Pension vs. ISA: The Pro’s & Con’s

Tuesday, 1st December 2009 16:16 - by Resident IFA

Legal & General, Hargreaves Lansdown, and Money Mail recently produced a natty little table showing the relative monetary merits of saving into a Pension or an ISA (Individual Savings Account). They took a comparison of a Tracker ISA (i.e. following the FTSE100) and Pension plans with 1% and 1.5% annual management charges, the contributions being £200 (net) per month over 40 years. Nowadays, a 1.5% annual management charge would be pretty reasonable on a Personal Pension, and possibly under-playing the situation if a number of externally-managed investment houses funds (i.e. Invesco Perpetual, Jupiter, Gartmore, etc.) are included. In this Blog, I’ll always be referring to a basic-rate taxpayer i.e. one that has a 20% liability. Let’s look at it from the perspective of some of the basic Pro’s & Con’s of contributing to a Pension: Pro’s  Tax relief on contributions. Using the above £200, an extra £50 would enter the fund as tax relief.  Active management. The ISA Tracker fund used an example in the table is a ‘passive’ fund i.e. it simply follows a benchmark. Some would argue that, over time, this is a more effective (certainly cheaper) approach than using a specialist ‘active’ fund manager. I would argue that a good manager with a track record to match is worth their salt.  The money cannot be accessed until 55 at the earliest. I am not saying that everyone has a lack of self-control that leads them to spend saved funds at the drop of a hat, although I see having the discipline of funds sequestered until a specific date as a positive thing. Con’s  Lack of access. As if to contradict my previous point, you only have investment control whilst the money is in a Pension, and are then only allowed to take 25% back as tax-free cash between ages 55 and 75. Thus, 75% of the accrued fund has an incontrovertible purpose to provide a (taxable) retirement income.  The income received from a Pension is taxable.  Effect on a Pensioner’s ‘Age Allowance’ (AA). The threshold is £22,900 income in the 09/10 tax year, whereby every extra £2 above this reduces the AA by £1. Someone under 65 can receive £6,475 before attracting tax; this rising to £9,490 between 65-74, and £9,640 for a person over 75. In the analysis by the aforementioned companies, Pensions still come out pretty well; realising a much larger fund at retirement, and similar income to the ISA at retirement on the 1.5% annual management charge Pension variant. A Pension fund, on death before retirement and the drawing of an income, can also be more tax-efficient. Money in an ISA is free of Income and Capital Gains Tax (CGT), but not death duties (Inheritance Tax (IHT)). If a Pension plan is written under a suitable Trust, the benefits may be free of IHT. Of course, there are a number of factors and an individual’s circumstances/goals play a major part in which approach may be the dominant one in financial planning terms. At the risk of getting splinters in my derriere (!), I believe it is likely that a combination of Pension and ISA may work well, the ISA possibly filling the short/medium-term savings role, the Pension the long-term savings role. Whatever the weather, my view is that a Pension plan is the cornerstone that retirement is built upon. Until next time...