Cash ISA or AVC?

[sweepster70]

Which is better?
If I'm right, we pay around 72p per 1 pound in an AVC and any growth is added. Also we receive a certain amount tax free, depending on the pension pot. What's left will be 25% tax free with the remainder taxed.
A good 3 year ISA pays around 4.25%. Paying the max £20,000 each year, I can't see me making the same amount?
I understand the Government are possibly thinking about reducing this and there are tax limitations on the interest if I have over a certain amount of savings.

[heapsy]

Paying in to AVCs is a great way to boost your retirement pot. Saving on income tax and NI contributions along the way is also a wise move. Remember though, they cannot be accessed until you take your pension. It is always a good idea to have some cash savings in case needed. The next car, a holiday, emergency fund when things go wrong in life, such as a period of sick leave etc. Do both if you can. Interest rates are gradually coming down, so lock some of your ISA money away for a couple of years if you don't need it. Be careful not to have too much in cash. When the rates drop, and fixed rates come to an end, you could be in for a shock. This happened to me in 2009. This leads me to Stocks and Shares ISAs. I was section C, but didn't build up enough AVCs for the full 25% lump sum. I'm undecided wether to commute part of my pension, to get the full 25% lump sum. I also have a S&S ISA. One of the funds I intend to take as cash along side my AVCs, hence my comment re commutation above. Remember, the tax relief on ISAs works in a different way to pensions, allowing you to take the whole lot tax free, as and when you wish. They are not subject to the same rules governing pensions, so give flexibility when used in conjunction. A very long answer I know, but I've tried to cover all bases, hope it helps.

[sweepster70]

Paying in to AVCs is a great way to boost your retirement pot. Saving on income tax and NI contributions along the way is also a wise move. Remember though, they cannot be accessed until you take your pension. It is always a good idea to have some cash savings in case needed. The next car, a holiday, emergency fund when things go wrong in life, such as a period of sick leave etc. Do both if you can. Interest rates are gradually coming down, so lock some of your ISA money away for a couple of years if you don't need it. Be careful not to have too much in cash. When the rates drop, and fixed rates come to an end, you could be in for a shock. This happened to me in 2009. This leads me to Stocks and Shares ISAs. I was section C, but didn't build up enough AVCs for the full 25% lump sum. I'm undecided wether to commute part of my pension, to get the full 25% lump sum. I also have a S&S ISA. One of the funds I intend to take as cash along side my AVCs, hence my comment re commutation above. Remember, the tax relief on ISAs works in a different way to pensions, allowing you to take the whole lot tax free, as and when you wish. They are not subject to the same rules governing pensions, so give flexibility when used in conjuction. A very long answer I know, but I've tried to cover all bases, hope it helps.

Thank you for the detailed reply.
Like you, I will have to reduce my NRA 60 a little if I want the maximum lump sum. It's always good to know the different options that are available for investing your money.

[RobertT]

Based purely on contributions and ignoring investment growth/interest and accessibility, pensions are better than ISA's as long as you don't pay any more than 20% tax on the taxable element.

AVC's are even better, as your contributions are made before tax is paid and there's the benefit of salary sacrifice(PSE). Plus you have the option to transfer them out for greater flexibility.

There's a thread on a similar subject here: viewtopic.php?f=27&t=114449&p=1106483&hilit

For low earners, there's a nice perk with the Starting Rate for Savings, which enables you to earn up to an extra £5k interest per year on top of the normal £1k limit(for basic rate tax payers). That is over and above any money you have in tax efficient savings like cash ISA's.
https://www.gov.uk/apply-tax-free-interest-on-savings
Perhaps something to think about for when you retire?

[Wullie10]

Avc has been great over the years but am I right In saying the one attached to the new collective pension plan is not so good ?

[RobertT]

Avc has been great over the years but am I right In saying the one attached to the new collective pension plan is not so good ?

The tax benefits of the new AVC arrangement with the RMCPP are exactly the same as with the old AVC's(Bonusplan & Flexiplan), which have been great for me over the years aswell, and paying into them represents one of the best financial decisions I've ever made.

As far as the RMCPP is concerned, you could argue the standard lump sum plus Booster has the potential to make up the majority of the tax free amount when you take your benefits, so AVC's are secondary to that. But there is the option to take advantage of the extra tax benefits compared to a SIPP, and then transfer them out for drawdown or annuity, which could be a good choice for anyone wanting to retire earlier.
But bear in mind, you have to take all your RMCPP benefits at the same time, so the pension and lump sum(inc booster) will be reduced if taken before 67. Full details are in the AVC handbook.

The investment choices are a bit uninspiring with only 5 funds to choose from, plus the lifestyle strategy. Only time will tell how they perform.

[NWpostie]

Avc has been great over the years but am I right In saying the one attached to the new collective pension plan is not so good ?

The tax benefits of the new AVC arrangement with the RMCPP are exactly the same as with the old AVC's(Bonusplan & Flexiplan), which have been great for me over the years aswell, and paying into them represents one of the best financial decisions I've ever made.

As far as the RMCPP is concerned, you could argue the standard lump sum plus Booster has the potential to make up the majority of the tax free amount when you take your benefits, so AVC's are secondary to that. But there is the option to take advantage of the extra tax benefits compared to a SIPP, and then transfer them out for drawdown or annuity, which could be a good choice for anyone wanting to retire earlier.
But bear in mind, you have to take all your RMCPP benefits at the same time, so the pension and lump sum(inc booster) will be reduced if taken before 67. Full details are in the AVC handbook.

The investment choices are a bit uninspiring with only 5 funds to choose from, plus the lifestyle strategy. Only time will tell how they perform.

I agree I'm always of the opinion stocks and shares long term has a better return than ISA or building society savings accounts, this is showing well for my Flexiplan as I opted for growth and Bonus plan is part growth part savings plan, the new AVC is now set for growth the original set up was for lifestyling which I think is to slow for the length of service I plan for Royal Mail.

[sweepster70]

Once you have enough money in the AVC that pays your tax free lump sum, is it still worth while paying into the AVC knowing that you will be paying 20% tax on it?
Would the first 25% of that be tax free (UFPLS) with the remainder at 20%?
Also, if you have enough money for the tax free lump sum on the new pension by paying the extra 1% without paying additional AVC's, would you still get the first 25% of your additional AVC tax free?
A little long winded, but thanks in advance.

[RobertT]

Once you have enough money in the AVC that pays your tax free lump sum, is it still worth while paying into the AVC knowing that you will be paying 20% tax on it?
Would the first 25% of that be tax free (UFPLS) with the remainder at 20%?
Also, if you have enough money for the tax free lump sum on the new pension by paying the extra 1% without paying additional AVC's, would you still get the first 25% of your additional AVC tax free?
A little long winded, but thanks in advance.

If you thought the question was long winded, here's the answer.....

There are 2 different options when taking AVC's via the RMCPP, and what you can do with them will depend on when you stop paying in and when you access your benefits. Which I perhaps didn't communicate very well in my previous post.
Have a good read of the AVC Handbook for more info.

If you're taking your AVC's at the same time as your other benefits, all three elements(pension, lump sum & AVC's) are bundled together when working out the tax liability.

In that instance, afaik any excess cash from AVC's and potentially from the lump sum(inc booster) too, after the total 25% tax free cash from your RMCPP benefits has been accounted for, will be then be paid as a UFPLS with the first 25% of that also tax free.

How much tax you pay on the other 75% will depend on what other income you have.
Based on current standard rates, any income between £12,571 - £50,270 is taxed at 20% and anything over is taxed at 40%.

However, if you've already stopped paying into the RMCPP when you come to take your benefits, you do have the choice to transfer out your AVC's beforehand. Which might be better for some people.
For example: you leave RM at 65 but don't take your RMCPP benefits until 67, you can transfer out your AVC's to a personal pension sometime inbetween.

You could then take 25% tax free and drawdown the rest and so potentially avoid breaching an income tax band, compared to accessing it all in one go with other RMCPP benefits.

As far as the tax is concerned, it's important to understand how you benefit from that on the way in aswell as how you pay it on the way out.

Each £1 gross going in to your pension/AVC will only cost you 72p net, factoring in tax relief and salary sacrifice(PSE). So even if your total AVC pot is paid out as a UFPLS and you're in the 20% tax band, you'll get 25p tax free and lose 20%/15p on the rest, meaning you get 85p in your pocket and you're still better off by 13p compared to the 72p you pay in.

That uplift from 72 to 85 represents an 18% increase on your money and the potential increase from 72 to 100(if you can avoid tax altogether) is nearly a 39% increase.
You won't get those returns from any other financial product, just by paying in!

If you decide to stop paying AVC's, you'll have an extra 72p in your pocket for each £1 gross that would have otherwise gone in, which you can then put somewhere else like an ISA or spend it, etc.

*Figures are based on contributions only.

[sweepster70]

Thanks Robert, a very in-depth and helpful reply.
I am hoping to retire no later than 65 with my Birthday being in February. The new pension has an NRA of 67, so if I were to wait until April to cash in my pension and AVC's, it would be a new financial year and my income (Pension only) wouldn't trigger the 40% tax. Would I be right in thinking this?

[RobertT]

It doesn't sound as if you'll get anywhere near the 40% tax band, but without knowing any numbers nobody can say 100%.

Just use the tax bands as a guide.

The first £12,570 of your income from wages or pension, is tax free.
From £12,571 to £50,270 tax is payable at 20% and above that is 40%.

Any tax free amounts won't count towards those limits but the taxable element of any UFPLS payments, will.


*Scottish tax bands are different.

[sweepster70]

Thank you.