News Archive - November 2008
A Pension or an ISA?
17/11/2008A common question from clients who do not have the benefit of a company pension scheme is whether they should have a personal pension or 'something else' to save towards their retirement.
One theory is that you are better off saving into an ISA. ISA savings are easily accessible and any growth within the fund is tax-free. You have the option of using a cash ISA (which works like a bank account) or a Stocks and Shares ISA which can invest in the same unit-linked investment funds as a personal pension. On retirement, the ISA will provide a lump sum with which the pension can do as they please.
In comparison, personal pensions are seen as very restrictive for the long-term saver because the fund cannot be accessed until age 55. Even then, only 25% of it is available as a lump sum and the rest must be used to provide income (usually via an annuity), which is then taxable.
So what's so good about personal pensions? Well, the answer is income
tax relief.
At the moment a basic rate taxpayer gets 20% tax relief on their pension
contributions. This means that for every £80 you put into a pension,
an extra £20 is paid in by the Government. More importantly, that
extra £20 will also benefit from any growth that your fund experiences.
If you saved £200 per month each into a Stocks and Shares ISA and a Personal Pension for 25 years then the total contributions (ignoring any growth and tax relief) would be £60,000 each. (200 X 12 X 25).
If we assume that the charges on the ISA and the pension are the same, and we assume a net growth rate of 5% per annum after charges on each policy, then after 25 years the comparative fund values would be around £119,500 in the ISA and around £149,500 in the pension. The longer the time period concerned, the more marked the difference would be.
For higher rate taxpayers, the benefit of a pension is even more pronounced because they get an additional 20% tax relief on their contribution via their self-assessment Income Tax return.
ISA savings have their place, but I think that making some kind of regular pension saving is key to a happy retirement.
Many are unhappy with the idea of buying an annuity, but in fact annuities make a lot of sense for older people who want a reliable income with no investment risk. Next month I will discuss annuity rates and the prospects for pensioners over the next 12 months.