Use your ISA or property as a pension

Saving for retirement is vital, but so many of us are turned off by the inflexibility and performance of pensions. What are the alternatives?

1. ISAs – Equities and Cash

If you’re not keen on saving into a pension, one method of saving for retirement is to save via your annual ISA allowance. We can currently stash £10,680 away each year, either investing the whole lot in a Shares ISA (up to £890 each month) or up to £5,340 of it in a Cash ISA.

As this limit is linked to the Consumer Price Index (CPI) (rounded to the nearest £120) it will rise to £11,280 (£940 per month) from April 2012, half of which can be saved as cash.

Cash ISAs

The money you save/invest in an ISA has already had income tax taken off, of course. But in the case of Cash ISAs, the interest earned is paid tax-free. ISAs do not even need to be declared on your tax return.

And the best bit is, your lump sum is yours to do with as you wish when you retire (or indeed any time) with no tax to pay.

Shares ISAs

Shares can certainly fall in value as well as rise, but history tells us that equities tend to do better than cash over the long term. If you have ten years or more until retirement, a Shares ISA could be a good choice for (at least some of) your retirement savings.

Potential Warren Buffetts can research and invest in shares in any company listed on any ‘recognised Stock Exchange’ and most UK funds via their Shares ISA.

If that seems like a lot of hard work, you can choose between unit trusts, investment trusts or Open Ended Investment Companies (OEIC) etc.

But for an easy life, we’re particularly fond of cheap index trackers, as with low annual charges, you keep more of what you make!

Tax benefits for higher-rate taxpayers

Unfortunately, even investing within a Shares ISA doesn’t spare us from paying 0.5% Stamp Duty on UK Shares.

And as basic rate taxpayers don’t pay income tax on dividends even outside an ISA, there isn’t any benefit there.

But, it does mean higher-rate taxpayers avoid paying additional tax on their dividends, which can be substantial. So, even if you’re a basic rate taxpayer at the moment, investing within a Shares ISA could save you some income tax (when you may be a higher-rate taxpayer) in the future.

Most importantly, ISAs offer protection from Capital Gains Tax (CGT) (the tax we must pay when selling anything that has increased in value). And although the current threshold is more than £10k, you may be looking at this level of gain in the future and appreciating your Shares ISA protection!

Unlike pensions, investing within a Shares ISA thus gives us full control over our money, as we can invest it where we choose, and access it whenever we like.

But equally, this could mean it’s vulnerable to temptation – could you trust yourself to leave it alone until retirement?

2. Property

Many of my friends regularly declare “My house is my pension”.

Buying a property (rather than renting) and paying off the mortgage during your working life can leave you with a home worth a considerable sum when retirement comes, which is very satisfying.

Certainly, seeing your retirement plan in the form of bricks and mortar, rather than money in a banker’s hands, or shares in the risky stock market, can be reassuring. And by and large, properties tend to increase in value over the long term (some seemingly exponentially!).

And property can produce a retirement income in a number of ways. You could downsize the home you currently live in when you retire (and live off the interest on the excess).

You could release equity by selling part of your home, obtaining an income while you’re living there. Or use any spare cash to buy another property or two now and rent them out, planning to either sell, or live off the rental income when you retire.

But relying on property to fund your retirement is not without its risk.

As we’ve seen in recent years, prices can drop (rather than rise) releasing far less equity than expected. Downsizing may not free up very much cash as you hoped. Rental properties could be tenant-less for long periods and maintenance can take a lot of work (and money).

And of course, as a property is yours to do as you wish, could you resist the temptation to sell up and buy that sports car/take that round-the-world cruise?

So there you have it, a few ideas to help you decide where to save for retirement.

My advice? Don’t plump for any one method but try and spread your risk amongst two or more if at all possible.

Who knows what the future will bring – but if there is a housing blip when your retirement comes, or a dip in the stockmarket, if you’ve spread your cash you might just have the means to ride it out.

But whichever method(s) you choose, just remember, the sooner you start, the better!

Happy saving!

More: 7 Top Cash ISAs and 5 Top Shares ISAs | New crisis hits the housing market