The Big Pension vs NISA conundrum
The end of tax year will soon be upon us and the question we get asked by clients on a regular basis is whether they should be adding money to a pension or a New Individual Savings Account (NISA). Prior to Pension Freedoms which allowed greater access to pensions the answer generally depended on how much flexibility was needed when taking the money out again and when they needed access to the money. If you need access before age 55 my answer is still NISA but if you need access post 55 the answer is more than often pension. The reason being is that in the majority of cases you will end up with more money but let me explain to you how this works.
This is simply due to tax relief that is available to pensions on the way in and the tax free access that is available to some of the fund on the way out. If we take someone aged 53, looking to retire at age 63 with a salary of £60,000. The last of the kids have finished full time education giving them more disposable income and they can now afford a monthly reduction in take home pay of £500 a month. For a higher rate tax payer £6,000 to be added to a NISA will be paid from income which has been taxed. For the same reduction in pay due to tax relief you would end up with a £10,000 pension contribution. Over 10 years this results in contributions of £100,000 in the pension or £60,000 in a NISA.
We have assumed that there is no fund growth but when this person reaches retirement they would like to take income of £6,000 net per year. If they take it from their NISA it is £6,000 that would need to be taken out each year to meet the income and this would all be tax free. If we assume that they remain a higher rate tax payer when they retire, which 1 in 7 pensioners remain, a higher rate tax payer would need to take £8,572 per year from a pension to meet the £6,000 net income requirement. This would include 25% tax free cash being taken with each payment.
After 10 years if we assume that there is still no investment growth the NISA would have no money left. A higher rate tax payer would still have £14,280 remaining in their pension fund. A basic rate tax payer in retirement would have £29,410 in their pension.
It was widely rumoured before George Osborne’s last budget that pension tax relief in some form was under threat and that the impending EU referendum got him to pull back from this for fear of upsetting voters. Maybe our new Chancellor Philip Hammond will decide it is time for a flat rate of pension tax relief scrapping the relief for 40 & 45% tax payers.
So if you are thinking of putting money into a pension that may be the last chance to get those extra tax reliefs.