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'Blend ISAs with pensions' - Government urged to make some real changes Go compare with our comparison table

'Blend ISAs with pensions' - Government urged to make some real changes

11 August 2010 / by Rachel Mason

There has been a lot of talk about pensions recently, particularly around the dismissal of final salary pension schemes and the massive pension deficits many companies are now laden with. It is estimated that ten FTSE 100 companies have total disclosed pension liabilities greater than their equity market value according to research from the Pension Capital Strategies research. British Airways, BT and Invensys are estimated to have liabilities at more than double their equity market value. The near collapse of Equitable Life and no clear focus from government has left many with either no company pension or very poor schemes where the employer pays the minimum they can get away with.

For young people, pensions are bewildering and not a high financial priority, particularly when their main focus is often saving up for a deposit on their first house.  
However, saving for retirement is important, especially when you consider the basic state pension is just £5000 a year; there are not many people who could survive on that especially when you consider fuel costs and other basic needs. So are pensions really the best option?

George Ladds, head of investment and pension research at Fair Investment Company looks ways to encourage young people to save for retirement:

"We should all be saving money for our retirement – the sooner the better – but many of us are still not. Ask any young person about saving for a pension and their eyes will glaze over. There are a number of reasons for this - young people can't see the benefits of saving for something so far off into the future and think it is irrelevant to them, many don't understand pensions or think they are too complicated and others may think they can't afford to give any significant amount of their salary up in order to pay into pension. In reality, young people have other priorities.

"But it is important to try and encourage people to understand that saving for retirement is vital if they are to ensure they don't end up having an impoverished standard of living in their old age, and one way of doing that is showing that there are other, more simple, flexible and relevant options. Just because you have to save for your retirement doesn't mean you have to do it through a pension – ISAs can provide a good alternative and a great way to get people to start thinking about saving for retirement.

"If you consider the maximum annual allowance is £10,200 many young people are not going to be able to save anything like that, so this is why ISAs are great way to start saving, saving just £50 a month at a young age can make a big difference. All the investments are invested in a fund that has the same tax benefits as a pension fund, so they grow in a similar way.

"The big difference is in the flexibility. With an ISA, money can be taken out at any time and an income can be taken tax free whereas with a pension benefits cannot be taken until you are 55 and only 25% can be taken as cash. The rest has to be taken as a taxable income. Of course there are arguments that pension contributions offer tax relief (so £100 costs just £78 for basic rate tax payer) but I would argue a tax-free income in retirement is highly attractive.

"So what does this mean in practice? Well, as an example - if you were a 65-year-old man and had £100,000 in a pension potcurrently your best annuity quotes are around £550 a month* which is then taxable. There is a school of thought that this will decline over the next few years especially as people live longer. But with an ISA fund of £100,000 invested in a high yield income fund paying say, 7% a year this would provide a tax free income of £700 a month. However you should keep in mind that an annuity is guaranteed for life, whereas with an ISA, your income and capital is at risk.

"So if the employer doesn’t have a scheme then people should be encouraged to save and it should be made easy. At the moment your employer cannot pay into ISA but that might change. If you get people thinking about pensions early then as people forge careers they will join employers with better schemes paying more money into their pension, they may also benefit from higher rate tax relief so pension saving becomes more relevant to them. I would like to see ISAs blended with pensions and state pensions – this could make for an attractive proposition to encourage young people to save.

"I think this added flexibility of being able to access the cash in an ISA is why ISAs can be a much more attractive retirement savings option for younger people. As long as they are sensible and only use the fund for major lifestyle events such as buying a house or a child going to university and not just raiding it for any old thing, it could be the way to get people interested in saving for their future. More importantly, it could get people to start thinking about saving.

"But to make this work, the government needs to stop burying its head in the sand and wasting money on hair brain schemes (like Group Stake Holder Schemes or Nest) and come out with a sensible flexible way for people to understand the importance of saving for their future. If they don’t they are just storing up a retirement time bomb where no-one can afford to retire, and those that do turn to the state for more money.

"We have had successive governments who have done nothing, my challenge to the coalition government is: Are you going to join a long line of governments who just passes the baton to the next person? Perhaps if we took away MPs gold plated pensions they might actually do something."


* for a single male aged 65, non smoker, £100,000.00 purchase amount, conventional, level escalation, nil guaranteed period, paid in arrears without proportion.


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**Guaranteed gross income.
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