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Tax relief upfront is the same as tax relief later: Pensions versus ISAs

Pensions versus ISAs from a tax perspective

There is nothing magical about pensions versus ISAs, the UK’s two tax-free savings wrappers, that somehow enables pensions to break the laws of mathematics.

Both pensions and ISAs deliver one-shot tax relief, as well as allowing your savings to grow tax-free.

  • Pensions give you the relief upfront, by rebating the tax you’d otherwise pay on your contributions.
  • ISAs give you the tax break later, since you pay no tax when you cash in your ISA investments.

You’ll often hear people claim that pensions are better than ISAs because upfront relief is more valuable. “You have more money to compound over the years with a pension,” they say, which they claim gives pensions the edge.

But this is wrong – all things being equal.

Now, all things are rarely equal, and I’ll get to that in a minute.

But first the science bit.

Pension versus ISAs: A quick recap


  • With a pension, you get tax relief on your contributions.
  • If you pay 40% tax, say, then a £1,000 contribution costs just £600 of taxed income.
  • You pay tax on the money you take out when you retire.


  • With an ISA, you get no initial tax relief.
  • Instead, you put some of your taxed salary into the ISA.
  • However, you do not have to pay tax on the money you withdraw later.

Mathematically speaking, there is no difference between these two situations, provided the tax rate is the same.

Proof that ISAs and pensions are the same, maths wise

Here’s some algebra to prove pensions and ISAs are equivalent – all things being equal.

Consider the variables:

  • A lump sum investment of £x
  • Tax rate of t%
  • Annual growth of i%
  • Investment period n years

With an ISA you get no initial tax relief, and you pay no tax on withdrawal.

The formula for how your money compounds over ‘n’ years is therefore simply:

  • ISA = x * (1+i)^n

With a pension you get tax relief of t%, but you also pay t% tax when you withdraw the money later.

The formula for how your money compounds over ‘n’ years is:

  • Pension = x/(1-t) * (1+i)^n * (1-t)

Now, (l-t)/(l-t) cancels out. This leaves us with:

= x * (1+i)^n

Which is exactly the same as the ISA!

This is why some prefer to use the phrase ‘tax deferment’ rather than ‘tax relief’ when talking about pensions. The relief you get upfront is cancelled by the tax you pay later – all things being equal.

A worked example of tax equivalence

Here’s an example of pensions versus ISAs with real numbers.

Consider a higher-rate taxpayer who:

  • Sets aside £1,000 of his gross salary to invest every year
  • Pays 40% tax
  • Gets 10% a year growth on his investment
  • Leaves it to compound for five years
  • Draws an income of 5% a year in retirement

With the ISA, he is funding his contributions out of his taxed income.

Higher-rate tax is 40%, so our man’s £1,000 contribution is multiplied by (1-0.4=0.6) to reduce it by 40%, then compounded over five years, and then finally, he takes out 5% (so we multiply by 0.05).

  • £1,000×0.6×1.1×1.1×1.1×1.1×1.1x.05 = £48.32

With the pension, our chap can put in the £1,000 from his salary tax-free. However, he must pay 40% tax at the back-end.

This time, we get:

  • £1,000×1.1×1.1×1.1×1.1×1.1×0.6×0.05=£48.32

The same!

Important caveat: Things are NOT equal

I’ve shown there’s no difference between an ISA and a pension from a pure maths standpoint.

But I said that was with ‘all things being equal’. And things aren’t equal!

Caveat 1: Lower-rate taxpayer in retirement

Most people pay a lower-rate of tax in retirement (0-20%). This can make a pension a better option than an ISA for higher-rate taxpayers who will be lower-rate taxpayers in retirement, because the rate they pay on withdrawing the money (20%) will be lower than the tax relief they got on when they put the money in (40%, or 45% for additional rate payers1 ).

In my worked example, instead of multiplying by 0.6 to represent the tax on withdrawal, as a lower-rate payer you’d multiply by 0.8, which gives a much higher income of £64.42.

But there’s more! You still have an annual income tax personal allowance as a pensioner. So a good chunk of your pension income may not be taxed at all. (The first £11,000 at the time of writing, presuming no other taxable income streams are complicating matters.)

On the other hand, some of your personal allowance should be used up by (hopefully) a State Pension at some point in your retirement. The State Pension counts as taxable income.

As you can see the marginal tax rate you’ll pay can be very uncertain 15-20 years in advance.

Caveat 2: Tax-free lump sum with a pension

A second important factor is that you can take out a one-off 25% lump sum2 entirely tax-free with a pension.

On this portion of your money you get tax relief going in, and yet can pay no tax on that 25% coming out later – the best of both worlds!

Again, this gives pensions an edge over ISAs.

Caveat 3: Employers pay into pensions, but not ISAs

Employers contribute to pensions, which can be a substantial advantage, and there are National Insurance savings too.

Pensions are also better protected if you lose your job and need to claim benefits.

Pensions versus ISAs: Same but different

In the old days – that is, three or four years ago – we’d now shift gears to talk about the huge and hidden downsides of pensions.

Gloomy organ music would rise up out of nowhere, an unseen wind would shutter the windows and plunge us into darkness, and we’d somberly recount the onerous restrictions on what you could actually do with your money that you’d saved into your pension when you were old enough to need it.

All that changed though with the 2014 Budget’s pension freedoms.

There are still some rules on what you can do with your pension pot – most particularly when you can get access to it. Currently you need to be 55, but that age climbs if you’re younger and many fear it will keep rising.

You do also need to be aware of the tax implications of different withdrawal strategies.

In contrast, with an ISA you can spend your accumulated money how and when you like. It’s always tax-free.

But still, when it comes to how you invest your pension pot once you’ve retired and how you withdraw it, most of the old strictures are gone.

Most dramatically, you’re no longer compelled to buy an annuity. You can instead invest your pension in other assets to create an income that suits you.

Famously, you can even withdraw the money to buy a Lamborghini if that floats your boat.

Our contributor The Greybeard has been covering this brave new world of pensions and deaccumulation. Please do check his articles out.

The changes mean that most people on a fairly normal retirement path will conclude that a low-cost pension based around tracker funds or an ETF portfolio is the best vehicle for retirement savings.

My co-blogger The Accumulator certainly thinks pensions have the edge.

ISAs are still massively valuable for all-purpose savings. They can also back up your pension contributions, and diversify the risk of future governments fiddling with the rules.

And if you want to retire very early, ISAs will probably have to feature heavily in your strategy, given the age restrictions on accessing pensions.3

In an ideal world you’d have both a pension and ISAs. But whatever you do make sure you’re using some sort of shelter to stop tax reducing your investment returns.

Note: Older comments below may pre-date the pension freedoms. Check the dates! Also I’ve not gone into Lifetime ISAs, as there are signs that the government is already having second thoughts about the inherent inconsistencies in this halfway house. If they are implemented we’ll come back to them, so please do subscribe for updates.

  1. But beware of reduced annual allowances if you’re a high-earner. []
  2. Technically it’s called a Pension Commencement Lump Sum, or PCLS. []
  3. If you’re trying to retire in just ten years say, then the annual ISA contribution limits are going to be a snag. Make sure you’re fully up-to-speed on capital gains tax strategies and the like. []
{ 106 comments… add one }
  • 1 ermine April 28, 2010, 12:17 pm

    The higher tax rate/lower tax rate isse is the kicker which makes pesnions more attractive. As you get older, pensions look more attractive too because

    you’re closer to seeing the gravy, and less risk of catastrophic societal failure wiping out savings

    you’re usually earning more, if you have progressed in your career of gotten more savvy as a freelancer. So you’re more likey to be a higher tax payer

    if you’re on PAYE and using salary sacrifice then the NI savings are worth having for a lower rate taxpayer

    you can take a tax free lump sum of up to 25% of your pension pot, so if saving in the 5 years before retiring that guaranteed saving of 40%/5 years is a return of 8% p.a. for HRT or 30%/5 = 6%p.a. for SRT

    I’d agree, that for younger people in the first half of their career an ISA scores all round, on flexibility if nothing else. But for older people within 10 years of retirement, the pension looks much more attractive. I am not sure that the standard angle of save for a pension as young as possible is a good idea. Saving to that aim, maybe – I’d save in an ISA for the first half of my working life, then a mix, and then switch to pump up the pension savings exclusively in the last 5-10 years…
    .-= ermine on: what happened to the middle class in the UK? =-.

  • 2 The Investor April 28, 2010, 12:47 pm

    All good points Ermine. Basically the whole issue is so big I’ve decided to split it out into a series of posts (my first draft was 3000 words!) The danger is boring you all with repetition, but probably helpful as you never know which post someone will see first.

    I agree with your ‘event horizon’ suggestion, which is a good point.

    While we wait for the next post, I’d add that pensions are pretty much a no brainer if your employer offers matching contributions whatever tax rate you’re on (100% return in a year? Yes please!) with the caveat that if you have zero control over how the money is invested, you need to take a look at how you’re being charged.

    It’d take a near-fraudulent/incompetent pension manager to whittle away the benefit of 100% matching contributions, but I’m sure it’s been done once… e.g. Equitable Life… 🙁

  • 3 drillbit April 28, 2010, 3:08 pm

    I think you’ve missed an important risk factor with pensions which is that the rules constantly change so you should factor this into your calculations
    For example:
    1970’s to 2002: SERPS
    1980’s: Personal Pensions & SIPPs
    1990’s: Stakeholder Pensions
    2002: S2P replaces SERPS
    2000’s: Pensions simplifaction (A day)
    2010’s: NEST

    A day simplification is now being undone by governments increasing regulations such as restriction on tax relief, changing early retirement rules, etc.

    My own opinion is if you’re younger than say mid-40s then the rules will almost certainly be different when you retire and you should be prepared that your justification for pensions being a superior investment than ISAs may come up short. If you’re expecting to get a 25% tax free lump sum forever then I think you’re being naive.

    Cash in the hand now is worth a lot more than a vague promise in 25 years time!

  • 4 Simple in France April 28, 2010, 3:41 pm

    I’m not in the UK, but we have some of these same arguments in the US–what tax bracket are you in now, which one will you be in later ? etc.

    One thing that I keep coming across is people arguing that tax rates will be higher in 10,20 or 30 years so you will end up paying more than you expected anyway. But I’m not entirely sure I buy that. They can only go up so far . . .
    .-= Simple in France on: Radical simplicity, frugality–for couples only? =-.

  • 5 The Investor April 28, 2010, 7:20 pm

    Hi Drillbit. As I said to Faustus above, this article is about tax equivalence, although even then I had to bring in some other issues. I haven’t overlooked regulatory risk — it’s going to have to go in that future article. (I do mention it here, incidentally). This article alone is nearly 1,000 words!

    Also (and I don’t expect readers to read all my posts! 🙂 ) this discussion began because another reader asked why I use ISAs not pensions! (The short answer being for the reasons you state). I’m far from niave about Government meddling and share many of your concerns.

    That said, I think you’re being naive if you think a future Government couldn’t tweak or even scrap ISAs, equally, or suddenly impose some windfall tax on future withdrawals of 10/20/whatever percent. If they can do it to pensions they can do it to ISAs.

    It’s also a fact that as things stand a higher-rate taxpayer with some employer contributions who is a lower-rate taxpayer in retirement is likely to be quids in, by going down the pension route. It’s not hard with a decent company pension to pay £3K of higher tax income to get over £10K straight into your pot (tax relief plus generous employer contributions). Hard to beat that enormous headstart with an ISA.

    One can’t really plan for situations that don’t currently exist, but I agree one can spread one’s risk.

    Anyway thanks for your comments, which I don’t actually disagree with in principle — quite the opposite!

  • 6 The Investor April 28, 2010, 7:21 pm

    @SIF – Agree, see comments to drillbit and Faustus. If you look at the history since WW2 the overal tax take has crept ever higher, so who knows? Fingers crossed!

  • 7 Thomas Jones April 28, 2010, 11:22 pm

    In the example for the Pension, in reality you’d have to allow for 25% of the fund tax-free as opposed to it all being taxed at 40%.

    The 25% tax-free cash isn’t mutually exclusive, you can’t have one without the other.

    It’s unliklely that someone wouldn’t take the tax-free cash as 25% of the fund would be taxed when this could be avoided by investing it for maximum tax efficiency e.g. ISA.

    £1,000 compounded over 5 years at 10% per annum is £1,610.51. 25% tax-free cash £402.62, placed in a tax efficient vehicle e.g. ISA to generate 5% income = £20.13.

    The remaining 75% is taxed at 40% (£1,207.88 x 0.6 = £724.73)

    5% income (£724.73 x 0.05 = £36.24)

    £20.13 (income generated from tax-free cash) + £36.24 (taxed income) = £56.37.

    Its approximately a 16.7% increase in income over the ISA.

    If the tax-free cash lump sum was too big to fit in a single year’s ISA allowance it could be phased in for future years and perhaps, put in the spouse’s ISA allowance, where available.

  • 8 The Investor April 29, 2010, 12:22 am

    @Thomas – Agreed, it’s in my caveats. The top part of the article is just addressing the issue of how tax later is same as tax earlier.

    Agree the (totally arbitrary) taxfree allowance 25% is a big plus for pensions, as said.

    Thanks for doing the maths though!

  • 9 drillbit April 29, 2010, 1:57 pm

    Thanks for replying. You point out that I could be naive in thinking that the ISA regime will change. Yes there’s a risk, but seeing the risk from the position of the politicians we get these arguments:
    * 40% tax relief is looking more and more like it’s going to go. It’s in the LibDem manifesto, Aviva in their submission to the government on pensions change wanted to see a harmonised 30% relief, etc. It easy to see how a politician could present this to the public as “fairness” in getting rid of it. See https://www.pensionspolicyinstitute.org.uk/default.asp?p=164 for how higher rate tax payer enjoy the lion’s share of the relief
    * the lifetime allowance will dwindle over time. It’s only been around since A day, and yet it’s already being restricted. It’s currently 1.8m and I can already see the “fat cat bankers & their pensions” headlines that could appear.
    * the annual allowance isn’t looking too healthy either. Already 50% tax earners have a 20k “anti-forestalling limit”.
    * the average pension pot is tiny (https://www.pensionspolicyinstitute.org.uk/default.asp?p=84)
    * total tax relief on pensions is around £31 bn which is a useful chunk of change in these troubled times

    Contrast this how a government could restrict ISAs. They’re immensely popular, you’ve received no tax benefit on the way, so being taxed for just withdrawing your cash would seem a difficult sell to the public. The main thing I could see is that a politicians could bring in a “lifetime allowance” after which you couldn’t put any more in. Labour tried this when they brought in ISAs but was quickly rejected after the inevitable outcry. (http://www.independent.co.uk/news/business/money-isa-mortgage-fears-1287380.html)

    So yes cover your bases with both vehicles, but my money would be on pensions being attacked first (which may be an argument to enjoy the tax relief whilst it lasts!)

  • 10 Faustus April 29, 2010, 5:01 pm

    I really hope you are right drillbit, and agree that it is easier for future governments to tinker with pensions regulations (which are difficult to understand) than with ISA rules (which are straightforward). For that reason I think public outcry would be much more savage with the latter.

    Would be good to know the fiscal cost of these schemes – I also suspect that the Treasury loses far more with pension tax rebates (where the upper limit of contributions is huge) than it does with ISAs (though that difference may diminish as decades pass and people build larger holdings).

    In any case, it just doesn’t make sense for the government to penalise savings at a time when we need to reduce dramatically private indebtedness.

  • 11 The Investor April 30, 2010, 7:36 pm

    @Faustus – As a generalisation, I would be willing to bet good money that people in debt (excluding mortgage debt) more vote Labour, and people with savings more vote Conservative. Not everything Governments do are in our best wider interests, sadly. There’s the little matter of pandering to the different constituencies.

    (All parties do this IMHO, not just Labour – e.g. The Conservatives crazy-right-now inheritance tax policy – but Labour do it the most directly).

  • 12 The Investor April 30, 2010, 7:37 pm

    @drillbit – I’d just echo what Faustus said, and say thanks for the detail. Will definitely ponder your views and it will likely work into my series on pensions/ISAs for retirement. The popularity point is particularly relevant and I hadn’t fully taken that into account.

  • 13 Ben January 15, 2011, 10:16 pm

    do the recent changes to the pension rules change these arguments significantly?

  • 14 The Investor January 20, 2011, 12:45 am

    @Ben – I believe they do, yes. Pensions are getting ever more flexible and attractive, especially SIPPS, although they’re still not quite as attractive as ISAs in some respects. (Personally, I’d like to see the two regimes combined).

    I’ll write a new SIPP article at some point in the next month or so, hopefully.

  • 15 Perry February 20, 2013, 10:10 am

    Just found this old post and it is as fascinating, relevant and true as it was 3 years ago, many thanks

    The other thing about pensions for me is that pension income is only taxed after you’ve used up your personal tax free allowance (£8,105 for most people, or £10,500 for over 65’s in 2013).

    So if your only income is from ISA’s you’re missing out on another £10k of tax free income. I’d always advocate that everyone earns at least their personal tax free allowance, even if they’ve done the right thing and sheltered the majority of their assets and income from tax

    Of course, as per other comments above tax policies are subject to change!

    Perry at financialfreedomuk

  • 16 The Investor February 20, 2013, 10:16 am

    @Perry — Good point about personal income. You also have the 25% tax-free lump sum from a pension, which I’m tending to think about more favourably than I used to. Suspect a mix is best for most people, if only for regulatory arbitrage!

  • 17 Happy Larry January 10, 2014, 1:39 pm

    Just another thing to add to this old post that might be relevant to some people. With the child benefit changes I was pretty much left with little option but to switch my ISA saving contributions to the pension.

    Prior to this I was pretty much split 50:50 pension/ISA with my taxable income just about spot on 60k and monthly ISA savings were entirely from the take home in the 50-60k bracket. However with having three kids the impact of the effective tax on this band due to the CB changes tipped the scales very heavily towards pension contributions instead of ISA contributions.

    Had I been earning much more this might not have been as simple or as easy a decision but for now it works!

  • 18 The Investor January 10, 2014, 2:25 pm

    @Larry — Cheers for thoughts. Yes, a solid strategy that we’ve covered here: http://monevator.com/how-to-keep-child-benefit-and-retire-richer/

  • 19 ermine November 22, 2016, 1:48 pm

    There is still something a little bit magical about pensions which is the PCLS, when one is old enough to draw from the pension. F’rinstance in a couple of years I will always be a BRT taxpayer as my pension is over the BRT threshold. However it still makes sense for me to contribute my £2880 p.a. into a SIPP which gets grossed up by 20% to £3600. So I win 20% on the way in and get to pay 20% on the way out, why bother?

    Because 25% of that is tax-free, so I get to keep £720/4=£180. For sure, that’s not a huge win, but worth sloshing through a SIPP. If I were earning then pushing earnings through a SIPP gives a bigger reduction, the 25% PCLS effectively knocks something off your 20% basic rate tax if you can wash your salary through the pension from one year to another.

  • 20 Mathmo November 22, 2016, 2:22 pm

    Nice illustration. I’d have said there are three other things not in the main article —
    – NI exemption on pensions contribution made through work makes it a huge benefit. employer benefits too, so if you own your own company it’s win win win. Not just a different tax rate but a different tax. No NI payable when you draw the pension. (As ermine says in comments).
    – Children can gain a grossing-up of pension contributions even through their tax rate is zero. They have most to gain from the long investment life of the pension
    – You can’t get at a pension — this is good because you aren’t tempted to be diverted from your long term saving goals, but bad because the government might change the rules on you. This is important — don’t let your pension arrangements get too far away from a significant portion of the electorate!

  • 21 John B November 22, 2016, 3:01 pm

    I think you want to update the article with the Inheritance Tax implications of pensions, see https://www.gov.uk/tax-on-pension-death-benefits and its focus on age 75 and no requirement for a beneficiary to be a spouse. ISA inheritance is also possible for a spouse.https://moneyfacts.co.uk/guides/isas/inheriting-isas–the-new-rules/

    I’ve not looked into these as its not relevant to me

  • 22 John November 22, 2016, 3:38 pm

    The point about potential rule changes really is the biggest issue with pensions for younger investors. I, for example, have the choice of locking up money for a period of time with no real idea when I’ll be able to access it or how (even under current rules it’s 25 years until I’d be allowed to touch it).

    I still contribute, but only because I can use salary sacrifice and my employer donates their NI saving. Effectively I’m losing £420 cash for each £1,000 in a pension, which sounds like it should be a ridiculously good deal but really isn’t given the risks. If it wasn’t for the equally high risk that the tax relief on ISAs will be removed or limited then I doubt I’d bother with a pension unless I could salary sacrifice and/or there was a decent employer contribution.

  • 23 Catherine November 22, 2016, 3:43 pm

    Hi – I’m wondering if anyone has any thoughts on how to build a portfolio when you only have your company’s pension provider’s options (I’m with Zurich, for example). The closest things to passive trackers still have rates of 0.3%. Is that still better than going with the default (actively-managed) funds they set me up with automatically?

  • 24 Bellabeck November 22, 2016, 4:07 pm

    For those who may be lucky enough to stay (just) in HRT bracket once retired, then building up the largest permitted ISA fund permitted enables the pensioner to keep the pension income around the break point from BRT to HRT (whatever level that applies at the time, currently £43K but perhaps higher from tomorrow) and still enjoy a higher standard of living by taking natural yield (or greater) from the ISA pot. Think this is a very strong argument for investing in both pension and ISA if you are in a position to do so.
    In terms of children, the arguments for contributing £2,880 p.a. are persuasive, indeed I have done so since 2003 for my two sons even though they only joined the work force in the last few years.

  • 25 Fremantle November 22, 2016, 4:16 pm


    If your company is topping up, that’s free money that you’re otherwise missing out on. Plus if you change jobs, you could always transfer to a low cost SIPP.

  • 26 John B November 22, 2016, 4:21 pm

    @Catherine, check if your work pension provider allows partial transfers out. If they do, they you could just pull the funds out each few months and use a separate provider. Note that you’ll struggle finding another provider that will charge under £200 p/a to run a pension, so its only worth it if the sums are large enough

  • 27 The Investor November 22, 2016, 4:49 pm

    @all — Thanks for the extra thoughts. The tricky thing from the perspective of this article is it initially just explained the maths. (I meet people all the time who think that pensions are mathematically superior because of the initial relief versus later absence of tax). Over time the “But wait!” concluding section has grown, and I am loathe to grow it further. Perhaps at some point I’ll do a proper pensions article and chop the whole lot off after the maths bit concludes. @TheAccumulator’s ISA versus Pensions article is a bit more of a overview on the detail, although it’s a few years old now, too.

  • 28 The Rhino November 22, 2016, 6:30 pm

    I’d second Mathmo’s NI comment. Salary sacrificing into a pension can be unbelievably tax efficient. If you have a situation whereby you need only a small portion of your salary, you can sacrifice yourself down to minimum wage. I’ve managed to cut my IT and NI bill by about an order of magnitude using this approach. I also get the saving in employers NI contributions paid into my pension. Its an unbelievable deal – so good I fear for its removal each budget.

  • 29 John B November 22, 2016, 7:25 pm

    @Rhino seconded. I earned minimum wage and pumped £400k into my pensions over 9 years using salary sacrifice. It was the bedrock of my FIRE decision last month.

  • 30 The Investor November 22, 2016, 7:47 pm

    I do actually mention the National Insurance advantage in the article.

    *pout* 🙂

    Might be useful to readers to hear a worked example from someone down here in the comments — TheRhino? (And yes, perhaps it’s worth a full article sometime).

  • 31 John B November 22, 2016, 8:22 pm

    When I negotiated how to get a £44000 salary and £2200 pension contribution to be optimally assigned, I used http://www.aviva.co.uk/salary-sacrifice/tsandcs.html (enter 44000, 0, 0, 26000, 2200, then no sacrifice, 0% NI retained by employer) and you get a solution that is cost neutral to the employer and gains £8600 for the employee, who gets £13500 pay, £36800 pension payment.

    So £50k paid out, with only £2.5k taxable, from a nominal £46k HRT package

  • 32 The Investor November 22, 2016, 10:14 pm

    @John B — Thanks for sharing, and yes that’s pretty sweet. I guess most people who can earn c.£50K can’t live on £13.5K for whatever reason.

    (As someone who is self-employed with my own company and lots of un-sheltered investments from many years ago (argh!) that I can sell if I need to (albeit sometimes with CGT consequences) my own situation is similar if even more Byzantine to your example 🙂 Perhaps I should ask @TA if he does salary sacrifice, I can’t remember.)

  • 33 Hariseldon November 22, 2016, 10:32 pm

    The flexibility of an ISA might be useful, my SIPP is going to be expensive if I want to draw a lump sum (after the 25% tax free sum has already been used) whilst with an ISA I could draw a larger sum if needs must…

    Clearly if possible its best to follow both routes , both have advantages and we are fortunate that its not an either / or choice.

  • 34 The Accumulator November 22, 2016, 10:42 pm

    Yes, am sacrificing salary like fatted calves in the temple.

    @ Catherine – there’s lots of evidence that costs are the best predictor of performance. i.e. if two funds have the same objective then the cheaper one can be expected to best its pricier rival.

  • 35 FrugalFox November 22, 2016, 10:56 pm

    I’ve been debating with myself (sad but true) for some time about my choice to up my pension contributions next year or just add more to my ISA.
    I plan to retire well before state retirement age so I will need more money in ISAs but the big boost I can get from employer contributions into a pension still looks hard to overlook.

  • 36 Mr optimistic November 22, 2016, 10:59 pm

    There is also the possible inheritance tax advantages to a pension but yes the risk of rule changes are large. If the employer matches contributions, quite often doubling up, the you really must avoid over thinking and take it ! Further contributions then I’m.

  • 37 Mr optimistic November 22, 2016, 11:01 pm

    ..not sure. Must learn how to control the spell checker!

  • 38 David November 22, 2016, 11:45 pm

    Here’s a simple example. You earn £50,000 and you have two children. You then get promoted and your employer gives you a £10,000 pay rise.

    Take the money through PAYE and you will pay 40% tax and 2% employees national insurance, plus you will have to pay back your entire child benefit, which is £1,789 per year for two children. So you end up with just £4,011 of your £10,000 pay rise and have suffered an effective marginal tax rate of 60%.

    Do a salary sacrifice instead and you will get the whole £10,000 in your pension. The employer saves 13.8% employers national insurance so they might also let you have some of that £1,380. And you get to keep your child benefit.

    For three times the money I’ll take the pension risk. I’d be surprised if ISAs didn’t get limited in some way before I reach retirement in any case – they weren’t designed to be used as a shadowy pension vehicle to build up additional streams of tax free ‘unearned income’.

  • 39 Richard November 23, 2016, 7:48 am

    Isn’t there also the benefit of bankruptcy ‘protection’, or any sort of creditor after your assets for whatever reason – excepting divorce, with a pension (at least until you start drawing it)? So while a hopefully a very remote liklihood, your retirement nest egg won’t vanish because of a failed buisness or you being sued.

  • 40 DblEntry November 23, 2016, 8:31 am

    Pensions are a no brainier if like me you suffer the 62% marginal tax rate on earnings above £100k and are not capped by the earnings restriction (please pass the world’s smallest violin I see you all gesturing…)

    I salary sacrifice down to under £100k which combined with employer NIC saving passed on means I get about 200% of the current cash cost going into my pension. Even taxed at 20% on the other side, that’s an unbelievable deal. Obviously only available because of the unjustifiable tax distortion anyway, but better to stick it back to No 11 where it hurts.

  • 41 John B November 23, 2016, 10:15 am

    It will be ironic of course if all this praise of salary sacrifice comes just before Hammond stops it. Unlike most pension rules, it seems a ludicrously generous loophole to me, only exploitable by those with cosy relations with their employer. The last autumn statement included a line about the Treasury being concerned about pension SS, and we know Hammond will be removing fripperies like gym membership from it. Now pensions were explicitly excluded from the consultation (https://www.gov.uk/government/uploads/system/uploads/attachment_data/file/549682/Salary_sacrifice_for_the_provision_of_benefits-in-kind_HMRC_consultation.pdf section 3.3), together with cycle schemes, but the planned changes save much less money than going for pensions. There have been no pension teasers, as there were before the Budget this year when Osborne backed off, so perhaps its planned for the Spring, but I can’t see it lasting

  • 42 Naeclue November 23, 2016, 10:26 am

    Inheritance tax savings can be made with SIPPs. Pensions sit outside one’s estate and as such there is no tax to pay on passing residual defined contribution pensions to beneficiaries. If you die before age 75 beneficiaries can also draw from the pension free of income tax under the current rules.

    One thing to keep a close eye on with pensions is the lifetime allowance. £1m may seem a high amount to someone young but compound growth over many years and large contributions can get you there sooner than you might think. The tax for exceeding the LTA will seem like a kick in the teeth if you end up paying it, but potentially still worthwhile for salary sacrificers, self employed and Ltd company owners.

  • 43 David Burdon November 23, 2016, 10:29 am

    I came across this site looking for advice on low cost ISA trackers. I’ve just read the article above. One issue missed is the cost of pension platforms and other fees. Especially if you have a large fund and are trying to run a SIPP. Everyone – IFAs, platform providers, fund managers wants the 0.5% to 2% cut. In a world of 1-3% returns and 1-2% inflation this is very scary. It’s why I’m opting to put my spare cash into ISAs.

  • 44 L November 23, 2016, 10:38 am

    I realise that political risk is probably a bigger deal for pensions as they are tied up for decades, but surely ISAs are just as open to tampering by any future government? It’s unlikely that this would be in the form of making ISAs more like pensions (i.e. ‘now your ISA acts like a LISA’), but imagine how inconvenient it would be if they did away with ISAs entirely – there would be a lot of panicked FIers!

  • 45 Naeclue November 23, 2016, 11:22 am

    One downside to personal pension saving that has not been mentioned is that it is slightly more expensive to do than saving in ISAs. An extra 0.3% in fees over 20 years is 6%. That would negate the 5% saving a basic rate taxpayer gains from the 25% tax free pension commencement lump sum.

    On the other hand, once a pension pot becomes large enough, a SIPP provider with a capped fee, such as Hargreaves Lansdown can be used to reduce the fee overhead. A £200k pension pot at HL invested in ETFs only costs £200 a year to run compared to an equivalently invested ISA, i.e. only 0.1% more.

    The new LISA sounds like a really good deal to me for those who qualify. Again, provided the charges are not so high as to wipe out the tax handout from the government.

    Most of the early personal pensions (pre stakeholders) were diabolical investments as the fees and commission would hugely outweigh any tax savings. The scoundrels that sold these pension plans would overly emphasize the income tax saving aspect as well by not pointing out that income tax was deferred rather than eliminated.

  • 46 Naeclue November 23, 2016, 11:35 am

    @David, your post crossed mine and I made a similar point. The financial services industry is still riddled with sharks although the excesses are no longer as widespread as they once were. However, it is possible to invest in stakeholders or SIPPs reasonably cheaply if you shop around and keep a close eye on the various fees. The tax savings can make the additional cost of saving in SIPPs worthwhile.

  • 47 Catherine November 23, 2016, 11:37 am

    @Fremantle, @John B, @The Accumulator – thanks for your thoughts. I’ll definitely call my pension provider and ask about the partial withdrawal and whether I could move that money to a SIPP.

  • 48 Mark November 23, 2016, 11:55 am

    Everything else being equal, I think pensions are tax-advantaged, for four reasons:

    1. Tax rate arbitrage. Contribute with high rate relief, draw down at basic rate
    2. Ability to reduce effective tax rate further by using tax-free allowance when retired
    3. The 25% tax-free lump sum (or disallowance of 25% of pension income when calculating tax liability)
    4. Potential to make small pension contribution and get it grossed up even when not paying income tax

    The only disadvantage I see with pensions is the possibility that any or all of these advantages could be removed by future Chancellors, as well as other unattractive measures introduced.

  • 49 The Investor November 23, 2016, 12:11 pm

    The only disadvantage I see with pensions is the possibility that any or all of these advantages could be removed by future Chancellors, as well as other unattractive measures introduced.

    The inability to access your money whenever you want before age 55 (or whenever) is definitely a drawback with pensions versus ISAs, even if one can spin it as an advantage (because it stops you splurging your money on a sports car during dizzy fit in your 40s) or if one personally think it’s not a drawback because you’re saving for retirement.

    If pensions had been vehicles where you could put whatever you want in whenever you want, and take it out whenever you want (subject to tax on withdrawal of course) they’d be far more popular.

    I’m not saying that level of accessibility is practical or even desirable from the government’s point of view. I am saying it’s a downside that we shouldn’t overlook just because it’s virtually a truism of pensions. 🙂

  • 50 Naeclue November 23, 2016, 1:08 pm

    @Mark, I would add these 2 previously mentioned items to your list. Both very important to me.

    5. NI savings for salary sacrificers/self employed.
    6. No inheritance tax

    What saddens me about the current system is that, as is often the case, the biggest beneficiaries are those who are least in need of the benefits. A more egalitarian pension system should be devised, but I really cannot see that happening. There are too many vested interests in the existing overcomplicated system.

  • 51 Mark November 23, 2016, 2:15 pm

    @Naeclue, thanks, I’d forgotten to include those two points, but agree with them. So that’s a huge weight of advantages to pensions over ISAs.

    For basic rate taxpayers under 40, the new Lifetime ISAs have more to commend them than the conventional variety, and of course standard ISAs appeal to those of us who’ve hit, or are likely to hit, the Lifetime Allowance for pension value.

    I share your view that there’s great iniquity in the pensions system. The biggest by far is the favourable treatment given to those in defined benefit schemes, most of them in the public sector and hence subsidised by those who are less advantaged. But I think the fact that tax relief is at individuals’ marginal rates is almost as anomalous. Setting it at a fixed rate of 25-30% would distribute the relief more equitably.

    Finally, there’s some pretty overt age discrimination at work. Why has the Lifetime Allowance fallen for those who haven’t reached it yet, but not those who have? While the latest figure – £1m, plus inflation – may sound like a lot, for those who eschew risk so favour annuities, it buys an income of a relatively modest £20k or thereabouts a year, if inflation protection is sought. It’s not that long ago that the threshold was (from memory) £1.85m, and annuities yielded around 6%, giving an annual income of some £110k.

  • 52 Naeclue November 23, 2016, 5:04 pm

    @Mark, I understand some peoples complaints about public sector pensions, but I know a few people who work in the public sector doing incredibly important work in poor conditions for lousy pay. I personally think they deserve all the pension they will get. I am not talking about the high waged consultants and bureaucrats here, more the people on the front line.

    The drop in the LTA is all about saving money. It would be grossly unfair and more importantly, detrimental to pension savings if this was lowered for those who had already reached £1m, or are likely to, without offering protections of some kind. The government has intentionally made changes in such a way that existing pension savers and pensioners are no worse off following changes for fear of undermining confidence in the system. This attempt to ensure no one is worse off is the reason for the peculiar “No tax to pay if you die before you are 75” rule.

    The recent LTA peak was £1.8m by the way and when it was lowered people had the option of fixing at that level, provided they stopped contributing/accruing benefits. This fixed protection had to be applied for by the way rather than being automatic. I do wonder how many people in drawdown might be in for a shock when they hit 75 and were not aware that they should have applied for fixed protection 20 years previously.

    The whole idea of LTAs for DC pensions is daft anyway as it is practically impossible for many people to know whether they would hit the limit until close to retirement. A far more sensible system would be to simply cap the amount of tax relief from pension contributions. Give everyone a tax relief limit of say £200k, adjusted for inflation, and say once you hit that limit you are no longer allowed to contribute to a DC pension. Employer contributions to be subject to the same overall limit.

  • 53 John B November 23, 2016, 5:29 pm

    The protections were of little use even if you thought you would hit £1m+inflation in 20 years time with continued contributions, as all you could do was crystalise your pension now, stopping those 20 years of contributions. My projections keep a close idea on the number at the number in 9 years time when I can access my pension, and I’m think I’m save, but I could be within 10%. And who really believes the inflation indexing will occur?

  • 54 The Rhino November 23, 2016, 5:45 pm

    OK, I think JB has covered it but here are a few more
    hypotheticals on the salary sacrifice angle

    3 examples ranging from none, through intermediate (white belt)
    to extreme (black belt)!


    Gross salary = 40k (so simple BRT scenario)

    Example 1. No salary sacrifice

    Pay £400pm into a SIPP yourself from net pay so:

    gross pay = 3333.33

    pension contrib = 400
    20% tax rebate = 100

    so 500pm gross into SIPP, net pay is 2063.73

    doing this means the following IT (income tax) and NI (national
    insurance) situation:

    IT = 542
    NI = 327.6

    Total = 869.6

    Example 2. White Belt salary sacrifice

    Pay £500pm into a SIPP direct from employer via salary sacrifice so:

    gross pay = 2833.33

    pension contrib = 500
    employer NI contrib on top = 69

    so 569pm gross into SIPP, net pay is 2215.69

    doing this means the following IT (income tax) and NI (national
    insurance) situation:

    IT = 357
    NI = 260.64

    Total = 617.64

    Example 3. Black Belt salary sacrifice

    Pay £2000pm into a SIPP direct from employer via salary sacrifice so:

    gross pay = 1333.33

    pension contrib = 2000
    employer NI contrib on top = 276

    so 2276pm gross into SIPP, net pay is 1188.13

    doing this means the following IT (income tax) and NI (national
    insurance) situation:

    IT = 66
    NI = 79.2

    Total = 145.2


    All these options are cost neutral to the employer. If they won’t
    agree to giving you the employer NI savings then ask them why the
    hell not as it doesn’t cost them anything

    Example 2 actually increases *both* net pay and SIPP
    contribution, so its a no-brainer even if you need all your pay
    to live off

    Example 3 requires ability to live on less than original net pay,
    or have some other sources of spends available to you, but look
    at the reductions in taxes!

    what you can then also do is figure out what you would have to
    earn if you were to achieve the same level of income/SIPP
    contribution from example 3, but using the example 1 approach
    and you can give yourself a pat on the back that you’ve magic’d a
    ~20k payrise out of thin air

    disclaimer – there’s a lot of no.s here, I may well have made an
    error somewhere, but I think the approach is sound and it should
    give you the general gist that salary sacrifice into a SIPP is a
    potentially powerful beast..

  • 55 Naeclue November 23, 2016, 6:09 pm

    @John, the various pension protections do not mean you have to crystallise. They just mean you have to stop paying in. If anyone wanted to they could take fixed protection and not crystallise until just before their 75th birthday. Whether that would be wise would depend on the size of the pension pot and other personal circumstances.

    Some people managed to hold on to LTAs of £1.8m (me included), which seems unfair but lots of age dependent things in life are more unfair. I was paid to go to university by taxpayers, contributing nothing towards fees at a time when tax rates were higher than they are now. Look at student financing now – where is the fairness?

    A certain age cohort had a lot of financial advantages over those before and after them. These advantages are unfortunately still being clawed away and the younger you are, the more you will be affected.

  • 56 Naeclue November 23, 2016, 6:19 pm

    I believe that salary sacrifice is now going to be banned. Not sure how that will be policed for those who are self employed.

  • 57 The Investor November 23, 2016, 7:49 pm

    Couple of relevant tidbits from the Autumn Statement (where the end of higher-rate tax relief was sidestepped once more!)

    Pension “recycling” to be curbed:

    Salary sacrifice — some headlines initially read it was over, but it seems it’s only the silly perks like buying a case of wine from your employer etc. Core pension / childcare / low emission cars / bike purchase trio remains intact (for now?):


  • 58 The Rhino November 23, 2016, 9:58 pm

    One other thing I meant to add in the notes of my prev comment, is that in example 3 you are actually netting more than your original (example 1) gross pay, i.e.

    original gross pay = 3333.33
    example 3 pension contribs + net salary = 2276 + 1188.13 = 3464.13

    pretty cool!

  • 59 The Investor November 23, 2016, 10:35 pm

    @The Rhino — Cheers for the detail. I might work your comments and those of John B up into a post at some point. 🙂

  • 60 Jeff November 23, 2016, 11:01 pm

    ISAs are advantageous for people who might emigrate, since there are fewer restrictions on where you can take the money.

    I use my ISA allowance every year.

    Anything that would be taxed at 40% gets paid into my pension, so I only pay basic rate tax.
    If there is anything left between the 2 limits (I do live cheaply), then it goes into a normal broking account, where I attempt to utilize my annual CGT allowance.

    As for egalitarian, well even after taking my 40% tax reliefs, my pension will still be less than equivalent professionals on a cushy final salary scheme in the public sector.
    So it would not be at all egalitarian to rob private sector tax payers of their 40% relief, to fund even larger public sector pensions.

  • 61 John B November 24, 2016, 12:24 am

    I never understand the resentment about public sector pensions, its a clearly advertised part of the job package, and makes up for lower basic pay and the lack of bonuses/cars and other perks.

  • 62 JonWB November 24, 2016, 12:58 am

    @TI, @The Rhino, @John B

    There is also the “crop rotation” system using carried forward allowances.

    Something like earn GBP 100K, retain 66% of Child Benefit.

    Year 1 – GBP 100K salary, no pension, no Child Benefit.
    Year 2 – GBP 40K salary, GBP 60K pension via salary sacrifice, 100% Child Benefit.
    Year 3 – GBP 40K salary, GBP 60K pension via salary sacrifice, 100% Child Benefit.

    Then repeat. A bit different if you get Employer NI added in, but hopefully you get the gist.

    It is also very useful if you align this “crop rotation” system with timing for a new mortgage. The banks will be much more accommodating if you go see them in Year 1, 4 or 7 than in Year 2, 3, 5 or 6. All of a sudden the 3 year deals look like the best on offer!

    It has all got a lot more complicated with tapering of annual allowance and the grandfathered rights for salary sacrifice in the GBP 100K -> GBP 210K salary range.

  • 63 FIREplanter November 24, 2016, 2:25 am

    Note “Caveat 3: Employers pay into pensions, but not ISAs”

    I am in the NHS pension, a CARE Defined benefit scheme where you pay in a tiered contribution based on your pensionable salary and will be due pension benefits at retirement at 1/54 of gross earnings of each individual working career year + CPI inflation accumulated. I have recently worked out that the ‘Employer’s contribution’ to this scheme is just an accounting device and does not figure much at all in the final benefits you get. I gather that it is basically a guaranteed scheme by the Government and hence is a rock solid pension, but somehow I still feel I am drawing the short straw here, not getting my contributions worth of pension, or even any employer contribution benefit at all??

    How does employer contribution boost pensions elsewhere?? Anyone have any examples?

  • 64 Richard November 24, 2016, 8:43 am

    @Fireplanter – your DB pension will pay out a lot more than you will pay in (plus hypothetical growth on your payments). To determine your equivalent employer payment, take the final amount you will get and work out the amount of cash you would need to get that privately. Then work out how much you will pay in and the growth of that money. The difference is the employer contribution (including growth on that). The older you are when you join the scheme, the more the employer has to ‘pay’ in to give you the benefit.

    I was part of a CARE scheme and my employer contribution worked out to be around 11%. Plus all the risk is on the employer. Many employers used the move to DC to significantly reduce their own payments into schemes. That plus low growth and you see why a lot of people look jealously at the public sector DB schemes they wish they had!

  • 65 arty November 24, 2016, 9:00 am

    RE the resentment about public sector pensions, as JB says, it is not only a clearly advertised part of the job package, making up for the lower pay, but let’s not forget that the average “gold plated public sector pension” is somewhere in the region of £5k per year. Hardly what you would call extravagant.

  • 66 Richard November 24, 2016, 9:27 am

    @firestarter – I did a quick rough calculation. Assume you earn 100,000 a year in NHS. That gives pension salary after 40 years of around 74,000 a year. You would pay in 14.5% or 14,5000 a year. With 4% growth, your equivalent private pit would be 1,400,000. But the equivalent amount of cash required to buy 74,000 a year privately looks to be around 2,300,000. So 900,000 has come from employer plus growth, which means employer is probably paying in around 9% in this case.

    Changes in pay, when join and when you leave all impact on this though (if you join at 20 at leave at 21 you will probably find that you have overpaid for your pension – in fact if you join young and leave youngish then you will probably overpay. It is the later years when it switches to the employer. These are jobs for life 🙂 ). Note the % is very high compared to what DC schemes usually mandate – but this is reflected in the value you get out at the end.

  • 67 Richard November 24, 2016, 9:37 am

    Sorry, one final point on that. The point around age is true, but really only if you are earning 100,000 off the bat at 25 and paying in 14.5%. As that sort of salary and contribution level doesn’t usually kick in until much older, those on lower salaries pay in lower contributions and so the effective employer contribution will be greater (or similar) earlier. I guess this is part of the reason to tier contributions – to smooth employer contributions over all pay levels and ages.

  • 68 John B November 24, 2016, 10:02 am

    Final salary schemes benefit those who progress. I plodded in the Civil Service for 10 years, 25-35, leaving on the same grade as I entered, so it won’t be much. My dad plodded for 35 years, but got a promotion 6 months before he left, which boosted his pension a lot.

    I returned to do my old (extremely specialist) job 5 years later, as a contractor working through an umbrella company for a private company providing a new system. The umbrella company were delighted to run full salary sacrifice, so I had no envy for my ex-colleagues with their gold-plated pension which they had no control over.

  • 69 The Rhino November 24, 2016, 12:28 pm

    @JWB – like that crop rotation a lot, very smart compromise if you can’t quite go the whole hog and live off 40k indefinitely. Mortgage perk is a very sweet bonus..

    I have a colleague who is CEO of a startup – paying himself ~60k, 3 kids, early 50’s so very near pensionable age.

    I have told him repeatedly to salary sacrifice, get all his CB back and pocket the employers NICs. But he won’t do anything. He must have left 10s of k on the table over the last 5-6 years.

    His missus also works part time for him so he could so easily get any required income back through her side of things at almost no tax.

    Absolutely crazy.

  • 70 flotron November 24, 2016, 2:26 pm

    Can somebody please clarify how the crop rotation method at 100k salary works if annual contributions are capped at 40k? Or are you able to carry forward unused allowance from one year to the next (2)?

  • 71 John B November 24, 2016, 2:29 pm

    From http://www.pensionsadvisoryservice.org.uk/about-pensions/saving-into-a-pension/pensions-and-tax/carry-forward

    “Carry forward allows you to make use of any annual allowance that you may not have used during the three previous tax years, provided that you were a member of a registered pension scheme.”

  • 72 The Rhino November 24, 2016, 2:34 pm

    ah – oh yes, the 40k cap, so the rotation is primarily because of that, not necessarily because you need a bit more cash to spend averaged out over the 3 years, thanks for pointing that out, i’d missed it

  • 73 The Rhino November 24, 2016, 2:41 pm

    On a different note, apologies if its already been explained somewhere in the comments, but how is the LTA so low? It doesn’t make any sense to me. As someone did point out in the comments, it buys about 20k of income via the traditional annuity route. So thats effectively the max income someone in the UK can get in retirement if they just retire and buy an annuity which I’m guessing is still the de facto thing to do amongst the plethora of other options? Its so far out of whack with economic reality its almost unbelievable??

  • 74 John B November 24, 2016, 3:06 pm

    With full state pension, £26k should be enough to live on, so I expect the government don’t see why they should subsidise saving beyond that. And of course they do, through ISAs.

  • 75 vanguardfan November 24, 2016, 4:27 pm

    The LTA is not out of whack with the current reality of average pension pot size. Of course quoted average figures of around £35k are not very meaningful, we really need to know the size of pension pots among over 55s, but very few people will have a six figure DC pension pot never mind a 7 figure one.

  • 76 The Rhino November 24, 2016, 4:39 pm

    @JB – not sure I really buy that, sure 26k is *enough* to live on but it must still miss a huge % of pensioners expectations?

    It seems odd that the LTA rather than being increased in line with inflation has been almost halved. Did someone get it so wrong to start off with? I wonder how much smaller it can get? Maybe, like you say, its because while the LTA has been decimated, the ISA has been blown up like a balloon since 2010. £3,6000 stocks and shares to £20,000 next time round!

  • 77 Richard November 24, 2016, 5:21 pm

    So £1000 per month for 40 years at 4% comes in at just over 1,000,000. £1000 per month is probably more than most pay in. £3333 per month (so the full 40,000 a year) would be around 4,000,000 in 40 years at 4%. You would hit £1,000,000 in about 18 years with 40,000 every year. As few will pay in 40,000 a year for prolonged periods, 1,000,000 is perhaps a realistic max if growth is only 4%.
    The issue really is growth levels. At today’s predicted growth levels (hopefully very pessimistic), you have to pay in huge amounts to get anywhere near a decent pot and / or early retirement. I for one hope growth returns and DC schemes start to outperform DB schemes! Some dream 🙂

  • 78 JonWB November 24, 2016, 5:36 pm

    @The Rhino.

    The LTA is absolutely hated by everyone and in particular anyone who deals with payroll and defined benefit pension schemes. The current situation where those with Fixed Protection are forced to enrol in a new pension when moving employment only to have to opt out immediately to ensure they don’t lose Fixed Protection is a bureaucratic farce.

    The LTA only exists to deter those with sizeable pension pots from continuing to contribute. But it does that by using a threat that only materialises when you are 75 (assuming you don’t need to crystalise > £1m), rather than having any penalty apply in the interim period. Sure there is a painful trade off as the LTA has dropped precipitously, it’s been a difficult decision for those who are mid 50’s or older and looking to protect the higher LTAs. But for anyone younger, it is irrelevant. 20 years is as good as a lifetime in terms of legislative changes on pensions.

    I’m pretty confident the LTA will be dropped when income tax relief at the highest marginal rate goes. It’s very difficult for the government to implement the removal of tax relief at the highest marginal rate – particularly for defined benefit pensions – which is the only reason it hasn’t gone yet. When it does go, the LTA will already have served it’s purpose as an upfront deterrent and will be dropped. It may be a few years later, but I’m confident that it will go.

    Decimating the LTA and ballooning the ISA allowance has the same effect from opposite ends, they are both designed to bring forward tax receipts. But the real problem for the government is people taking early retirement. That decimates tax receipts as we are so PAYE heavy as a tax base and retirement taxes (especially with ISAs in the mix) are just much, much lower.

  • 79 The Investor November 24, 2016, 7:21 pm

    Whilst the Lifetime Allowance (which, unitiated, is what they are talking about when they say LTA, which was never defined here 🙁 ) is clearly a joke sticking plaster / scarecrow of a policy, I’d push back on the idea that it should cap anyone’s retirement income ambitions entirely. And I’d agree with the general sentiment that it isn’t the Government’s place to plump up retirement income indefinitely via tax relief. As has been said before on this thread, higher earners already get a tremendous deal. Salary sacrifice almost pushes it even further beyond what’s reasonable.

    I’m not arguing either should be scrapped, but I can well understand the sentiment that they should.

    There are other ways to generate a retirement income beyond a pension. For a start — and on point with this article — saving into an ISA.

    Anyone who started with PEPs and moved to ISAs could easily have a decent six-figure stash in those vehicles by now. Perhaps “should” if they are the sort to find the LTA allowance a hassle. FT columnist John Lee’s ISA has been estimated at £4.5m now, and I’ve read maths showing he’d have beaten that if he’d bought (/been able to buy) a small cap tracker at the start. So that’s a pretty mighty tax efficient vehicle.

    Until recently you could also earn several tens of thousands of pounds of dividend income tax-free every year. Pretty incredible. Sadly that’s now just £5,000 a year via the allowance, but still not to be sniffed at. Plus the savings allowance.

    Then there’s the CGT allowance of £11,400, although I’d agree it’s not ideal for the average person to be planning to juggle that around into their 80s.

    There are also VCTs etc if people must take the tax angle.

    Pre-dividend tax changes it’d be pretty easy to add all the above up and get well above £50K-60K tax-efficient income in retirement. Harder now, but still not a reason to say “the LTA is £26K, therefore I’ll spend the rest on wine, wo/men, and song…” 🙂

  • 80 Richard November 24, 2016, 7:49 pm

    One other risk (maybe outlined above) is changes in taxation. If income taxes go up in the future then pensions may lose out. If they go down then ISAs lose out (but this seems less likely). In this sense, pensions have the risk that you end up paying even more tax in retirement than you would have done if you just take the cash now (for those in their 20’s and 30’s – mitigated somewhat if you use sal sac). Esp if you pay in and take out at the same marginal rate! At least it may wipe out any potential benefit. With ISAs you know you are done and dusted tax wise (unless regulatory change as pointed out above).

    So income taxes have been dropping generally over the decades which is good. But the emergency budget threaten by Osborne and the state of the public finances makes me worry the trend may start to reverse (though to date they have targeted more optional taxes)

  • 81 Naeclue November 24, 2016, 8:07 pm

    @jonWB, I hope you are right about the LTA being abolished. Apart from the absurdity of being limited by an unpredictable limit, a detrimental affect I have witnessed more than once is that it is quite a pusher for early retirement for productive people who would probably continue to work otherwise. Faced with the prospect of exceeding the LTA, the alternative is to crystallise and start drawing. But if you do that and are already a 40% or higher tax payer you end up paying 40/45% on the entire pension along with the marginal nasties that kick in above 100k. That leads to “Oh well, I don’t need to work anymore anyway, so I will pack it in now.”

  • 82 Naeclue November 24, 2016, 8:19 pm

    @Richard, one of the arguments the pension industry used against ISA style pensions was that people would not trust the government not to change tack later and tax pensions on the way out when no up front tax relief was given on the way in!

    I am not sure I fully buy that and am extremely distrustful of the pensions industry (+ entire financial services come to that). I think they revel in all the complexity as they can charge more because of it. They also love the tax relief system as it increases assets under management by 25%. If that was lost, the pension industry would see a 20% cut in fee income, unless they could claw it back elsewhere.

  • 83 John B November 24, 2016, 8:33 pm

    It was said that Osborne wanted to tax on the way in to get a temporary economic boost to get him in No 10 in 2020, oh those happy days. I’d not be surprised if they imposed a £1m limit on ISA funds, beyond which you were charged your marginal tax rate. Its a powerful populist argument, why should the government subsidise the saving of the rich. Hopefully my needs are modest enough that I’ll not be considered rich, so can hide below the limits. I think I can budget to be under HRT at all times in future.

  • 84 The Investor November 24, 2016, 9:25 pm

    @John B — I have a hard time imagining them being so retrospectively Draconian with ISAs, short of a symbolic gesture in a total national fiscal emergency (which who knows we may be moving towards with the £60bn Brexit gap and talk that the debt to GDP ratio could soar in 20-30 years if immigration really is curbed). It would go against the entire spirit of the ISA proposition for the past 20-odd years. More likely to cap/restrict contributions going forward if they did anything.

    (I am not going to say retrospective taxation doesn’t happen because we can all find edge cases where we could argue that it has, but taking a vehicle that has always sat outside even of reporting to HMRC and then putting an arbitrary £1m limit on it seems unlikely to me.)

    What this discussion reminds me (for the umpteenth time) is that I really do need to buy a Principle Place of Residence by hook or crook if I stay in the UK, since that is the tax-free shelter par excellence that virtually everyone wealthy-ish takes for granted. All these numbers (e.g. £1m LTA) are much smaller when you’re not sitting in your own multi-£100Ks home, free of taxation, and contemplating generating the income to pay for your rent from your investments.

    Also, I finally got the chance to watch the Budget in full this evening, and noticed he’s not done going after Limited Companies, tax-wise. (Consulting on future changes for now). Hadn’t seen that flagged up in the main reporting, though I suppose it has been covered on the niche accounting sites etc.

  • 85 John B November 24, 2016, 9:41 pm

    @TI its certainly best to not stand out from the crowd. All proposals are weighed against their voting interest groups, and homeowners are a very powerful one, hence the inheritance tax allowance just for housing going to children, when a general increase would be much fairer.

    If you are within the top 1% of an asset class you can get out of paying using advice and clever trusts etc, but being in the top 5-10% does leave you open for a raid.

  • 86 David November 24, 2016, 10:28 pm

    Hi Investor

    Glad you mentioned property ownership – I was just thinking talk of pensions wasn’t complete without it! With tax free Rent a Room allowance going up from £4,250 to £7,500 this is a useful contribution to tax free pension income for anyone who lives in an area with high rental demand and has a home which lends itself to building or converting an annexe of some kind. A good diversifier as well.

    Regarding limited company taxes – are you referring to further review of IR35, to the increase in flat rate VAT scheme to 16.5% (which is really 19.8%) or something else? He did re-confirm that corporation tax will fall to 17% by 2020/21, so that’s good news.

  • 87 Richard November 24, 2016, 10:46 pm

    I was going to say, it does feel like he takes with one hand and gives with the other for contractors (taking is quicker than giving, but then they were trying to balance the books by 2020). I think corporation taxes will fall further, you want to make sure you are undercutting the competition across the channel (or Irish Sea) once you are an ‘independent nation’.
    Perhaps as John B says, contractors are just not quite a strong enough ‘voting group’ to get balance in one go.

  • 88 The Investor November 24, 2016, 11:34 pm

    @David @Richard — Yep, this is additional to the flat-rate VAT piece. Hammond made two references to it in the speech. First, setting the scene:

    “…tax receipts have been lower than expected this year, causing the OBR to revise down projected revenues in future. Added to this is a structural effect of rapidly rising incorporation and self-employment, which further erodes revenues.”

    Later on he said:

    “The tax system needs to keep pace. For example, the OBR has today highlighted the growing cost to the Exchequer of incorporation.

    So the government will consider how we can ensure that the taxation of different ways of working is fair between different individuals, and sustains the tax-base as the economy undergoes rapid change.

    We will consult in due course on any proposed changes.”

  • 89 John B November 24, 2016, 11:40 pm

    That’s one reason why I expect dividend tax to rise from 7.5%. Its a common strategy to introduce a new tax at a lower rate, then increase it towards the 20% income taxt/VAT levels. I don’t think the people who argue that its unfair given corporation tax are making any progress.

  • 90 Richard November 24, 2016, 11:56 pm

    I suppose the government could argue why should they be providing a tax ‘incentive’ to a particular group of people, if they believe there are too many of these people. Remove tax incentives and allow the ‘free market’ to decide.
    I do think that moving towards taxing everyone’s income the same but reducing tax on company profits feels more fair. Everyone pays the same tax based on what they pay themselves, but companies get more profits to invest and grow themselves. If the directors want to pay themselves more of these profits at a higher personal tax rate then that is fine.

  • 91 Moggers November 25, 2016, 12:18 am

    For me, the pension wins by a long, long way as the primary vehicle to save – age restrictions are the *only* downside. I say this as a lower rate tax payer (by choice because I limit my working hours).

    The reasons:

    1) I live very, very cheaply. I can live on just above the personal allowance comfortably.
    2) I take saving for my future, self sufficiency and personal responsibility very seriously indeed.
    3) I built up a decent amount (attempting to save to buy a house outright) outside my pension early in my working life which can subsidise any unforseen additional expenses. Had I known what I know now, I probably would have frontloaded the pension even earlier.
    4) …and I don’t own a house, primarily because of ethical reasons to do with finding the whole housing situation in the UK abhorrent. I now will not put my hard earned money into housing and much prefer the liquidity and diversity of other investments. My rent is not ‘dead money’ as most believe it to be – it’s a very reasonable amount for a service, and not locking up my money in bricks when there’s a million+ other investments in the world makes sense.
    5) I do not trust the state pension. Indeed, I don’t trust anything that’s unfunded other then by the tax take at the point of payment or government borrowing.

    So, why are pensions (SIPPs) so good, even as a lower rate tax payer:

    a) Once it’s locked up, I can’t touch it no matter how tempted I am by a Nissan GT-R.
    b) Via Salary sacrifice, I get NI and Marginal rate income tax back.
    c) I get a decent employers contrib (but none of their NI saving, which grates)
    d) A SIPP doesn’t form part of my estate on passing – it can be passed on whole.
    e) It allows me to control my marginal rate of tax on my work as I see fit.
    f) I take being able to support myself in old age without state help very seriously indeed. Have you seen the price of care homes? I’ll hopefully be backpacking around the world, but if not, I’d rather pay for a good one than throw myself on the mercy of the state.
    g) If I can remain in good health, I will probably continue to live on or around the personal allowance in retirement. So no tax in, no tax out.

    I really, really hope they don’t tinker with pensions because most people inexplicably ‘don’t understand or trust them’. The SIPP is one of the most easy, clear and fair things left in UK society, and fits my model of how people should act.

    Next year, I’ll be reducing my pension contribs slightly, and saving 4k in a LISA – which I think is the first step towards destroying the SIPP by the government sadly, partially because I like the idea of two wrappers. And partially because if the government wants to bung me money that could be used towards a house if prices ever rectify, given the ridiculous 6 figures worth of taxes I paid early in my career and their insane actions in propping up the price of shelter I might as well take it. I don’t agree with it – get rid of all the silly schemes imho, but I’ll take it.

    No doubt some people may think I’m crazy, but the actions of governments, central banks corporations and people in general leading up to and after the financial crisis – cutting interest rates, letting debtors and parasitic finance win whilst creating mass moral hazard have left me very comfortable with the choice I’ve made. I’m merely making sure all choices are within my control and I am personally responsible for looking after myself without additional aid.

    Note – I probably would be living an entirely different life – and a less fun one – if houses (to buy) were reasonably priced.

  • 92 weenie November 25, 2016, 3:44 pm


    Thanks for the explaining LTA = Lifetime Allowance.

    I was wondering what the Lawn Tennis Association had to do with all this! 🙂

  • 93 Mark November 26, 2016, 1:43 pm

    @ John, on average public sector salaries are slightly higher than private message ones. The pivot occurred in the Blair years. A cynic might call it gerrymandering…

  • 94 Mark November 26, 2016, 1:47 pm

    Your dad was lucky. The custom of giving long-serving and highly valued colleagues pay rises shortly before they retired was commonplace in both private and public sectors until quite recently, and goes a long way toward explaining the demise of final salary pensions. Now, even in the public sector, many defined benefit schemes are based on career averages, for that very reason.

  • 95 Mark November 26, 2016, 1:51 pm

    I’m no fan of company pension schemes. Would they allow you to take the contributions and put them in a SIPP to self manage? Most employers will, since it costs them nothing.

  • 96 Mark November 26, 2016, 2:00 pm

    Good point! So obvious that I and others overlooked it entirely! Yes, for those aspiring to FIRE in particular, the inability to touch pensions until the age of 55, with a few very limited exceptions, is a pain. And I find it an arbitrary and unhelpful limit, and unjust that it used to be 50 and will gradually rise even higher.

    In my own case, currently 47 and in ‘FIRE’ (sounds less scary than ‘on’ FIRE…) I have had to build up two similarly sized pots of capital, one to live on now and the other to take over when I’m 55. Which means in eight years’ time, I’ll either have to pay a slug of CGT when I sell the non-SIPP portfolio (not all of it is ISA-sheltered) or go abroad to a friendlier tax regime for a couple of years, to avoid generating a higher-then-needed passive income, and hence greater income tax liability. A nice problem to have, but still one that could have been avoided had the rules limiting access to pension income not been set as they are.

  • 97 John B November 26, 2016, 4:05 pm

    @Mark http://www.ons.gov.uk/employmentandlabourmarket/peopleinwork/earningsandworkinghours/articles/publicandprivatesectorearnings/2014-03-10 has many interesting points, but 2 that stand out are

    “Looking at those who are among the lowest earners in each sector, using the bottom 5% as a cut off point, public sector workers earned on average around 13% more than private sector workers in 2013 when adjusting for the different jobs and personal characteristics of the workers. When further adjusting for the different organisational sizes the estimate was around 8% more

    For the higher earners, using the top 5% as a cut off point, public sector workers earned on average around 6% less than private sector workers in 2013 when adjusting for the different jobs and personal characteristics of the workers. When further adjusting for the different organisational sizes the estimate was around 11% less”

    So I guess it depends where you sit in the jobs market.

    I’m puzzled why you think it will be hard to avoid GCT. Its a rare investment portfolio that can’t be managed to keep capitals gains under £11k a year. If we assume the mythical 4% return is half dividends, half capital growth, that’s £450k, which is a lot to not have sheltered. I’m FIRE at 48, and am doing the same juggling act, but hoping I don’t need to sell more than £44k of my unprotected portfolio a year, so can avoid even reporting capital gains, let alone paying it.

  • 98 Mr Right November 27, 2016, 10:06 am

    If the status quo could be guaranteed then pensions certainly win, and have considerably more than “an edge” over ISA’s, in particular for high earners. The biggest risk though is political. To invest in an ISA on the assumption that withdrawls will still be tax free in 15 or 20 years time is courageous, to say the least. This makes ISA’s slightly less attractive, but at least you could get your money out to safety if the environment turned hostile. Applying the same test to pensions exposes a significant drawback – as pension money is trapped until 55 it limits the response capability to future politically inspired tax raids or retrospective rule changes. As with ISA’s, only the very brave or most fiscally optimistic would claim there is no possibility of this over the next few decades. Viewed in this way pensions have a significant potential drawback, though it is almost impossible to quantify and plan around.

  • 99 BShnady November 27, 2016, 3:51 pm

    Since no record keeping or reporting is required for ISAs, no one knows what profits or losses anyone has incurred on their holdings, so any retrospective tax changes or raid seems very unlikely as there’d be no way to implement unless in some wealth-tax land grab scenario where x% over certain balances was raided. Possible but unlikely. With retrospective taxes very unlikely, this means that any changes would likely enable people to respond to them (which is as it should be). And since ISA contributions all come from taxed money, it’s hard to envisage ISA accounts attracting harsher treatment than regular, unwrapped taxed accounts. Unwrapped accounts don’t attract tax on withdrawal, so I think it’s unlikely that ISA accounts would ever either.

    The most likely attack on ISAs would be to limit the size. To date, governments have been steadily increasing the annual allowance; with that in mind, reducing this limit dramatically might be perceived as raising the drawbridge after the older generation has benefited, so that seems less likely. Perhaps more likely is some sort of cap on total ISA balances or cap on the tax free income within ISAs. A cap on ISA total balances, where people are coerced through tax penalties into transferring assets into an unwrapped state would seem a messy one to implement and oversee. Unless the cap was put at a particularly low level (making nonsense of the high annual contribution allowance), I suspect this would not generate huge quantities of tax revenue. It’s effects would be felt mostly by those in employment earning higher wages. Barring the very well off, many of those already retired would be able to mitigate much or all of the impact through use of personal/savings/dividend/CGT allowances, unless these were radically changed also.

    Of course, there is always the risk that a government may one day embark upon an enormous and usually ultimately destructive tax raid on its populace. Perhaps the best defence against that it to try to ensure the worst idiots are never elected.

  • 100 L November 29, 2016, 9:50 am

    Another benefit of salary sacrifice into a pension (not sure if it has been mentioned already), is that it reduces student loan repayments, useful for people on national average wages (say £30k) trying to bump up their retirement savings. I’ll happily have a bit more in my pension vs. a lower student loan debt at 1.5%? Or so interest.

  • 101 WestCountryEscapee November 29, 2016, 12:56 pm

    @David – the £7500 limit sounds good for Airbnb’ing the spare room!
    If you are freelance and work for a limited company then the pension has numerous advantages: you can contribute £40k per year free of NI, personal and corporation tax or more if you have not used the allowance for previous years.
    Of this £40k, you can contribute up to your PAYE salary limit as employee contributions and get a 25% immediate benefit with a corresponding uplift in the higher rate tax limit.
    The combination of these two makes it easy to maximise your contributions whilst minimising your personal tax, i.e. staying below higher rate – provided your lifestyle supports it!

  • 102 Erith December 2, 2016, 4:58 pm

    Great article, and food for thought.

    On your Pension v ISA example on tax, as you say, you can be smart about withdrawing enough to keep you under tax thresholds, but as I understand it, when you ‘crack’ your pension pot, you also get 25% of the ‘pot’ tax free, either as a lump sum, or in each withdrawal.

    There is also an opportunity cost to consider when investing.
    Let’s say you have post-tax cash of £1,000 to invest, and you are a 40% taxpayer.
    Your £1,000 put in a SIPP, gives you £1,668 because the tax man gives you the tax back. After 40 years at 10%, you get ~£75k
    Your £1,000 in an ISA, is still £1,000. After 40 years at 10%, you get ~£45k
    The cost to you today is exactly the same.

    Assuming you are not clever and pay 40% tax on your SIPP, (after your 25% tax-free lump sum) you get £52,500 – a clear win. If you manage to only pay 20% tax you get £63,750.

    For me the difference is in flexibility, and also aspirations on when you wish to retire. I am counselling my (Millennial) children to put as much into a SIPP as they can just now, but also make some ISA savings (80/20 rule). The ISA’s give them flexibility, but the SIPP gives them immediate returns in the increase in the investment amount. They can review this in a few years when they understand better what their own family & retirement plans are.

    And of course, given the latest tax rules, my remaining pension pot can now be left to them….

    Off to do some more maths myself!

  • 103 Jonathan August 13, 2017, 8:09 pm

    Pension pots have some significant advantages. For one, they’re recognized in double-taxation treaties (and even when there’s no treaty, countries usually respect the tax-exempt status of investment returns within the pot), so pension-based retirement saving for those planning to work abroad is best. An ISA is just some weird British tax-protection wrapper, which won’t help you if you emigrate and settle elsewhere.

    Pension pots are well-protected against adverse court judgments and bankruptcy proceedings. Pension pots are invisible to benefits means tests.

  • 104 David October 14, 2017, 7:32 pm

    I am considering taking out A.V.C with my council employer duration 10 years to add to my pension scheme which will attract tax relief. Cost 1pc annual charge with Prudential are there better ways to save

  • 105 Andrew July 7, 2019, 2:54 am

    Another benefit to pensions would be that if you are planning to emigrate then you pension investments would not be taxed by a lot of countries whereas an ISA is not recognised and would be taxed.

  • 106 Jeff July 21, 2019, 2:11 pm

    1 Tax relief up front is something you definitely get. Tax relief later is OK until the rules change and the relief is withdrawn.
    2 Up front tax relief on any income that’s taxed at 40% (or more) is particularly useful if you expect to be a basic rate taxpayer later.

    On the other hand, for many of us, tax relief up front means a SIPP and tax relief later means an ISA. Should I decide to emigrate, it’s easier to cash in the ISA and take the money with me.
    Hence for years, anything that would be taxed at 40% went to the SIPP and my ISA was filled with money that would have been taxed at basic rate. In some cases, I had to use the CGT allowance to sell taxed investments in order to contribute the full £20k to the ISA

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