Is a pension a better option for saving than an ISA?
Q: I'd like to save for my five-year-old daughter's retirement. I understand the virtues of stocks and shares individual savings accounts and the likelihood of growth over the long term, but would I be better off opening a pension, rather than saving in an ISA?
A: Francis Klonowski is principal of Klonowski & Co in Leeds.
However, I suspect you may not be eligible because your daughter was born at a time when child trust funds were being offered. Both these accounts raise a dilemma for parents, as the child becomes entitled to the money at 18 and you can't control how it is used.
So you need to decide whether you can accept this or would prefer to control when your daughter gets the money, and how much she gets at a time, especially if you wish to save for her retirement.
With pensions, you enjoy tax relief when you put money in. For example, if you invest £100, it becomes £125 in the pension fund as the provider claims back basic-rate tax relief.
As for ISAs, you'll get your tax benefits when it comes to drawing down your money. For example, when you take out money from a cash ISA, you don't have to pay any income tax on the interest you've earned.
When you withdraw money from a pension, you can only withdraw 25% as a tax-free lump sum - the rest has to provide some form of income, which is taxable.
Beyond that, you can invest in the same types of funds in both plans, and both benefit from tax-free growth.
Generally, though, I would only consider pension savings for someone this age if all their interim needs, such as university fees or a house deposit, have already been covered.
Tax-free lump sum
An inelegant phrase that is nonetheless accurate in what it describes: a one-off payment to a beneficiary that is free of any form of taxation. Usually received when using a pension fund to purchase an annuity, as 25% of the overall fund can be taken as a tax-free lump sum.
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.
Available from 1 November 2011, the Junior ISA will replace child trust funds (CFTs), which have been phased out. Junior ISAs will have a £3,000 limit and will be offered by high street banks, building societies and other providers that currently offer ISAs to adults. You can invest in either stocks and shares or cash. But, unlike CTFs, there will be no government contributions into each child’s savings pot. Money invested in Junior ISAs will be “locked in” until the child is 18, and the ISA will default to an adult one.