Pensions, ISAs and Tax

**moorfield** · 29 February 2008, 10:47

Have a look at this I posted a few days ago ...

http://www.telegraph.co.uk/money/mai...5/cmpen125.xml

Sobering isn't it ?

I think pension contributions become a no brainer for us contractors especially (1) once the new income shifting legislation starts to kick in and (2) you can keep under the higher rate income tax band on £35k ish a year to cover your living costs.

You can take 25% of your pension pot tax free at 55, the remainder you can leave until older age or draw off at or under the lower rate income tax band.
Future governments are unlikely to dick around with the new rules that would be politically very risky.

**Lewis** · 29 February 2008, 10:52

Being 36 myself I don't know the details but I have always assumed you just paid tax on the pension income after retirement. The benefits being (a) you gain from the money made on the tax saved and (b) your earnings are lower at retirement so your tax bill is significantly smaller than it is now. The two combined are a significant benefit.

ISAs are tax efficient but not as much as pensions as you have paid tax before you make your investment.

A stakeholder is flexible and has low management fees. I think the biggest gripe people have about pensions is that the money is locked away. Which for some people is a good thing! You don't want to spend your retirement money as then you will have nothing to live off so having it locked away avoids temptation.

In the event of death the money is not lost, it goes to your next of kin. The only real downside of a pension as far as I can see is that you need a lot in it to get a decent income and annuity rates may not be so good at your retirement but I suspect things will be very different when we come to retire.

Of course, the other reason to avoid them is if you have a low life expectancy. But as I have two grandparents who have lived to 100 and made a killing on their pensions I can see their good points.

Both my parents are happily retired on pensions that are inflation linked, they can sit back a relax for the rest of their days. They have friends that have none, maybe some savings. They run the risk of one day running out of money and having to try and live on benefits! Plus they are already working longer which I believe statistically reduces their life expectancy.

I have an old university friend who works as a senior pensions advisor. I trust her judgement and she says that they are a great product.

I have a modest pension and plan to have as big a house as possible come retirement so I can downsize and maybe be a landlord as well. I think the trick is to have eggs in many baskets.

As an aside, we are paying the max £300 per month into our 1 year olds stakeholder pension, just for 1 year. The amount that it will be worth come 65 is a very tidy present. As we can afford it now it seemed like a nice thing to do. I wish someone had done that for me...

**Lewis** · 29 February 2008, 11:00

p.s. as discussed in a previous thread. You may find an offset mortgage out performs an ISA in today's climate.

**dude69** · 29 February 2008, 11:46

Originally posted by Cheshire Cat View Post

If MyLtdCo pays pension contributions into a pot for me, that is an expense, no tax is paid on it.
When, at 65 or whenever, the pension fund "matures" and I buy an annuity with it, do I pay tax then? Or do I pay tax on the earnings from the annuity?
My father-in-law was banging on about pensions last week, saying that even though there is no tax upfront, they're still not a great long-term investment. Since he couldn't explain his position in detail, I'm not sure he's fully clued up, or at least is seeing the situation from his position as a man about 7 years from retirement, whilst I've got another 30 years (plus?) of grind ahead of me.
So, are pensions really a good long-term investment for a young-ish ldtCo director? What are the disadvantages? Could MyLtdCo just put cash into an ISA that I could withdraw and invest how I choose. I guess not, 'cause then people would pay 7k a year into an ISA and immediately withdraw it to avoid tax.

Hmmm. Anyone in a similar position pondering long-term finances?

Hi.

In terms of tax treatment, an ISA is quite similar to a pension.

However the flexibility of an ISA is infinitely superior.

It's quite simple: even though you get tax relief going into a pension, there is no tax relief coming out.

So assuming you pay tax at the same rate now and in the future, the income stream from each will be identical. That's because the ISA income is tax-free but pension income is taxable.

The differences come from:

* pension tax-free lump-sum of 25%
* pensions heavily restricted in amounts you can drawdown, you can never spend the capital whereas ISAs allow you to blow your capital on birds and booze and then claim benefits when you've spent it all

The restrictions on the pension money and uncertainty considerably reduce its utility.

Basically the ISA is rather more attractive, so top up 2 * £7k ISAs per year (if married), and then if you still have spare cash in the company, only then start funding the SIPP

**dude69** · 29 February 2008, 11:49

Originally posted by Lewis View Post

ISAs are tax efficient but not as much as pensions as you have paid tax before you make your investment.

It's identical.

Take £10k gross into pension, or £6k net into ISA

Invest for 30 years at 7% = £76,122 or £45,673

Withdraw at 6% per year on retirement = 6% gross from the ISA, or 3.6% from the pension

3.6% of £76,122 = 6% of £45,673

Of course if you want to withdraw MORE from the ISA you can, but with the pension you cannot.

And if you want to blow the whole lot aged 48, you can do that too, but only with an ISA

**Cheshire Cat** · 29 February 2008, 11:49

that main disadvantage with pensions that i can see is that by the time i reach retirement in 30+ yrs the annuity rates are likely to be even worse than they are now, with an elderly population living longer.
Plus, theres always the risk that a government comes along and makes changes to pension tax or something that means your income is reduced, although historically whenever major changes have occured they seem to have been applied from date X so as not to disadvantage those too near retirement.
Suppose it's a gamble like most things.

One question I have, re higher band of personal tax.
If MyLtdCo income is 100k p.a. and I draw 10k salary, pay 20% CT on 90k, leaving approx 70k to be drawn as dividends, the first 25k of this would be eligible for lower tax band (22% currently) and I would presumably have to pay 40% tax on the remaining 45k divvies.
Some people suggest drawing less in divvies to stay below the high tax threshold, but what's the point in MyLtdCo making profit if I'm going to leave it in the company and not have access to it. yes I could put some into a pension, say 10K, buy company equiptment, say 2-3k, but that leaves 30k+ in MyLtdCo that I will not be able to draw without incurring higher taxes. I thought the idea of paying CT is that then divvies didn't attract tax again.

E.g. If my company has 50k (pretax) profit, and I am AT the higher tax threshold, MyLtdCo must pay 20% (10k) CT, then when I issue the divvy I (personally) must pay 40% (16k) income tax so I see only 24k of the 50k.

I think I'm just confused...

**Cheshire Cat** · 29 February 2008, 11:55

Originally posted by dude69 View Post

It's identical.

Take £10k gross into pension, or £6k net into ISA

Invest for 30 years at 7% = £76,122 or £45,673

Withdraw at 6% per year on retirement = 6% gross from the ISA, or 3.6% from the pension

3.6% of £76,122 = 6% of £45,673

Of course if you want to withdraw MORE from the ISA you can, but with the pension you cannot.

And if you want to blow the whole lot aged 48, you can do that too, but only with an ISA

This assumes you're paying 40% tax when you draw your pension, chances are it's your main source of income and so you'll pay lower rate tax (4.6-4.8% of the £76,122 capital and not 3.6%)

**dude69** · 29 February 2008, 11:58

Originally posted by Cheshire Cat View Post

This assumes you're paying 40% tax when you draw your pension, chances are it's your main source of income and so you'll pay lower rate tax (4.6-4.8% of the £76,122 capital and not 3.6%)

Possibly.

I'm not planning to be a living off Tesco value bread when I retire though.

**ASB** · 29 February 2008, 12:51

Originally posted by dude69 View Post

* pensions heavily restricted in amounts you can drawdown, you can never spend the capital whereas ISAs allow you to blow your capital on birds and booze and then claim benefits when you've spent it all

One could argue this is an advantage for the pension if tulip really happens.

If the money is all in a pension then you don't have to spend it before getting means tested benfits. If it's in an ISA then you will have to spend it.

Pensions, ISAs and Tax