Should you swap your pension for an ISA?
A leading pensions commentator says people might be better off ditching their pensions and saving in an ISA instead.
Ros Altmann, a former government adviser on pensions policy and governor of the London School of Economics, claims that basic-rate taxpayers could be better off saving for retirement in an ISA rather than a pension.
“Unless they can rely on being wealthy or can be sure they will not fall back on means-testing in later life, those on basic-rate tax – which is nearly 90% of taxpayers - have a significant probability of finding pensions poor value,” she told Moneywise.
Altmann believes that disastrous government policy has “destroyed” the pension system in the UK. For those approaching retirement, there is also the impact of the credit crunch and stockmarket turmoil to contend with, with these collectively wiping out huge chunks of peoples' nest-eggs. Meanwhile, the cost of buying a retirement income through an annuity has increased dramatically.
“Over the past decade, the government has paid lip-service to wanting to encourage pension savings, while systematically destroying the incentive to save in a pension for most of the population,” says Altmann.
"The government did not want ordinary citizens to save, since that meant today's growth would be reduced [because they were spending less]. But with the baby-boom generation fast approaching retirement, this has left us woefully unprepared for the ageing population."
She specifically points to the introduction of pension credit into the state pension system in 2003 as one government measure that has eroded the value of saving in a pension for basic-rate taxpayers.
Pension Credit is a means-tested benefit that guarantees everyone aged 60 and over an income of at least £124.05 a week for individuals or £189.35 for couples. For Altmann, the concern is that people, who might be better off receiving pension credit, will not be eligible because their pension income and personal savings make them ineligible.
“Pensions are not really a 'suitable' investment for most people at all,” she says. “Anyone entitled to pension credit, and that is nearly half of all pensioners, will lose between 40% and 100% of their private pension in the means-test.”
Bearing this in mind, Altmann believes that many basic-rate taxpayers might actually be better off foregoing their employer pension contribution and saving in an ISA instead until closer to retirement. This, she says, will help them avoid means-testing penalties as well as “poor value annuities”.
"Pensions are old-fashioned and inflexible, and means-testing for pension credit means the benefits of saving into a pension is just not clear-cut," Altmann adds. "Once your money in locked into a pension you can't get it back, but saving in an ISA until closer to retirement will give you the chance to see if you're in-line for pension credit."
If you're not, Altman says people could consider moving their ISAs into a pension. But if they are, then they can spend their ISA savings with 100% tax relief.
Tom McPhail, head of pensions research at Hargreaves Lansdown, agrees with Altmann’s assessment of poor government pension policy, but says savers shouldn’t ditch their pensions just yet.
“If someone is aged over 50 then the question as to whether they should start saving into a pension is difficult to call,” he explains. “However, for people aged between 25 and 40, means-testing should not be an important consideration as the rules may have changed significantly by the time they retire.”
He adds: “The smart thing to do is to make yourself financially independent from the government by preparing for retirement and lifting yourself out of means-testing issue.”
McPhail also defends pensions as a tax-efficient, and flexible, way to save for retirement. Personal allowances mean couples aged over 65 can earn a joint income of £18,000 a year tax-free, or £9,000 for individuals.
“Even if you earn more than this, a large proportion will be tax-free, meaning people with pensions earn tax relief on the way in and way out of pension saving,” he explains.
For McPhail, the value of a pension comes from the fact that it forces people to lock away their money until retirement, while at the same time offering them flexibility for drawing an income.
“People underestimate the issue of longevity and how long they will live for,” he adds. “Annuities are expensive and it’s important people shop around, but an annuity will provide you with an income for the rest of your life – which could be 30 years or more.”
However, Altmann maintains that the inflexibility of having to buy an annuity, and uncertainty over how much this will cost, is putting people off saving for retirement.
"Younger people who don’t know if they can cope without their pension contributions or not might be better off using the money to put a deposit down on a house or paying off student debt," she says. "An ISA is a safer, more flexible way to save for later life without risking losing out on state benefits."
Invidivual Savings Accounts were introduced on 6 April 1999 to replace personal equity plans (PEPs) and tax-exempt special savings accounts (TESSAs) with one plan that covered both stockmarket and savings products, the returns from which are tax-exempt. The ISA is not in itself an investment product. Rather, it’s a tax-free “wrapper” in which you place investments and savings up to a specified annual allowance where the returns (capital growth, dividends, interest) are tax-exempt (you don’t have to declare ISAs and their contents on your tax return). However, any dividends are taxed within the investment, and that can’t be reclaimed.
In exchange for any lump sum – usually your pension fund – an annuity is “bought” from an insurance company and provides an income for life. When you die, the income stops. Annuity rates fluctuate daily and depend on your sex (although from 21 December 2012 insurers will no longer be able to use gender as a factor when calculating annuities), age, health and a number of other factors, so you have to pick the right one and, once bought, its terms cannot be altered, so seek financial advice.