Pensions, ISAs and Tax

[IR35 Avoider]

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

No it isn't. In almost all practical examples there is significantly more tax relief on a pension. This is because

• a quarter of the proceeds can be take completely tax free
• Contributions may receive tax relief at the higher rate but only be taxed (taking into account tax-free lump sum) at 75% of the basic rate
• employer contributions avoid NI as well.

If you have dividend income and you are 100% certain you are not IR35-caught (and I don't believe it is ever possible to be that certain unless you've had an investigation and survived it) then the advantage of the money not being tied up might make ISA more attractive. (Employer pension contributions immunise that portion of your contracting income against IR35.)

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.

It won't be identical, the pension will be better because of the 25% tax-free lump sum.

ISAs allow you to blow your capital on birds and booze and then claim benefits when you've spent it all

I hadn't considered the option of falling back on benefits, that may indeed change the calculation for those who consider it an option. I don't.

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

I have always used my full ISA allowance in addition to my pension funding, however when my (pre IR35 era) dividend-sourced savings run out I will let my wife use my ISA allowance.

[Lewis]

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.

Using your figures, the first 25k would attract no tax (you get a 10% tax credit for 'free'). The remaining 45K would attract 22.5% ( i.e. 32.5% higher dividend rate - 10% lower dividend rate) although these rates are applied to the Gross dividend amount not the net (do a search to find the difference).

The advantage of keeping money in is that if one year in the future you don't work much you can take it out in the lower band (i.e. tax free).

[IR35 Avoider]

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 example not only ignores the tax-free lump sum, it assumes that all the pension income will be taxed at 40%, i.e. it assumes you will have 40K per year in taxable income from sources other than the pension/ISA savings being discussed.

If you are going to have the equivalent of £800,000 lying around in addition to the money you are considering putting into ISAs or pensions, then I agree pensions may not be so attractive. I don't think this is going to apply to many people here.

[dude69]

No it isn't. In almost all practical examples there is significantly more tax relief on a pension. This is because

• a quarter of the proceeds can be take completely tax free
• Contributions may receive tax relief at the higher rate but only be taxed (taking into account tax-free lump sum) at 75% of the basic rate
• employer contributions avoid NI as well.

If you have dividend income and you are 100% certain you are not IR35-caught (and I don't believe it is ever possible to be that certain unless you've had an investigation and survived it) then the advantage of the money not being tied up might make ISA more attractive. (Employer pension contributions immunise that portion of your contracting income against IR35.)


It won't be identical, the pension will be better because of the 25% tax-free lump sum.



I hadn't considered the option of falling back on benefits, that may indeed change the calculation for those who consider it an option. I don't.

You will never, ever, ever, ever, ever, ever, ever, see 75% of the money in your pension again. Under any circumstances. And you won't get access to even the income or the 25% for potentially many years in the future.

That sucks considerably. How much does is the true worth of that money? It is a big big weight against all your arguments above.

I have always used my full SIPP allowance in addition to my pension funding, however when my (pre IR35 era) dividend-sourced savings run out I will let my wife use my ISA allowance.

Are you employed by a Ltd. company? The maximum contribution is £225k/year.

If you are paying that in, all I can say is I clearly need to put my rate up.

[glashIFA@Paramount]

[QUOTE=Cheshire Cat;470486]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.

Seems like theres always going to be a difference of opinion as to the best route so could argue that it makes sense to invest in ISAs and pensions too. i agree that annuity rates are more than likely going to be significantly worse in 30+yrs time - they've halved in the last 20 but the "government pot" is getting empty so i reckon the gov't will be doing as much as they can to incentivise people to make their own provision. Of course, they could also make changes to ISA legislation - when they were first introduced they only had a g'teed shelf life of 10 yrs althought his has now been extended.

a lot of you talk about BTL and being landlords. There are schemes out there that let you claim potentially valuable capital allowances.

Tax relief at your highest marginal rate on investments into the development of residential property over commercial premises and the chance to "gear" the investment.

Example.

Client investment £45,000
Personal bank loan £25,000
Total client investment £70,000

Tax relief at 40% £28,000 (£70,000 X 40%)
Net cash investment £17,000 (£45,000 less £28,000 relief)
Loan to partnership for
property purchase £105,000 (1.5 X client investment)

Total client interest in property £175,000 at net cost of £17,000.

So all the advantages of tax relief on the investment, same as pensions, and access to capital in approx 10 yrs so not tied up for ever, same as ISAs.

Before anyone comes back and says this is crap advice can i just say that this is not advice, its information. I'm just trying to let those who are interested know there are other investment options out there.

[Cheshire Cat]

You will never, ever, ever, ever, ever, ever, ever, see 75% of the money in your pension again. Under any circumstances.

How come?

[Lewis]

I have a question .... my wife has no pension. The idea is we live from mine, what happens when I die. Do I purchase an annuity that pays her a pension when I die or do we need to put something in place before retirement?

[Hex]

How come?

'cos it's locked away in your pension wrapper and you're not trusted with it any more.

[Hex]

I have a question .... my wife has no pension. The idea is we live from mine, what happens when I die. Do I purchase an annuity that pays her a pension when I die or do we need to put something in place before retirement?

You can buy an annuity that will keep paying her after you die. Obviously it's more expensive than one that doesn't.

[Cheshire Cat]

'cos it's locked away in your pension wrapper and you're not trusted with it any more.

but you can buy an annuity with it when you retire, and the value in the "pot" determines the income from the annuity. am i missing something else? is there a secret 75% tax on pensions?