Question
Our elder son, single and aged 50, earns about £16,000 p.a. as a self-employed piano and keyboard teacher.
My wife and I are in our eighties and are concerned about what will happen in the future. He currently has a tiny SIPP fund and two very small occupational funds from past employment. We are considering setting up a trust and are also able to pay regular gifts to him (and our other son and his children) out of income.
The question is whether to use the regular gifts to fund our elder son’s SIPP to increase his potential pension, or to invest into ISAs, for him, from which he could draw income in the future. Which is the better strategy?Answer
Regular gifts out of income (not capital, such as savings) immediately fall outside of your estate for inheritance tax purposes, so should help longer term tax planning provided you can afford them.
As for tax advantages, pensions benefit on the way in thanks to tax relief on contributions, so a basic rate taxpayer like your son will only have to pay in £80 to enjoy a £100 contribution. Whereas ISAs benefit at the other end, because income is not taxable. Assuming tax rates remain the same, these two tax benefits are effectively equal - see our ISAs page for an example.
However, as your son may well end up being a non-taxpayer in retirement, the benefit of tax-free ISA income could be less useful. And the added advantage of being able to take a quarter of the pension fund as a tax-free lump sum at retirement (having enjoyed basic rate tax relief on the way in) probably tips the scales in favour of pensions.
A pension is less flexible as it cannot be accessed before age 55 and the money must ultimately be used to provide an income for life, whereas an ISA can be accessed at any time. But this may be no bad thing if your motivation is your son's long term welfare.
One point to bear in mind if your son has scant pension provision is the rather silly pension tax credit system. Under current rules, if a single person aged 60 or over has a weekly income of below £142.70 then the Government makes it up to this amount via a 'Guarantee Credit'. This is obviously a good thing, but it rather defeats the purpose of building retirement savings in addition to the basic state pension, currently £107.45, unless you'll comfortably exceed £142.70 weekly income (note: savings are assumed to produce a notional weekly income of £1 per £500 over £6,000, pension income is included 'as is'). There's a risk you end up saving to simply replace a state benefit you would have otherwise received.
If your son is entitled to a full basic state pension then, as things stand, the first £1,833 of annual pension/savings income would simply replace the pension tax credit he'd otherwise receive. £1,833 of annual income equates to a pension fund of around £50,000 based on current inflation-linked annuity rates for a non-smoking 66 year old (the state retirement age from 2020). Of course, the pension tax credit system may change in future (the Government is still talking of introducing a flat weekly state pension of around £140 for everyone) and your son's occupational pensions and possible extra state pension (via SERPS/S2P) may mean this isn't an issue. But it's good to be aware.
I'd also check his tiny SIPP isn't incurring any fixed annual charges that are not cost effective on a small amount. Unless he's an active investor a stakeholder pension may be more appropriate.
Our elder son, single and aged 50, earns about £16,000 p.a. as a self-employed piano and keyboard teacher.
My wife and I are in our eighties and are concerned about what will happen in the future. He currently has a tiny SIPP fund and two very small occupational funds from past employment. We are considering setting up a trust and are also able to pay regular gifts to him (and our other son and his children) out of income.
The question is whether to use the regular gifts to fund our elder son’s SIPP to increase his potential pension, or to invest into ISAs, for him, from which he could draw income in the future. Which is the better strategy?Answer
Regular gifts out of income (not capital, such as savings) immediately fall outside of your estate for inheritance tax purposes, so should help longer term tax planning provided you can afford them.
As for tax advantages, pensions benefit on the way in thanks to tax relief on contributions, so a basic rate taxpayer like your son will only have to pay in £80 to enjoy a £100 contribution. Whereas ISAs benefit at the other end, because income is not taxable. Assuming tax rates remain the same, these two tax benefits are effectively equal - see our ISAs page for an example.
However, as your son may well end up being a non-taxpayer in retirement, the benefit of tax-free ISA income could be less useful. And the added advantage of being able to take a quarter of the pension fund as a tax-free lump sum at retirement (having enjoyed basic rate tax relief on the way in) probably tips the scales in favour of pensions.
A pension is less flexible as it cannot be accessed before age 55 and the money must ultimately be used to provide an income for life, whereas an ISA can be accessed at any time. But this may be no bad thing if your motivation is your son's long term welfare.
One point to bear in mind if your son has scant pension provision is the rather silly pension tax credit system. Under current rules, if a single person aged 60 or over has a weekly income of below £142.70 then the Government makes it up to this amount via a 'Guarantee Credit'. This is obviously a good thing, but it rather defeats the purpose of building retirement savings in addition to the basic state pension, currently £107.45, unless you'll comfortably exceed £142.70 weekly income (note: savings are assumed to produce a notional weekly income of £1 per £500 over £6,000, pension income is included 'as is'). There's a risk you end up saving to simply replace a state benefit you would have otherwise received.
If your son is entitled to a full basic state pension then, as things stand, the first £1,833 of annual pension/savings income would simply replace the pension tax credit he'd otherwise receive. £1,833 of annual income equates to a pension fund of around £50,000 based on current inflation-linked annuity rates for a non-smoking 66 year old (the state retirement age from 2020). Of course, the pension tax credit system may change in future (the Government is still talking of introducing a flat weekly state pension of around £140 for everyone) and your son's occupational pensions and possible extra state pension (via SERPS/S2P) may mean this isn't an issue. But it's good to be aware.
I'd also check his tiny SIPP isn't incurring any fixed annual charges that are not cost effective on a small amount. Unless he's an active investor a stakeholder pension may be more appropriate.
Read this Q and A at http://www.candidmoney.com/questions/question715.aspx
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