Life is too short to get caught up in the complications of pensions.
This article forms part of our Duelling Fools feature on 'Pensions vs ISAs'. You can also read the case for pensions and vote in our poll.
In an ideal world -- which lies several gazillion light years away from the one we toil upon – debating ISAs versus pensions would be knockabout fun.
It'd be like a TV programme to choose the best cuisine -- "Indian after the rugby! French on a first date!" -- or a lads' mag pitting one pneumatic blonde against an identical one, before favouring the girl "into nerdy investor types".
After all, pensions and ISAs have the same aim; the Government offers tax breaks to encourage us to save for our future, and so stop the Welfare State creaking to a halt in 20-something-or-other.
The maths is essentially equivalent, too. As we've pointed out before, the key difference is whether you get tax relief going in (pensions) or coming out (ISAs).
Consider a higher rate taxpayer who earns £100 gross (that is, £60 after tax), saves it and gets 9% growth for three years before drawing income at a rate of 5%.
Each year's income will be the same, for the ISA and the pension.
ISA: 60% x £100 x 1.09 x 1.09 x 1.09 x 0.05 = £3.89
Pension: £100 x 1.09 x 1.09 x 1.09 x 0.05 x 60% = £3.89
But as I said, any ideal world is called Soco-Smorgasbord 5, is populated by pin-ups lusting for stock pickers, and orbits a sun very far away from here.
The reality is much more complicated.
Sidestepping the competition
You might now expect me to go toe-to-toe on the mathematical advantages of one retirement vehicle versus another.
But I'm not going to do that -- pensions can only win, and I'm not a duellist to shoot myself in the foot.
- The 25% tax-free sum you can withdraw from a pension means tax relief going in and coming out on that portion, and that's a great advantage.
- If you're a higher-rate taxpayer now and a lower-rate payer on retiring, you'll benefit from the differential if you use a pension.
- If your employer pays extra into your pension, you'd be a fool to turn it down.
So pensions do have obvious extra financial benefits, even if the main benefit in the public's mind -- 'extra' money -- is partly an illusion, since much of it will be taxed back later.
Simplicity and freedom
I'm going to commend ISAs for their straightforwardness.
I won't counter with any quirky ISA benefits. That's because there aren't any in terms of saving and spending. You put money in, it grows tax-free, and you take out what you like, when you want.
Compare that with pensions -- but don't bother if you're under 45, because their complex rules will change and change again before you retire.
Pension restrictions cover:
- the age you can begin to draw on your pension;
- when you can claim your tax-free lump sum (assuming it lasts, given how politicians dislike it);
- how much (barely anything) your partner can claim of your pension if you die after retiring; and
- how you can use your pension pot to fund your retirement, with the Government favouring annuities (despite the fact they are currently priced for ever-low inflation).
Do you want to approach the last years of your life, after 40 years of saving, at the mercy of rules and regulations on how you dare spend you money -- after tax, remember!
I don't.
Worse, this fiddly regulation changes at the Government's whim.
To give one example, the Government recently cut back how much tax relief very high earners can claim from 2011 , and made things more complicated still to stop people sneaking around the rules in 2010.
At a stroke, supposedly sacrosanct pension guidelines are swept away (again), this time to supposedly salvage the public finances (though crippling public sector pensions remain notably untouchable). Most of us will never fall anywhere near into the income bracket concerned, but some fear all higher-rate relief could eventually be abolished.
So I'm not going to debate all the detail surrounding pensions because none of it will last -- especially since 2012 sees more upheaval, with compulsory pension enrolment, and no doubt dozens of new restrictions, too (and compulsory pay cuts to fund the schemes).
Live free -- use ISAs
Yes, the ISA rules could change. But it's harder to envisage a retrospective tax on ISAs then another pension fudge. It's easier to muck about with far-away pensions and Governments have form.
Indeed, ISAs are becoming more attractive, with the £7,200 contribution limit rising to £10,200 in April 2010 (or October 6th for over 50s).
Admittedly, pensions aren't as bad as they were. Pension savers once had to put money into high-charging funds that grew fat on money stolen (sorry, 'earned') from their client's nest eggs.
Self Invested Personal Pensions have improved matters. You can open a SIPP, split your money between ETFs, gradually shift towards low-cost bond funds as you near retirement, and trounce the majority of high fee funds.
But even SIPPs are governed by the Byzantine pension regime.
Be flexible: Do both
A duel needn't be to the death, and it makes sense to spread your money between pensions and ISAs. If one vehicle becomes onerous you can fall back on the other.
Again, I'll not offer some precise formula for determining the split, based on the state pension, the tax-free income allowance, the outlook for inflation, and how many leap years there are until you quit work.
Unless you're retiring soon, it'll all change, rendering precise calculations useless. And if you are, you need specialist advice.
Instead, I'd suggest spreading your money between the two, wrapping them around cost-efficient investments, re-investing dividends, and concentrating on the balance between living today and saving for tomorrow.
Some of your ISA money can always be moved into pensions (gaining tax relief) should it look worthwhile in years to come – whereas the opposite isn't true. In fact, this looked a no-brainer until recently, when the magnitude of lump sum investing changed due to that move on high-earners. (More fiddling. Funny that!)
You'll still be called a pensioner if half your pot is in ISAs. But at least you'll have some of the freedom that the old so envy in the young.
> Do you prefer pensions or ISAs? Vote now in our Duelling Fools poll.
