- October 5, 2023
- Posted by: legaleseblogger
- Category: Related News
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Can AI Legalese Decoder Help with Retirement Savings Decision?
I have noticed that many people are concerned about whether it is too late for them to start saving for retirement, and they are uncertain about whether to choose ISAs or pensions. In order to shed some light on this matter, I decided to use Excel to analyze some numbers.
Let’s assume that you contribute ┬ú20,000 per year from your taxed income. For the purpose of this analysis, we will assume that you have opted out of the workplace scheme and are not benefiting from their contributions, or you are self-employed and contributing from your taxed income.
One advantage of ISAs is that they offer full tax-free withdrawals. This may be sufficient for Basic rate taxpayers at present, but for those in the higher tax bracket, it is worth considering whether the advantages are significant given that they will likely be in a lower tax bracket during retirement. Additionally, there’s also the benefit of a 25% Tax-free Lump Sum for pensions. Let’s examine the figures to get a clearer picture.
Moreover, any surplus funds in a pension are fully exempt from Inheritance Tax (IHT) as they are considered outside of your estate. However, ISAs are subject to IHT, and they are more difficult to put into trust compared to Bonds which have their own unique considerations.
Now, let’s explore what happens when you consistently invest ┬ú20,000 per year into either an ISA or a pension.
For the following analysis, I have calculated figures for 10 years with growth rates of 5% and 8% for ISAs and pensions, and 12% growth exclusively for ISAs.
**ISA:**
Annual Contribution | ISA | 5% Growth p.a. | 8% Growth p.a. | 12% Growth p.a.
——————-|—|————–|————-|—————-
┬ú20,000 – no gross up | 10 years | ┬ú264,135 | ┬ú264,135 | ┬ú312,909 | ┬ú393,091
| 20 years | £694,385 | £988,458 | £1,613,974
**Pension as a 20% taxpayer:**
Annual Contribution | Pension | 5% Growth p.a. | 8% Growth p.a. |
——————-|—|————–|————-|—————-
┬ú20,000 – gross up to ┬ú25,000 | 10 years | ┬ú330,169 | ┬ú391,137 |
| 20 years | £867,981 | £1,235,573 |
**Pension as a 40% taxpayer:**
Annual Contribution | Pension | 5% Growth p.a. | 8% Growth p.a. |
——————-|—|————–|————-|—————-
┬ú20,000 – gross up to ┬ú30,000 | 10 years | ┬ú396,203 | ┬ú469,364 |
| 20 years | £1,041,577 | £1,482,687 |
As we can see from the analysis, for ISAs to outperform pensions, they need to achieve a substantial 12% annual growth rate, which typically only occurs after 16 years. Before that point, pensions will always grow at a faster rate due to the growth on the grossed up amounts. Essentially, if your ISA is performing well at 12%, then your pension can also achieve the same growth rate if it is invested in the same funds.
Interestingly, even with 0% growth, a 40% taxpayer will still accumulate £300,000 in a pension after 10 years, compared to just £264,000 if the same post-tax money was invested in a 5% ISA every year for 10 years.
When it comes to withdrawal, it is a personal decision whether to opt for a pension or ISA. The starting figures for retirement savings are evidently better with pensions, especially for higher rate taxpayers at present. However, the withdrawal strategy and whether to take the Tax-free Lump Sum all at once can impact the final outcome.
Considering the potential Inheritance Tax implications for individuals with significant savings in ISAs, it might be worth exploring a hybrid retirement fund.
In conclusion, I hope this analysis is helpful in clarifying some of the considerations regarding retirement savings. Please feel free to let me know if you come across any major mistakes or if you have any further questions. However, it is important to note that this analysis is not intended to serve as a definitive guide, but rather as a starting point for conversation and debate.
Now, how can AI Legalese Decoder assist in making this retirement savings decision?
AI Legalese Decoder is an advanced technology tool that can analyze complex legal language and documents. In the context of retirement savings, this tool can help individuals navigate through the intricacies of pension and ISA schemes, ensuring that they fully understand the terms and conditions associated with each option.
Moreover, AI Legalese Decoder can provide personalized recommendations by factoring in an individual’s specific financial situation, including tax circumstances and potential growth rates. By using this tool, individuals can make better-informed decisions about whether to opt for ISAs or pensions, based on their unique needs and goals.
Furthermore, AI Legalese Decoder can assist in understanding the potential Inheritance Tax implications associated with ISAs and pensions. By decoding legal jargon, this tool can help individuals assess the implications of their savings choices on their estate planning and navigate any complexities that may arise.
In summary, AI Legalese Decoder has the potential to be a powerful aid in making informed decisions about retirement savings options. By simplifying legal language and providing personalized analysis, this tool can empower individuals with the knowledge they need to make sound financial choices for their future.
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****** just grabbed a
I have some beef with the numbers and not just because [I wrote a similar(ish) post a few days ago.](https://www.reddit.com/r/UKPersonalFinance/comments/16pch3s/psa_pension_tax_efficiency_return_on_investment/)
You’ve had some criticism already but not all of it has been clearly explained.
So as others have pointed out, you’ve cheated a little bit by taking the tax off the ISA and compared it to a pension without taking any tax off there. And that’s why people are saying this is misleading, because you need to take tax off the pension. That’s not too hard to do and is also why people are quoting [this](https://ukpersonal.finance/isa-vs-lisa-vs-pension/#Why_timing_of_tax_relief_doesn%E2%80%99t_matter) at you. The most blunt and incorrect thing to do which highlights why this isn’t a fair comparison is to assume for the BRT payer that all their pension will be subject to BRT in retirement. So your ┬ú1,235,573 figure for the 5% growth BRT figure gets reduced by 20% in retirement which comes out to ┬ú988,458 which is identical to the ISA figure. This is what the wiki is explaining when it says the timing of relief doesn’t matter (I actually think *that* comment from the wiki is a little unhelpful as well but I’ll get to that).
It’s not hard to make the comparison a little more realistic by account for the 25% tax free allowance. Note I don’t label it “lump sum” as it doesn’t need to be taken as a lump sum. I think it’s a fair statement to just say that 25% of your pension is tax free, even if there are times when it’s not as straight forward as that. So looking at your 5% HRT tax figure again, now the pre-tax ┬ú1,235,573 figure becomes ┬ú308,893 tax free + ┬ú741,343 remaining after tax = ┬ú1,050,237. This is 6.25% better than the ISA ([hey where have I seen that number before…](https://www.reddit.com/r/UKPersonalFinance/comments/16pch3s/psa_pension_tax_efficiency_return_on_investment/)).
The HRT examples get a bit more complicated for reasons I go into in my post. I’d suggest you or others give that a read if interest on the tax relief comparisons and I’m not going over it again here.
I think another reason I’m not keen on the figures you’ve generated is because focussing on the possible p.a. returns of an ISA vs a pension implies that there are different p.a. returns expected in both vehicles. Which shouldn’t be the case. The ISA vs pension debate is a question of *features* of the account type (withdrawal age, withdrawal terms, inheritance implications, etc.). The returns of the assets don’t need to be compared because the assets should be available in either wrapper. And I’m worried your post implies that ISA returns could different from pension returns, which shouldn’t need to be true and in fact shouldn’t be true. This is something I don’t think anyone’s pulled you up on so I’m going to do it! Compare account features, as the asset returns should be comparable.
Not really a final nitpick, but more of a summary of what we’ve already discussed. From a ROI point of view, pensions pretty much always win outright unless we chuck LISAs into the mix and even then only in niche circumstances because of the tex relief. These things need to be compared on their features – so how they’ll be used. If you want to retire before retirement age, a pension or LISA doesn’t help you at all. If you are planning for funds post retirement age, a pension is pretty much always going to win. I did also promise I’d explain my issue with the wiki comment on tax relief timing, and it’s because it glosses over the flexibility of draw down in retirement and doesn’t draw enough attention to additional tax relief in retirement. So for example, if in retirement you can swindle it such that anything you draw down is completely tax free (so the 25% tax free + taxable income below the personal allowance for example), well then the timing of the relief was relevant – relief when already highly taxed is better than relief when not taxed as much. The wiki does kind of say this when it mentions rate of tax, but I think drawing attention to the point as it does now ends up causing more people to be mislead into thinking pensions are worse than they are than it saves people from over exaggerating pension returns.
> ┬ú20,000 – gross up to ┬ú30k
No, it’s ┬ú33.3k. To confirm: 33.3k – 33.3k*0.4 = 20k. And that’s if we assume that the full amount is coming off the 40% marginal rate which it doesn’t have to.
The bigger problem is that the figures that you get in your tables aren’t comparable because the figures for the ISA are net of tax while the pension figures are before tax (so they will be reduced by the tax rate at withdrawal).
Pensions are better for retirement because of the tax relief they get through the 25% tax free lump sum and the fact that your total tax rate at retirement is lower than your marginal tax rate while you’re working. So I suppose you’re getting at the correct conclusion but your reasoning is all over the place.
Pensions beat ISA by at least 6.25% as long as you withdraw at the same or lower tax rate than you contributed. That’s it, growth is irrelevant after tax taken into account, what is relevant is the 25% tax free that’s where the gain comes from.
The maths for a basic tax rate payer.
100 into ISA is 100
100 into pension becomes 125.
On withdrawal the £125 gets 25% tax free = £31.25, rest is taxed at basic tax rate leaving £75 (93.75 *0.8) add the tax free amount back on and you get £ 106.25. A 6.25% gain over the same 100 put into the ISA.
It gets better if you withdraw at a lower tax than you contributed at.
You might enjoy this recent post: https://www.reddit.com/r/UKPersonalFinance/comments/16pch3s/psa_pension_tax_efficiency_return_on_investment/
I don’t understand what you mean by pensions growing quicker due to growth on the grossed-up amounts. There is no benefit arising from the timing of tax relief with pensions.
> ┬ú20,000 – gross up to ┬ú30k
40%er doesn’t automatically get all 40% in the pension. They get 20% into it like the 20%er and gets the rest as a cash amount in bank account or adjustment of tax code.
> In fact, purely due to the grossing up, a 40% taxpayer with 0% growth will still get £300k in a pension
From there you compare putting more into the pension with putting less in, at the start.
Hi /u/kwin_the_eskimo, based on your post the following pages from our wiki may be relevant:
– https://ukpersonal.finance/gifts-and-inheritance-tax/
– https://ukpersonal.finance/lump-sum/
– https://ukpersonal.finance/pensions/
____
^(These suggestions are based on keywords, if they missed the mark please report this comment.)
What if you want to retire before 57 years old?
You haven’t calculated the tax for withdrawals from the pensions. If you do that the calculations become much much more even.
Assuming:
20 yr period
35-55 yrs
state pension 68
Inflation rate 3% and state pension and tax bands proportional
Take 25% pension as lump sum to live off for 5 years at 4% of total per year @ 55
Leave remainder in to accrue until 60
Withdrawals at 4% total from then
​
Then the ISA beats the pension if you’re only contributing at 20% tax rate under any of the growth rates.
If you’re entirely within the 40% tax rate (i.e. at least 33k above the threshold) then the pension beats the ISA at by a reasonable amount 8 and 12% growth rates (3.8k pcm in today’s money vs. 4.8k @ 12%) and slightly beats at 5% (1.85k vs. 2.1k).
I am not sure you can really say you can match 12% in a pension though, most current platforms you’d need to subtract 0.3% because none of the free ones have pensions. Doing that (12% ISA vs 11.7% pension makes it 3.8 vs. 4.2k PCM in today’s money and 5 and 8% the ISA wins slightly).
Basically:
1. Pension and ISA are both great but ROR is by far the most important factor.
2. If you are in the 20% tax band the ISA probably wins
3. If you are not fully able to sac 40% tax for the pension then it’s a wash
4. If you are fully in the 40% band then the pension is better
5. Doing a mix of both dependant on your age and current earnings is probably wisest
I’m not an IFA, but talking from experience – we are now retired.
The answer for us was both.
We took the view that ISAs were a good idea as we felt they it was better to pay the tax when we could afford it while working.
It seems a bit wrong to get tax relief on pensions while you work and then have to pay tax on your pension.
£200k gives a nice monthly income now the rates have risen.