Five strong alternatives to a pension

1 Start your ISA early

The most obvious alternative to a pension is an ISA. Last year's increase in limits, available to all investors in the current tax year, means a married couple can invest £20,400 a year between them and take out the proceeds tax-free.
That may not sound like much of a benefit, given that following the recent Budget, each individual can realise annual gains of £10,100 free of capital gains tax, and even gains that are subject to tax are charged at 18% for basic-rate taxpayers and 28% for higher-rate taxpayers.

But, while CGT allowances are safe for now, many experts fear this generosity cannot continue indefinitely, given the parlous state of the UK's finances.
Using their ISA allowance every year means investors will quickly build up a significant portfolio.

Killik & Co calculates that anyone who had invested the full amount permitted in ISAs and their personal equity plan (PEP) predecessors since they were introduced in 1987 – a total of £171,000  – would have built up a nest egg worth £302,000, assuming investments grew by 5% a year.
Even those who have not started using their allowances still have time to build a sizeable portfolio.

Killik calculates that a couple who each use their annual allowance for 20 years would amass a portfolio worth £708,000, assuming a return of 5%, which could generate a tax-free income of £35,000 each year.

Justin Modray, founder of, says those planning to use an ISA for retirement should have a plan for the funds they invest in.

Those who are 30 years or more away from retirement can afford some risk, choosing equity funds and including some emerging markets and commodity funds, which will be higher risk but have potentially higher returns.

As retirement approaches, he says, risk should gradually be reduced. "You should move to less volatile funds like corporate bonds, property or cash, as you do not want to run the risk that 20% to 30% of your fund will disappear overnight."

2 Stay the distance with a maximum investment plan

Investors could also consider a maximum investment plan (MIP), a life assurance-based product that was popular in the 1980s, but was discredited because of its high charges and poor performance.
However, Small says some of the new schemes being launched are better value. Skandia is among those offering these plans, which require regular contributions for 10 years.

The income within the plan is subject to life assurance tax, but proceeds are paid tax-free.

Investors can extend the contract beyond 10 years and take a regular tax-free income, but if they are cashed in early the returns could be very poor and you may even lose some of your investment.

As with the original MIPs, performance will depend on the underlying investments, although the new plans allow a broader selection of funds than in the past.

3 Use your CGT allowance

It is worth investing in shares and other assets that are potentially liable to capital gains tax (CGT) even if you have used up the full ISA allowance, says Small.

The annual exemption of £10,100 on gains and low tax rates means it should be possible to time investment sales to avoid paying tax completely, or to pay it at a low rate.

4 Take your assets offshore

Offshore bonds may be worth considering for wealthy investors who have used up the alternatives already mentioned. As they are based outside the UK, the bond does not incur any tax.

Investors can withdraw up to 5% of the amount invested annually without incurring tax because the HM Revenue & Customs treats this as a return of capital.

These can be especially useful for individuals who expect to pay a lower rate of tax after retirement, as the tax-free roll-up of income within the fund means they avoid having to pay the higher rate of tax that would be payable on bonds issued onshore.
But the charges can be high and performance will depend on the assets – investment funds or other assets – put within the bond.

5 Opt for planned exit VCTs

If you have used up all these ideas and have the stomach for risk, you could consider a VCT. You can invest up to £200,000 a year into a VCT and get 30% tax relief – assuming you have paid that much tax in the first place.

When the funds are sold the proceeds will also be free of CGT provided they have been held for at least five years, and there is no need to pay higher-rate tax on any dividends from the fund.

These are high risk: many of those launched in recent years ended up making big losses for investors, so you have to choose carefully.

Also, it can be difficult to realise your investment when you need to, as buyers of VCT shares can be hard to find.

To get over this, you can opt for "planned exit" VCTs which, as their name suggests, are wound up at a specified time.

Downing, one of the VCT managers which is highly rated by advisers, offers a number of these type of schemes.

This article was originally published in Money Observer - Moneywise's sister publication - in May 2010