Peter thought that he was on the right track - he paid his ISA allowance each year and contributed into a pension. His concern, though, was whether he was really doing the right thing and at the right level.
He took a seat in front of his adviser, Trevor, and explained the situation: “I like ISAs, and the PEPs and TESSAs before them. They are a simple concept and the rules have not changed for a number of years. You know what you can put in, how they work and what you can take out - unlike the ever-changing and complex nature of pensions! There have even been a number of suggestions about doing away with pensions totally – what do you think?”
Trevor responded quietly: “Undoubtedly ISAs have been a success story, but do they encourage the right sort of saving?
One of the key arguments against pensions has been the lack of access to the money until age 55, whilst ISAs and their successors - PEPs and TESSAs - are all accessible and could be spent before retirement. If started early enough, the current ISA allowance could provide a reasonable fund on retirement - maybe even enough to meet long term income requirements. Furthermore, such income would not be subject to the restrictions of an annuity or GAD rates. It is important to note, though, that a fund of the size required to produce a reasonable income could become subject to Inheritance Tax (IHT).
For pensions, whilst you cannot access the money until age 55, there is tax relief at the highest marginal rate - subject to an annual allowance and a lifetime allowance. They also offer tax-efficient investment roll up and a tax-free lump sum. And whilst there is no requirement to buy an annuity, the amount that can be taken out is restricted, which could help to
prevent early fund depletion. Pensions should also be IHT efficient until age 75.”
Paul interjected: “So what should I do?”
Trevor continued: “It is great that people have the ‘ISA habit’, but for me the real solution is probably a combination of the two – pensions and ISAs at least.
Retirement planning is about more than pensions, so pensions and ISAs working together could be very tax-efficient. Somebody with a dramatically reduced GAD maximum could supplement income with an ISA until rates improve (hopefully). Similarly, in later life using an ISA income and not pension income could be part of an IHT mitigation plan. The tax-free nature of ISA withdrawals, coupled with a phased retirement exercise, could be a useful tax exercise.
They can even be used together - close to retirement a pension contribution from an ISA (perhaps assuming no other ready cash) would receive tax relief and then be accessible on retirement. If opting for fl exible drawdown then nothing would really have changed, except that the tax relief will have been added.
There are a number of tax wrappers available, some with advantages/limits (EIS/VCT) going in and some with advantages/limits on withdrawal (CGT allowance, onshore/offshore bonds). The key to good planning is using these wrappers in the most efficient way within your risk profile, with a suitable investment strategy and in line with your real plans on retirement.”
“So” said Peter “more of the same?”
“Yes” said Trevor “and a bit more long term planning!”
Mike Morrison
Head of Platform Marketing
AJ Bell