do you do with your ISA cash when you decide to stop working?

 

All subjects we will cover in the future. In the next edition I will look at how you might set about constructing a portfolio within your ISA or Pension wrapper and help you navigate through the jargon that once made investing impenetrable to a large part of the population.

 

ISA vs Pension at a Glance

 

 

 PENSIONISA
What is the tax position of my
contributions?
Contributions direct from salary before
tax. Individual pensions claim tax back
on your contributions.

Basic rate tax payers get a £125 benefit from every
£100 contribution. Higher rate tax
payers can reclaim a further 20%.
Generally more efficient than savings
accounts but you are saving income
that has already been taxed unlike a
pension.
Can my employer contribute? YesNo
What if I’m made redundant? Assuming no contributions are made, your pension pot will remain static.
A large pension pot will not affect your
entitlement to state benefits.
A high amount of savings in an ISA
will affect your entitlement to certain
means-tested state benefits.
What is the investment risk?There is a risk that the value of your
pot could fall, but generally you have
the option to select funds that reflect
your appetite for risk.
Cash ISAs have no investment risk
although many pay less than inflation
so your capital is thereby eroded.

Stocks and shares ISA carry investment
risk and can fall as well as rise in value.
When can I access my money? Not until age 55Anytime although sometimes with a penalty.
Options at retirement?25% lump sum tax free. Purchase
annuity or remain invested and draw
down income.

Potentially
take entire pot and reinvest
Entirely flexible - take an income from
the interest or investment returns Draw
down an income from the ISA pot.
In the event of death? If you have purchased an annuity the
provider keeps the remainder. Any
proceeds left in income drawdown
passes to your beneficiaries after the now free of the previously punitive 55% 'death tax'
ISA savings form part of your estate. If
your total estate exceeds £325,000 you
will be subject to Inheritance Tax.
Will my income run out before I die?An annuity guarantees you an income
for the rest of your life.

It is possible that you could run
out of money under a drawdown
arrangement.
If you only use interest or returns
from your ISA pot, then (depending on
investment performance) your income
should not run out in your lifetime. If
you decide to take a regular portion of
your ISA pot as income, you could use this up.
How is my income taxed? When you take your pension income, it
will be subject to Income Tax.
Your income will be tax-free

 

 





Leave a Reply