Is it worth having a pension?

[Lootman]

For an employee you can get your employer to pay into an occupational pension whereas they cannot contribute to an ISA.

The US has what i think is a wonderful solution to this and other related dilemmas. Employer pension plans come in two forms. One is like the UK system where there is tax relief on the way in but full taxation as income on the way out. (Paying income tax on what is really a capital gain is really annoying).

But there is also an option which is more like a UK ISA: no tax relief on the way in but tax-free on the way out. The latter is called a Roth plan after William Roth, who was the GOP senator for Delaware for much of the same time that Joe Biden was the other one.

The same choice comes with individual US pension plans, called IRAs, which come both in a before tax and after tax form (Traditional versus Roth, in their lingo).

Moreover a traditional plan can be converted at any time to a Roth plan, although there is tax on that. The reverse is not possible as far as I know.

I think that is what Osborne hoped the LISA ISA variant would turn into eventually. One problem though is that a lot of people would be worried that the no tax on withdrawal might suddenly disappear in the future under a different government.

Another thing I should have mentioned about Roth employer plans is that the employer contributes as well, although typically there is a "vesting" period and if you leave your job before then, it can be reclaimed.

An interesting option is that you can borrow from such a pension plan, and repayments and interest go back into your account, boosting it. Some people buy their homes that way and pay their mortgage to themselves!

[taken2often]

On compounding it is correct it would be the same rate. What we are thinking about is that the tax amount tends to be low in the early years, and compound it over the period. To do an accurate assessment you would need to know the exact tax relief over the 30/40 years to see what it represented in the final fund. I think PCLS is a con and allows them to tax you on your own funds during your retirement. That is why I think it cannot ever be removed.

[TUK020]

There are calculations that show this not to be the case for a standard ISA over a 40 year period, all things being equal. The reason is that growth over that time happens on a larger sum within the pension than in the ISA*. Hence better compounding.

May I stick my oar in here? (!)

This notion of "better compounding" is false, IMO. I remember seeing this notion yonks ago in the time of PEPS. One day I decided to try and understand it using simple financial equations as models (also comparing PEPS to Pensions). I decided it was (polite) nonsense - likely used as a selling point by some people selling PEPS, or simply a misunderstanding.

Briefly: Compounding is compounding. It works the same way on £1 as it does on on £1,000,000. In the old days, before PCs, and in financial textbooks, you could see various financial tables laid out. Mortgage schedules, compounding tables, annuity tables. They were the computed values of the related financial equation, so you could use one to say work out the final amount of regular savings at a given interest rate. They were either given as a real number or scaled to say £1000. The point is, the compounding values are independent of the amount of money, which is simply applied as a scaling factor. Your 10x £100 is somebody elses 10x £1,000.

Mind you - this is neither here nor there as to whether an ISA or Pension is "better"! I leave that to others to decide for themselves.

Yes the compounding makes no difference between an ISA and a SIPP (or other DC pension) as if you are paying in to a pension at the same tax rate as withdrawing the uplift (and its compounding) are exactly cancelled out.

The advantages of a pension come from the

1) 25% tax free lump sum (which means that some of the uplift on contributions and the compounding of that is not wiped out when withdrawing).
2) You get a similar advantage if you can arrange to get a higher uplift on contributions due to being in a higher tax band when contributing to the pension than when you are withdrawing (ie you are at the time of withdrawal in a lower tax band)
3) For an employee you can get your employer to pay into an occupational pension whereas they cannot contribute to an ISA.

The disadvantage of a pension is that you cannot withdraw anything before age 55 (likely to raise to age 57 shortly) and if older than that and you withdraw anything more than the tax free lump sum then further contributions are severely limited.
Whereas with an ISA you can withdraw whatever you wish at any time and also later still contribute upto the standard ISA limit. (I'm ignoring for these purposes the LISA ISA variant with its various limitations).

Pensions make sense if you can 'arbitrage' the rates of tax when you are earning vs when you withdraw.
They also have Inheritance tax advantages if you are looking to transfer wealth to the next generation.
Unfortunately, they also have limits - the LifeTime Allowance

[TUK020]

There are calculations that show this not to be the case for a standard ISA over a 40 year period, all things being equal. The reason is that growth over that time happens on a larger sum within the pension than in the ISA*. Hence better compounding.

May I stick my oar in here? (!)

This notion of "better compounding" is false, IMO. I remember seeing this notion yonks ago in the time of PEPS. One day I decided to try and understand it using simple financial equations as models (also comparing PEPS to Pensions). I decided it was (polite) nonsense - likely used as a selling point by some people selling PEPS, or simply a misunderstanding.

Briefly: Compounding is compounding. It works the same way on £1 as it does on on £1,000,000. In the old days, before PCs, and in financial textbooks, you could see various financial tables laid out. Mortgage schedules, compounding tables, annuity tables. They were the computed values of the related financial equation, so you could use one to say work out the final amount of regular savings at a given interest rate. They were either given as a real number or scaled to say £1000. The point is, the compounding values are independent of the amount of money, which is simply applied as a scaling factor. Your 10x £100 is somebody elses 10x £1,000.

Mind you - this is neither here nor there as to whether an ISA or Pension is "better"! I leave that to others to decide for themselves.

Yes the compounding makes no difference between an ISA and a SIPP (or other DC pension) as if you are paying in to a pension at the same tax rate as withdrawing the uplift (and its compounding) are exactly cancelled out.

The advantages of a pension come from the

1) 25% tax free lump sum (which means that some of the uplift on contributions and the compounding of that is not wiped out when withdrawing).
2) You get a similar advantage if you can arrange to get a higher uplift on contributions due to being in a higher tax band when contributing to the pension than when you are withdrawing (ie you are at the time of withdrawal in a lower tax band)
3) For an employee you can get your employer to pay into an occupational pension whereas they cannot contribute to an ISA.

The disadvantage of a pension is that you cannot withdraw anything before age 55 (likely to raise to age 57 shortly) and if older than that and you withdraw anything more than the tax free lump sum then further contributions are severely limited.
Whereas with an ISA you can withdraw whatever you wish at any time and also later still contribute upto the standard ISA limit. (I'm ignoring for these purposes the LISA ISA variant with its various limitations).

Pensions make sense if you can 'arbitrage' the rates of tax when you are earning vs when you withdraw.
They also have Inheritance tax advantages if you are looking to transfer wealth to the next generation.
Unfortunately, they also have limits - the LifeTime Allowance

[G37y]

Thank you for the further replies, however I’m still not sure if a SIPP is the right thing for me or not. In my initial post I did write that I was putting the maximum into my ISA every year, so it was always a straight investment choice between pension and my ordinary dealing account, the main driver for me was the ability to avoid the 15% withholding tax on US shares. This actually extends to some companies listed on the LSE or AIM but doing all their business or being incorporated in the USA like SOM, SPSY and DGOC. The 15% withholding tax on the dividends on these 3 companies which I hold amounts to over 2k. I do realize that the amounts I would be able to put into a pension are relatively small, the charges high compared to my dealing account and the fact I would almost certainly end up as a higher rate tax payer if I ever wanted to make a complete withdrawl. Just one question about 25% tax free withdrawals. If one was made, would the whole of what was left be subject to income tax? Am I completeley dreaming if I think that another 25% could be made later tax free? (I think I know the answer to that but can always hope)

[ursaminortaur]

Thank you for the further replies, however I’m still not sure if a SIPP is the right thing for me or not. In my initial post I did write that I was putting the maximum into my ISA every year, so it was always a straight investment choice between pension and my ordinary dealing account, the main driver for me was the ability to avoid the 15% withholding tax on US shares. This actually extends to some companies listed on the LSE or AIM but doing all their business or being incorporated in the USA like SOM, SPSY and DGOC. The 15% withholding tax on the dividends on these 3 companies which I hold amounts to over 2k. I do realize that the amounts I would be able to put into a pension are relatively small, the charges high compared to my dealing account and the fact I would almost certainly end up as a higher rate tax payer if I ever wanted to make a complete withdrawl. Just one question about 25% tax free withdrawals. If one was made, would the whole of what was left be subject to income tax? Am I completeley dreaming if I think that another 25% could be made later tax free? (I think I know the answer to that but can always hope)

You can only ever take a maximum of 25% of the pot out tax free. However there are different ways of doing that.

1) Crystallise the whole pot and take 25% tax free. The rest can then be drawn down later but will all be taxed at your marginal rate.

2) Some pension providers will allow you to crystallise the pot in pieces rather than all in one go. This is generally known as phased drawdown or phased crystallisation. So for instance if you had a £200,000 pot you might crystallise £50,000 and take £12,500 as a tax free lump sum. You could then either drawdown the other £37,500 at that time paying your marginal tax on it or draw it down over a few years (again paying tax on it). The other £150,000 would remain uncrystallised until you wished to access that part in a similar way. This option is not available from all providers and such splitting of the pot may with some providers lead to them levelling extra charges. This option was more popular before the next option UFPLS was introduced.

3) With UFPLS you drawdown an amount from your pension and the first 25% of the amount drawn down is tax free the other 75% is taxed at your marginal rate. The remaining pension is left uncrystallised but is gradually used up as you repeatedly access more of the pot using UFPLS. With both UFPLS and option 2 (phased drawdown) the uncrystallised portion of the pot may continue to grow until it is accessed - hence you can get a larger tax free lump sum compared to when you crystallise the whole lot at once since 25% of that growth will be tax free.

[Eboli]

For what it is worth my thinking here worked backward from what I needed at retirement. Though I cannot predict what will be a comfortable amount for you I worked on the assumption that I would be comfortable if I could generate something close to the higher rate tax threshold as income. I used this as the starting point for deciding how to apportion my rate of savings between an ISA and a SIPP. The advantage of the SIPP was getting the tax relief going in (as I was paying higher rate tax at that time) and paying as little tax as possible on the amount coming out. Using current rate the division is about 3/4 to the ISA and 1/4 to the SIPP, i.e. I try to draw about £37,500 from the ISA and £12,500 from the SIPP. On this the whole is tax free leaving disposable income of £50,000. I have the same investments - all investment trusts - in both the ISA and the SIPP though in the ISA I also have about one-fifth in slightly "racier" trusts (happily including PCT, SMT and WWH). I retired early once I had reached my goals and have been a near Doris ever since, though every so often I may top up PNL, which I use as a 'cash substitute'. So yes, I am happy to have a pension and on the above I am in little danger of breaching the LTA (although I took fixed protection a few years ago when that was at £1.5m). The 25% lump sum sits safely somewhere untouched to be used, if needed, on healthcare.
Eb.

[Urbandreamer]

Thank you for the further replies, however I’m still not sure if a SIPP is the right thing for me or not. In my initial post I did write that I was putting the maximum into my ISA every year, so it was always a straight investment choice between pension and my ordinary dealing account, the main driver for me was the ability to avoid the 15% withholding tax on US shares. This actually extends to some companies listed on the LSE or AIM but doing all their business or being incorporated in the USA like SOM, SPSY and DGOC. The 15% withholding tax on the dividends on these 3 companies which I hold amounts to over 2k. I do realize that the amounts I would be able to put into a pension are relatively small, the charges high compared to my dealing account and the fact I would almost certainly end up as a higher rate tax payer if I ever wanted to make a complete withdrawl. Just one question about 25% tax free withdrawals. If one was made, would the whole of what was left be subject to income tax? Am I completeley dreaming if I think that another 25% could be made later tax free? (I think I know the answer to that but can always hope)

As I think we have established, there is a difference between the title of the thread and the question, does a pension make sense for you. Ideally you would seek financial advice from a professional, but the cost would outweigh the benefit of doing so.

As has been pointed out, you should consider if you can take advantage of changes in your life that affect your tax position. Many people are in a position to drop down to a lower tax band when they "retire". I, for example, intend to pay 0 income tax for about 7 years after I retire. Eboli obviously does the same manipulation to pay basic rate tax.

The IHT benefits of a pension may be of no interest to you. I suspect that the bulk of your "wealth" is already covered by other IHT relief's.

Charges on a SIPP are not as high as you might think, try A J Bells calculator to see running costs with them Don't ignore the fact that they have additional charges when you go into drawdown or on Foreign exchange.
https://www.youinvest.co.uk/sipp/charges-and-rates

I pay £120pa + dealing costs, which would be a bit less than your withholding tax, but I don't pay FX charges.

At the end of the day I suspect that the deciding issues might be how much you are allowed to contribute per year, how long you will be doing so and the issue of withholding tax.

[Myfyr]

Thank you for the further replies, however I’m still not sure if a SIPP is the right thing for me or not. In my initial post I did write that I was putting the maximum into my ISA every year, so it was always a straight investment choice between pension and my ordinary dealing account, the main driver for me was the ability to avoid the 15% withholding tax on US shares. This actually extends to some companies listed on the LSE or AIM but doing all their business or being incorporated in the USA like SOM, SPSY and DGOC. The 15% withholding tax on the dividends on these 3 companies which I hold amounts to over 2k. I do realize that the amounts I would be able to put into a pension are relatively small, the charges high compared to my dealing account and the fact I would almost certainly end up as a higher rate tax payer if I ever wanted to make a complete withdrawl. Just one question about 25% tax free withdrawals. If one was made, would the whole of what was left be subject to income tax? Am I completeley dreaming if I think that another 25% could be made later tax free? (I think I know the answer to that but can always hope)

As I think we have established, there is a difference between the title of the thread and the question, does a pension make sense for you. Ideally you would seek financial advice from a professional, but the cost would outweigh the benefit of doing so.

As has been pointed out, you should consider if you can take advantage of changes in your life that affect your tax position. Many people are in a position to drop down to a lower tax band when they "retire". I, for example, intend to pay 0 income tax for about 7 years after I retire. Eboli obviously does the same manipulation to pay basic rate tax.

The IHT benefits of a pension may be of no interest to you. I suspect that the bulk of your "wealth" is already covered by other IHT relief's.

Charges on a SIPP are not as high as you might think, try A J Bells calculator to see running costs with them Don't ignore the fact that they have additional charges when you go into drawdown or on Foreign exchange.
https://www.youinvest.co.uk/sipp/charges-and-rates

I pay £120pa + dealing costs, which would be a bit less than your withholding tax, but I don't pay FX charges.

At the end of the day I suspect that the deciding issues might be how much you are allowed to contribute per year, how long you will be doing so and the issue of withholding tax.

I dont think AJ Bell charge anything extra now for drawdown payments. Neither do Hargreaves Lansdown.