Volatility in the pensions investment sector and increasingly tight restraints on how assets can be ...
Volatility in the pensions investment sector and increasingly tight restraints on how assets can be saved and used, some consumers are turning to the investment market to save for retirement rather than buying a pension and annuities.
Jon Briggs, associate director, pensions, at Chartwell Investment Management takes a look at the options on offer and asks whether putting in a savings plan is better than placing it in a pensions wrapper.
The subject of state pension benefits is becoming more and more uncertain every year and individuals are forced to think seriously about planning for retirement. In today's world of good living, retirement planning is an important decision that should not be taken lightly. At retirement, people expect to enjoy a level of lifestyle that they have been accustomed to while working. However, without proper planning, very few people will achieve this.
Traditionally, people have funded their retirement by paying regular contributions into some form of pension and then drawing an income from the plan when they reach their selected retirement date. This has been the case in the past, but there has always been an argument for using alternative products to fund that retirement.
When all is said and done a pension is merely a savings policy with certain benefits. Throughout your working life you will invest some of your income and turn it into a capital sum. When you eventually want to stop working, or at least slow down, you can turn this capital sum back into an income. This is the same whether you use a pension, Isa, endowment policy, building society account, or put your money in a shoe box under the bed! The principle is the same, but the outcome will certainly be different in each case.
The most obvious alternative to any pension is an Isa. These plans offer an attractive flexible alternative for many reasons.
One of the biggest advantages with regards to any pension plan is the up-front tax relief that is received on premiums. Isas do not receive any tax relief on the premium, so the amount you pay in is the amount invested.
One perceived disadvantage of pension plans, however, is that you are restricted to taking the benefits between the ages of 50 and 75 with a maximum tax-free lump sum of 25% and the remainder being used to provide an income. With an Isa it is entirely up to the client when they take the benefits from the plan, and these will be paid back tax-free, however, this flexibility may not be such a good thing for the not-so-disciplined investors among us!
Both pensions and Isas have the potential to invest in a broad range of different funds. Pension providers are now providing links to external fund managers, which means some of the top performing funds within the market place are now available for pension investors.
Both types of contracts have their limits on the amounts that can be paid in any tax year. Any person who qualifies to take out a stakeholder pension or personal pension can invest up to £3,600 per annum gross (£2,808 net of basic rate tax) in a tax year, however, considerably more can be invested by those people with the earnings to justify it. The maximum contribution that can be paid into an Isa in a tax year is £7,000. This gives considerable scope for saving large amounts across both types of plans.
In pure mathematic terms, investing into a pension still has a small edge over contributing to an Isa for basic rate taxpayers who will still have to pay basic rate tax in retirement. This is because of the ability to take 25% of the fund as tax-free cash at retirement - assuming this money is reinvested in a tax-efficient manner for further income.
The example below shows the anticipated returns for a male age 42 who invests £78 per month until his 60th birthday. It has been assumed that contributions into the pension/Isa will increase at 3% per annum (in order to provide a hedge against inflation) and the return over the period to retirement is 7%:-
|Personal Pension Plan||Individual Savings Account|
|Estimated fund at age 60||£48,057.89||£37,485.15|
|Tax-free cash available||£12,014.47||£37,485.15|
|Remainder available for pension income||£36,043.42||-|
Assuming it is possible to obtain a gross Annuity of 6% per annum index-linked (based on today's rates), the £36,043.42 would provide a gross income of £2,162.61 per annum. This equates to £1,686.83 per annum net of basic rate tax.
Assuming we also draw a tax-free income of 6% from the tax-free cash and Isa fund the results would be as shown below:-
|Details||Personal Pension Plan||Individual Savings Account|
|Income from tax free cash element||£ 720.87||£2,249.11|
|Income from remainder||£1,686.83||-|
As noted above, the Pension Plan comes out marginally better than the Isa because of the ability to take a tax-free income from the tax-free cash sum. The extra income provided of £158.59 is only an improvement of just over 7% upon the Isa fund so there is very little in it if flexibility is not an issue.
For higher rate taxpayers who expect to be basic rate taxpayers in retirement the sums really do favour pension investment to the exclusion of every other form of saving.
Both plans offer a relatively cost efficient way in which to invest in a wide diverse portfolio of equities, especially with the introduction of CAT standards on ISA's and low annual management charges on pensions. This enables the investor to invest in a broad range of equities along with benefiting from lower charges than experienced in the past.
For those investors who have already exhausted their pension and Isa allowances by saving for retirement, there are other products and strategies that can be used to fund for retirement. The most obvious of these is to look at investments that concentrate on growth and offset your capital gains tax allowance of £7,500 per tax year against any gains made. Investment Trust and Unit Trust savings plans offer a low cost and flexible solution and there are no limits on what can be invested into these.
There is no easy answer these days when it comes to deciding whether to fund retirement through a traditional pension product or some other form of investment such as an Isa. Each individual will have their own views and ideas about how they wish to fund for their retirement and we should always remember that each client is an individual and recommendations should always be made to suit that person's needs and priorities.
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