Pension savings vs stocks and shares ISA

[PheobeBebe]

I'm in my thirties and starting to get my act together in regards to my retirement planning. Please can someone explain pensions to me as if I know nothing? I'm doing an online calculator and it looks as though putting in 400 a month for 30 years (so 144,000 investment) would give me back a pension of £14,223 pa. Does this sound right? I'd have to claim a pension for 10 years before I'd see any 'return' for my investment?
I'm looking at stocks and shares Isa's too which, while I completely appreciate is more risky, for the same £144,000 investment but an average 10% return pa I could have a 'pot' worth £700k. With this sort of money moved into a savings account at 4% I could have interest of £28k pa, nearly double what I would get in a pension. Plus income from an isa won't be taxable unlike the pension, and if I died my kids could inherit the isa but not my pension?
I think I'm missing some valuable information because this difference is massive. Please tell me why I should have a pension...

You get tax relief on the pension so if you contribute £1000 another 20% is added (you can claim more relief if you are a higher rate tax payer). When you draw it down you pay income tax at that point. Essentially you defer the tax on it to a point in your life when you are earning nothing.

Assuming this a money contribution pension, your kids can inherit any undrawn amounts, but they will draw it down as though it will be there own income and taxed accordingly.

Thank you both. I didn't assume the same sort of return on a pension as I was just using an online calculator with what I can expect to receive back, and those were the results. If I did assume a similar return then, is there a cut off of how much/when my kids can inherit? I was reading about a 5 or 10 year guarantee period, so my thinking was that if I retired at 65 and died at 75 that they wouldn't get anything

If you take out an annuity (- guaranteed monthly payment until you die), the provider keeps what is left in your pension, although you can have an annuity that provides a lump sum if you die before an age you specify.

if you use drawdown - so take money out of your pension as you need it (but risk running out) and you are under 75 when you die, no tax is payable when your children access the fund. If you were over 75, they pay tax as they would income tax.

Theres no reason more would be in the isa.
As pp says you get the tax added to the pension but get charged it when you take it out.

Isa money would count as an asset for if you become unemployed or wanted UC where you can only have 5-16k etc.

Plus your employer may match pension contributions

I've been wondering the same thing as you OP. I have a small LGPS pension but am looking at other options to boost my retirement income. Private pensions seem to have very poor returns & although I understand the tax incentives they don't necessarily work for me because I don't earn enough to pay tax.
I have bought premium bonds & am now trying to max out ISAs if I can each year. It feels like I will have more control of my money this way than putting it into a private pension.
I am grateful for my LGPS pension though & may have thought differently without it.

Differences to think about-

• the pension pot will be tax free going in, taxed coming out (apart from the 25% lump sum)
• the ISA will be taxed going in (ie paid from taxed income) and tax free coming out. Most people are in a higher tax band in their working life than in retirement so this is worth thinking about.
• The pension pot is tied up until you reach 58+. The ISA can be accessed any time.

In terms of return, it makes a difference that the money going into the pension is tax free as you can then grow the part that would have been tax as well as the rest (of course this is taxable coming out but see points above). The rate of return is nothing to do with whether it's an ISA or a pension- that's down to the underlying assets you choose to invest in.

Depends on whether you buy an annuity or not and its terms. If you draw down, anything still in the pot can be left to your children.

Your numbers for a return from an ISA look off to me. You should assume you'll get about 5-6% whether money is in a pension or an ISA. Let's hope for more but no point being too optimistic.

There's a hundred ways to slice the numbers but, long-story short, you're almost certainly best off saving into a pension if this money if for retirement and you don't think you'll need the money before then. That's especially true if your are a 40% (or 45%) taxpayer now.

I'm looking at stocks and shares Isa's too which, while I completely appreciate is more risky

This isn't (necessarily) true. An ISA or a pension is just the wrapper that you hold an investment in, they can both hold exactly the same investments and it's the investment itself which is more or less risky.

OP, I hope you don't mind me saying but it sounds as if you need to do a bit more reading around to make the best decision for you.

Would you be able to explain what kind of calculator you used for the pension? Is this an employer's pension or something you are looking at taking out yourself?

If you can get an average 10% return in an ISA then you can do the same in a pension (I think that rate of return is on the high side, but the point is you can invest in the same things).

If you’re a higher rate taxpayer the pension makes most sense if you don’t need the money due to the 40% tax relief.

If it is a personal pension then your kids can inherit it.

The main benefits of a pension are:

• Contributions are before tax
• 25% of the fund can be taken tax-free
• If you are employed your employer will contribute to a pension (indeed you should have a company pension scheme: is that what you are looking into?)

In your analysis above you don't say what the online calculator is assuming about investment returns and the pension you buy - for example, does that £14,000pa pension increase in line with inflation or is it fixed? If you die, does the pension pay out at 50% rate to a spouse or not? The £14k pa doesn't seem unreasonable but it's important to understand as it makes a big difference whether it increases or not.

10%pa returns for the ISA is extremely high. Reduce that to a more reasonable 5-6%pa return and you rapidly end up back at the same sort of income as the pension would produce, except you've had to pay your contributions on an after-tax salary. If you are withdrawing all the interest to live on then the amount will gradually lose purchasing power each year due to inflation.

If you die before retiring both would be available in your estate. Same if you die after retiring but are using income drawdown (i.e. where you dip into your pension pot each month just like an ISA). If you buy an annuity then as you say you can buy it with a guarantee period, but after that it would "die with you". However, an annuity is really more like an insurance product - the benefit of it is that the payout is guaranteed once bought, including pension increases if you buy them (in your ISA example you have ASSUMED investment returns are good and interest at 4% but those may not happen) and also the annuity lasts as long as you do, even if you live to 90 or 100, whereas your ISA will just eventually run out, or certainly run out of purchasing power due to inflation.

Finally, check our Lifetime ISAs. You can pay in £4,000 per year up to age 50. They are something of a halfway house, with the government contributing tax relief. However, employers will still not pay into them.

Presumably you don't yet have the £144,000 but would be saving it over the next 30 years. So the amount of interest you get from an ISA or stocks and shares is going to be a lot less than you have suggested as you wouldn't have the full investment until retirement when you would want to access it. If you had the £144,000 now to invest then it would be a different story.

As others have said a pension and an ISA are simply tax efficient wrappers, you can have the same investments in both so returns shouldn't be any different. But it will depend on your pension provider and the funds they offer. Ideally you would look to be in a higher risk fund as you are young and derisk as you approach retirement.

Also you are now allowed to drawdown your pension pot, meaning that when you get to retirement you can dip into the pot and take what you need.
The other option, guaranteeing a certain amount per annum, is called an annuity. This is something you can buy with your pot, but which few people now do.
If doing drawdown (most do) then even on your death the pot still exists as part of your estate.

Pension pot are not part of your estate.

Unlike Isas.

If you’re in your 30s look at Lifetime ISAs as well as pensions, particularly if you’re a basic rate taxpayer.

I’m doing a mix of pension saving and LISA for retirement - I like the fact that I can access the LISA money (albeit with a penalty) if I really need to, plus you get money added from the government and - if you leave it to 60 - no tax on the way out.

They are in the sense that they can be passed to your family.
They are not in the sense of being taxable.

See if this video helps explain why the Pension wins over ISA: m.youtube.com/watch?v=y-4s1wqwQ7k
Video is from 2021 so somethings like pension annual allowance has changed but the overall principle applies.

Pension you get tax relief on the way in, so not only what you pay in grows, so does that tax relief.
ISA you pay into from your after taxed income. It grows tax free. It is accessible.

As is often the case, having some of both is likely an ideal situation, as you may want some money before retirement age.