A one year investment track record is rarely long enough to establish how consistent a fund manager is. Three years is an improvement, but five years is far better.

Here we look at twelve of the most popular IMA investment sectors and reveal the top performing fund over the past five years. The results are a combination of popular funds that are widely available on the main investment platforms and more obscure choices that investors would struggle to access.

Here are the 12 sector topping funds from the past five years.

Sterling Corporate Bond – M&G Strategic Corporate Bond

Managed by Richard Woolnough, who joined the M&G retail fixed interest team in January 2004, M&G Strategic Corporate Bond fund aims to maximise total return (the combination of income and growth of capital). Over the past five years, the fund has returned 40.65% compared to a sector average of 11.14%.

Active Managed – Neptune Global Alpha

This fund aims generate a positive total return, from investment predominantly in equities and bonds. It has certainly acheived that investment objective over the past five years, with returns of 91.14% compared to a sector average of 34.16%. Neptune Global Alpha is managed by the award-winning Robin Geffen who has over 30 years’ investment experience.

Asia Pacific Excluding Japan – Fidelity South East Asia

This fund aims to achieve long term capital growth from a portfolio made up of the shares of companies throughout the Pacific Basin, but excluding Japan, with a bias towards larger companies. It is managed by Allan Liu, who took control of this fund in July 2003. Fidelity South East Asia has returned 188.89% over the past five years, compared to a sector average return of 119.06%.

Balanced Managed – CF Ruffer European

Whilst not a household name fund, CF Ruffer European has managed to deliver a return of 129.32% to investors over the past five years, compared to a sector average of 30.86%. Sitting perhaps unfairly in the Balanced Managed sector, this fund invests in a diversified portfolio of pan-European equities, although it may also invest in fixed interest securities.

Cautious Managed – CF Ruffer Total Return

Another appearance from CF Ruffer, with their Total Return fund which aims to achieve low volatility, positive returns from an actively managed portfolio of different asset classes, including equities, bonds and currencies. Managed by David Ballance and Steve Russell, this fund has returned 66.20% over the past five years, compared to a sector average of 19.85%.

Europe Excluding UK – Neptune European Opportunities

This fund aims to generate capital growth by investing predominantly in a concentrated portfolio of securities selected from European markets, excluding the UK. Over the past five years, Neptune European Opportunities has returned 108.84% compared to a sector average of 51.90%.

Global Emerging Markets – Baillie Gifford Emerging Markets Growth

Managed by Richard Sneller and William Sutcliffe, over the past five years this fund has returned 187.45% compared to a sector average of 137.61%. The fund aims to maximise the total return through investment, whether direct or indirect, primarily in emerging markets worldwide and in any economic sectors of such markets.

Japan – Neptune Japan Opportunities Retail

Chris Taylor has managed this fund since joining Neptune in June 2004 as Head of Research, with 28 years’ investment experience. The fund aims to generate consistent capital growth by investing predominantly in a concentrated portfolio of Japanese securities. It has returned 115.59% over the past five years, compared with a sector average of just 7.92%.

North America – Neptune US Opportunities

This fund has been managed by Felix Wintle for six years, and over the past five years it has returned 83.84% compared to a sector average of 21.08%. Neptune US Opportunities aims to generate capital growth by investing predominantly in a concentrated portfolio of Northern American securities which may include Canada as well as the US.

Property – SWIP Property Trust

The SWIP Property Trust aims to provide investors with a total return consistent with a balanced commercial property portfolio. Managed by Gerry Ferguson for just over five years, this fund has just about acheived a positive return with performance of 0.14% over the past five years, compared to a sector average of -1.74%.

UK All Companies – Rensburg UK Mid Cap Growth Trust

This fund aims to achieve capital growth from medium sized UK companies, specifically to exceed the capital growth achieved by the FTSE 250 Index. Over the past five years (to 1st December 2009) this fund has returned 92.90% compared to a sector average of 28.48%. The fund is managed by Paul Spencer who joined the Rensburg team in March 2006 from TD Waterhouse where he was Head of Research.

UK Equity Income – Schroder UTL Income

Whilst Neil Woodford is the big name in this IMA sector, it is Ian Lance and Nick Purves from Schroder who have the best track record over the past five years. Their fund, which aims to provide a growing income, predominantly from investment in UK equities, has returned 51.16% over the past five years, compared to a sector average return of 24.32%.

Past performance is not necessarily a guide to future investment returns. The value of these funds may go down as well as up. Performance figures are correct as at 15th January 2010 unless stated otherwise. Sources: Financial Express and Morningstar.

“In this world, nothing”, said Benjamin Franklin, “can be said to be certain except death and taxes”.

Everything else is uncertain, and therefore involves an element of risk. However, risk means different things to different people.

From the individual investor’s perspective, it can refer to the extent to which your capital might be at risk if you make an investment, or alternatively it could mean the opportunity cost of you choosing one investment over another.

Fund management companies use a range of different and frequently obscure measures to show risk within each fund that they manage. At Barings, we believe it is down to us as product providers to explain technical terms clearly for financial advisers and investors.

We don’t always get this right but, with this in mind, I would like to go through some of the most widely quoted measures of risk you might come across when looking at the performance of individual investment funds, and try to de-mystify some terminology.

Alpha

One of the most commonly used terms, but probably one of the worst examples of jargon, is “alpha”, sometimes represented by the Greek letter “α”.

The term alpha comes from the hedge fund world, and simply means the degree to which a fund has outperformed or underperformed the benchmark it is trying to outperform. This is usually taken to be a very simple measure of the skill of the investment manager, although this is not necessarily the case. While a high alpha figure should be a positive sign, it should be treated with some caution. The fund manager may be taking a lot of risk to achieve such high returns.

Alpha can also be used in the sense that it describes the potential rewards available to a manager with skill in a particular market. Where a market is thought to be highly efficient, there may be less potential for investment managers to deliver “alpha”. The US equity market, for example, is a notoriously difficult one for active managers to beat.

Beta

In the same vein, “beta”, or the Greek letter “β”, is commonly used to show the portion of the fund return which is attributable to the market. For example, if a fund delivers 8% to investors, and the market has risen by 5%, then the alpha would be 3% and the beta could be said to be 5%.

“Beta” is also used in a second sense however, and that is how the volatility – or the pattern of performance – of the fund compares with the underlying market index.

If the returns from a fund twist and turn with the returns from the stock market, it would be said to have a beta of 1.0. It would be precisely as volatile as the market in which it invests.

If, on the other hand, the amplitude of returns was higher, and the fund tended to deliver stronger or weaker performance on a regular basis, the beta would be higher. Lower but more steady returns would mean a beta of less than one and the fund could be said to have relatively “defensive” characteristics, or at least when compared with the market it was investing in.

Tracking error

Tracking error is another term which gained currency in the 1980s and 1990s. This shows the “standard deviation” (yet more jargon I’m afraid for the non-mathematicians) of the returns between the fund and the market index over a particular period.

Standard deviation measures the degree to which returns tend to be clustered together around the average or the extent to which they are widely dispersed.

Tracking error is typically calculated to one standard deviation. This means that 67% of the time the difference between the return of the fund and the return of the benchmark index will be no greater than the tracking error.

Information ratio

Finally, another very commonly used measure of risk is the information ratio. This is an attempt to gauge the skill of the investment manager in a slightly more scientific way than simply looking at the alpha.

Calculating it isn’t difficult though. It simply involves taking the annualised relative return for the fund – the outperformance or the underperformance relative to the benchmark index – and dividing this by the tracking error.

The end figure shows how much “value” has been added by the investment manager for the risk taken. Looking at all of these various measures, the information ratio is probably the only one, where more is almost always better. All of the others simply help to provide more information about the way the fund is run.

If you are considering investing, and you discuss it with a financial adviser, you will soon see how hard they work to establish your individual attitude to risk. At the same time, it is reassuring to note that they are likely to have thoroughly researched and evaluated the individual risk metrics of a host of investment funds before recommending any products to you.

Ian Pascal is Marketing Director at Baring Asset Management in London. Ian is responsible for all marketing communications including promotion of mutual funds, alternative investments and private clients.

Reviewing your investment portfolio on a regular, at least annual, basis is essential.

In the current economic climate it becomes even more important to conduct a regular and thorough review of your holdings. This needs to be done in the wider context of your overall financial planning, as a stand-alone review of funds can often neglect other considerations.

Here are the five main areas to consider the next time you review your investment portfolio. The same factors apply equally to a review of your pension portfolio.

1 – How much risk are you taking with your money?

When you are investing money, you need to take risk in order to stand a chance of receiving a reward. This is a fundamental principle of investing money. Of course the degree of risk you take is down to you. Any investment portfolio can be structured to have a very cautious or very adventurous risk profile, or anywhere in-between.

When we engage with new clients and review their existing investment portfolios, we often find a complete mismatch between the amount of risk they are taking with their money and their personal investment risk profile. Sadly it is often the case that they are taking much more risk than they should be taking.

Understanding the investment risk profile of a portfolio is not simple and may require the services of a professional adviser. However, you can get a reasonable feel for how much risk you are taking by understanding the proportion of your portfolio held in safer assets such as cash or fixed interest compared to more risky assets such as equities or property.

2 – What is your long-term asset allocation strategy?

Every investment decision you make is an asset allocation decision. There are four main asset classes available to any investor – cash, fixed interest, equities and property. The amount you allocate to each of these asset classes will have the biggest impact on the long-term returns generated by your investment portfolio.

Many investors make their investment decisions at fund or stock level, without consciously thinking about an asset allocation strategy. This can be costly because returns from fund or stock selection tend to account for only tiny proportion of overall investment portfolio returns. It is getting your asset allocation right that makes the biggest difference between success and failure.

There is another very good reason for having a long-term asset allocation strategy. When markets are turbulent, as they have been recently, having a documented asset allocation strategy will enable you to remove some of the emotion from your investment decisions. It allows you to make logical moves that are not dictated by what the markets are doing at that particular time.

3 – Which fund managers should you sack and replace?

Whilst asset allocation is the most important factor, we believe it is also possible to add value through a process driven selection of fund managers.

When you review your investment portfolio to decide on the ongoing suitability of individual funds, you need to consider more than past performance. There might be good reason why a particular fund has delivered the returns it has over the past year. Looking beyond past performance figures is an essential step in reviewing your portfolio because this should prevent you from switching out of funds at the wrong time.

However, if a fund is consistently underperforming compared to alternative options, do not be afraid to sack and replace it. Most modern fund supermarket platforms make very modest charges for switching between funds. A switching charge of 0.25% of the amount switched is typical, and time out of the market whilst the switch is taking place is minimal. Within many pension and Investment Bond policies there are no charges for switching between funds.

Of course you always need to think about the tax consequences of a fund switch. Also, avoiding poor performance as a reason to switch out of funds means not using good past performance as a reason to switch into funds! Consider a whole variety of quantitative and qualitative factors including risk-adjusted returns, volatility and charges.

Five questions to ask before you invest in a fund

4 – Where are the charges going?

It costs money to invest your money. There are typically two types of fund management charges – an initial charge when you invest the money and then an annual management charge deducted each year. Some funds also have an exit charge for when you sell your holdings.

In the case of both initial and annual charges, these are often partially charged to pay commissions to a financial adviser. A typical charging structure for a collective investment fund might be a 4% initial charge and a 1.5% annual management charge. Of these, 3% commission might be paid to the financial adviser when you make the investment and then 0.5% commission is paid each and every year.

Sadly, in some instances investors continue to pay higher charges without getting a defined ongoing service from the financial adviser who recommended the investment.

Take a careful look at the charges you are paying on your investment and understand where the money is going. If you are not getting a good level of ongoing service from your financial adviser but you are continuing to pay them out of fund management charges, sack them and replace them with an adviser who will deliver good service.

5 – How should you measure future performance?

In a rising market, there is a fair chance that your fund might also go up in value. When investment markets fall, funds are likely to fall as well. The measure of success or failure in either of these situations tends to be the success of your fund relative to the performance of a given market or sector. This ‘relative’ performance differences from ‘absolute’ performance as it also includes situations where your investment loses money.

What is important is to establish a benchmark to measure the success of your investment portfolio in the future. Your benchmark might be ‘absolute’ (such as a 5% return each year, or a certain percentage above the interest rate available from cash) or ‘relative’ (such as the average of a particular investment sector or market index).

Having a benchmark in place allows you to carry out a meaningful review of your investment portfolio rather than simply looking at a performance figure in isolation. Set your benchmark at the outset when you invest money and then use it each and every year to track the success (or otherwise) of your investment strategy.

Martin Bamford is site editor of BrilliantWithMoney and a Chartered Financial Planner at Informed Choice.

Each ‘focus on’ examines the objective of the fund, an analysis of recent performance, the manager, charges and other factors.

Within this ‘focus on’ we take a closer look at the Caznove European fund. This fund sits within the European Equities asset class.

Fund objective

This fund aims to achieve long-term capital growth by investing in any or all European markets, excluding the UK. It aims to maximise the overall rate of return with capital growth as the primary goal.

The Authorised Corporate Director (ACD) of this fund seeks to invest in a diversified list of companies. The manager looks for industry groups demonstrating above average growth prospects; factors such as strong financial characteristics and proven management are emphasised.

This fund has a flexible country allocation strategy which delivers additional diversification.

Track record

This is a first quartile fund over one, three and five years. For the year to date it has returned 15.79% compared to a sector average return of 10.17%. This places it 23rd out of 196 funds in the sector.

This fund has a strong and consistent long-term performance record, with first or second quartile performance in every discrete annual period since 2004.

The managers

This fund is managed by Chris Rice and Steve Cordell. Rice is the head of Cazenove’s European team and Cordell is their pan-European fund manager. They previously worked together at HSBC.

Rice has been with Cazenove since 2002 and has been running this fund since joining them. He has seventeen years fund management experience, previously running the HSBC European Growth fund between 1999 and 2002.

The management partnership of Rice and Cordell is supported by two dedicated European analysts; Lionel Rayon and Morten Herholdt. This small team has substantial combined experience which should reassure prospective investors.

Style

This fund takes a top-down approach, making use of business cycle analysis to weight the fund towards their favoured stocks which demonstrate the right style characteristics. Their stock selection process focuses on growth and valuations. The managers claim to control risk tightly by the consistent application of this process.

Charges

The fund has a 5.00% initial charge and a 1.5% annual management charge, with a total expense ratio (TER) of 1.65%.

Conclusion

Europe is an incredibly diverse investment arena, particularly in the current economic environment, with some of more established economies having to support the weaker nations within a single currency infrastructure. The use of an actively managed fund with discretion about country allocation is vital when it comes to investing in Europe. Cazenove European is one of the strongest and most consistent performers in this sometimes difficult investment sector.

Martin Bamford is site editor of BrilliantWithMoney and a Chartered Financial Planner at Informed Choice.

The small but important print: This article was produced for information only and should not be considered a recommendation to buy, sell or hold a particular investment fund. Seek advice from a professional independent financial adviser before making a decision. The performance data in this article was provided by Financial Express and was correct as at 28th September 2009.

Each ‘focus on’ examines the objective of the fund, an analysis of recent performance, the manager, charges and other factors.

Within this ‘focus on’ we take a closer look at the Neptune US Opportunities fund. This fund sits within the US Equities asset class.

Fund objective

This fund aims to generate capital growth by investing predominantly in a concentrated portfolio of Northern American securities which may include Canada as well as the US. The fund aims to achieve top quartile performance within the appropriate peer group.

Track record

This is a first quartile fund over one, three and five years. For the year to date it has returned 22.25% compared to a sector average return of -0.20%. This places it 2nd out of 171 funds in the sector.

This fund has a strong and consistent long-term performance record, with above top sector performance in every discrete annual period since 2004.

The managers

This fund is managed by Felix Wintle.

Wintle has been running the fund for nearly six years. He joined Neptune Investment Management in January 2004. Prior to working at Neptune, he was employed by City Financial Asset Management. He became head of US equities in 2006 and subsequently became investment director in 2008.

In addition to the US Opportunities fund, Wintle also manages the Neptune Latin America fund. He is a graduate of Durham University and became a fund manager in 2003.

Style

This is an actively managed US equity fund and the manager employs a flexible investment style. The proprietary sector based research process at Neptune is used by the manager to build an unconstrained fund of his best ideas. The manager has been described by OBSR, an independent fund ratings agency, as ‘nimble’ in his approach as he seeks to outperform throughout the economic cycle.

Charges

The fund has a 5.00% initial charge and a 1.6% annual management charge, with a total expense ratio (TER) of 1.61%.

Conclusion

It is notoriously challenging to find a consistently outperforming actively managed fund in the efficient US equities market. Neptune US Opportunities manages to achieve this consistent first quartile performance by combining a flexible investment mandate with the strength of the research capability at Neptune Investment Management.

Martin Bamford is site editor of BrilliantWithMoney and a Chartered Financial Planner at Informed Choice.

The small but important print: This article was produced for information only and should not be considered a recommendation to buy, sell or hold a particular investment fund. Seek advice from a professional independent financial adviser before making a decision. The performance data in this article was provided by Financial Express and was correct as at 23rd September 2009.

There are over 3,000 investment funds and more than 230 fund management groups based in the UK alone. These range from household names to little known boutiques offering specialist expertise in a niche investment area.

Assuming you are planning to do more than simply pick the top-performing fund from last year (a mistake many investors continue to make) there are five important questions you should ask before investing in a fund. Here they are.

1 – Where does this fund invest my money?

Different funds invest money in different areas. Some invest in a single asset class or investment sector. Others invest across a range of asset classes, so-called multi-asset funds.

By understanding where your money is being invested, you should be able to work out how much risk you are taking with your money and also how the fund you are considering fits in with your overall investment or pension portfolio.

A good guide to where a particular fund is investing is the IMA Sector in which it sits. The IMA (Investment Management Association) is the trade body for the UK asset management industry. They allocate every fund in the UK to a specific sector based on the objectives and holdings of that fund. Examples of these sectors include Sterling Corporate Bond and UK Equity Income.

When you look up the fact sheet for a fund, it should be very clear about where the fund invests. This usually forms part of the objective statement for the fund. It might cover a much wider range of investment types or areas than the fund manager will typically use, which means they are able to invest there but might not always do so. Increasingly fund managers want the flexibility to move money around depending on market or economic conditions. Depending on how much control you want over where your money is actually invested, this might be a positive or a negative factor.

2 – What are the charges?

Never invest in a fund until you understand exactly what you are paying and who you are paying for the privilege. Investment funds typically come with two different charges – an initial charge and an annual management charge, the AMC.

The initial charge is the up front cost of investing in a fund. It can range from 2-6% and often includes an element of commission for the adviser recommending the fund. If you are investing without advice (on an ‘execution only’ basis) then you should ensure the initial charge is heavily discounted.

A form of initial charge is the bid/offer spread. This is the difference between the buying and selling price of units, and can be as much as 5%. This is one to watch out for, particularly on funds where there is no explicit initial charge or the initial charge has been discounted for some reason.

The annual management charge (AMC) is the amount deducted from the value of your investment each year and paid to the fund management group for managing your money.

Once again, this charge can often include an element of commission for the adviser or salesman selling you the fund, so look for a discount if you are investing directly. AMCs vary from 0.3% to 2.5% per year, and once they reach around 1.5% typically pay around 0.5% out as commission; sometimes more, sometimes less.

A more accurate measure of how much you are actually paying each year for fund management is the Total Expense Ratio (TER). This includes the cost of other expenses paid for by the fund, in addition to the AMC. Funds are not obliged to publish this figure, and not all choose to do so, but where they do it should give you a better idea of the real cost of the fund.

Some funds have a performance-related fee in addition to the AMC. This concept came from the world of hedge fund management and it not yet very common for mainstream investment funds. A typical performance-related fee might be 20% of the fund gain above a set benchmark. I’m personally not a big fan of these, particularly where the benchmark used is modest, but also because they might encourage fund managers to take greater risks with your money. They also tend not to penalise fund managers for failure; they still get paid the AMC if the fund performs poorly.

Another cost to look for is an exit charge. These are more common on institutional share classes where there is no entry cost to invest in the fund but a fee is charged when you leave.

3 – How consistent has the performance been?

Past performance is not usually a very good measure of how well a fund might perform in the future. The risk warning you will always see when investing about past performance not being a good guide to the future is there for a good reason. In fact, there is well documented academic research that shows a fund which performed well in one year is likely to do poorly the following year. Investors who chase performance are usually on to a losing strategy.

A much better measure of a fund is consistency of performance.

If a fund manager has been posting similar results, relevant to the sector, for three, five or ten years then there is a chance they will be able to repeat this consistency in the future. Of course it is not guaranteed that they will continue to do well, but a fund manager who has delivered consistent performs in the past has at least demonstrated their ability.

4 – How large is this fund?

Size isn’t everything, but when you are selecting suitable investment funds, size is one factor you might want to consider.

Investment funds vary in size from the very small (maybe only a few million) to the gigantic (several billion pounds of assets under management). Filtering out the extremes of fund size can make real sense.

If an investment fund is small this should tell you one of two things. Firstly, it has not managed to attract much money from other investors. Are other investors avoiding the fund for a good reason or is it really the best kept secret in the world of investment management?

Secondly, will the fund management group keep the fund open for the long term? Small investment funds tend to be those that get ditched by fund management groups or at least merged with others to create bigger funds.

Big funds, which have attracted many investors, face other problems. Once an investment fund gets to a certain size (say, £1bn) the fund manager might start facing some difficulties.

A really big investment fund can be more challenging to manage as investing the money in the best ideas can move individual share prices. As a result, the fund manager might not be able to invest the fund assets exactly as they might like. Getting large amounts of money out of investments that have gone wrong could be equally as challenging.

5 – Who is managing my money?

This is not always as clear as it seems. A key distinction is between a fund run by a fund manager and one run by a whole team at the fund management group. Both ’star manager’ and team-based approaches to managing funds have their attractions, but it is important you know who is ultimately responsible for making the decisions about where your money is invested.

Knowing who is managing your money should allow you to look at their background in more detail. If they have a relatively short track record at the helm of their current fund (say, less than five years) then you should take a look at the experience of their previous fund. You can even look at fund manager (rather than fund) performance on the Citywire website.

Some funds are promoted by one fund management group but the actual management of the money is outsourced to another group or manager. This is more common when the fund is investing in overseas equities, where local management of the money can really pay dividends. What this approach might mean is a household name promoting the fund but a tiny boutique actually managing the investments on a day-to-day basis.

Martin Bamford is site editor of BrilliantWithMoney and a Chartered Financial Planner at Informed Choice.

Higher earners saw their ability to get full income tax relief on pension contributions attacked in the 2009 Budget. New ‘anti-forestalling’ measures were introduced which restrict the level of higher rate income tax relief on offer for some investors. In simple terms, people earning over £150,000 in this or either of the previous two tax years face tax relief limits on pension contributions over £20,000 (or slightly higher in certain circumstances).

This year also sees the ISA contribution allowance increased from £7,200 to £10,200. The new limit comes into force from 6th October 2009 for investors who have reached their 50th birthday ahead of 6th April 2010. For the rest of us the ISA allowance goes up to £10,200 from the start of the 2010/11 tax year.

Pensions and ISAs have some different features, particularly when it comes to the tax treatment of contributions and eventual benefits. Deciding on what works best as a tool for your retirement planning depends on your personal circumstances, goals and objectives.

Here is a quick guide to some of the main features to consider. Let battle commence.

Tax relief on contributions

A key difference between pensions and ISAs is the tax relief each receive on the contributions. Whilst contributions to a UK registered pension scheme are usually eligible for income tax relief, investments into an ISA do not get these generous tax breaks.

Assuming you have sufficient earnings to justify the contribution (more on that later), your pension contributions should result in income tax relief at your highest rate of income tax, with a minimum of basic rate income tax relief added. This means that non-taxpayers and basic rate taxpayers get 20% tax relief added directly to their pension fund. Higher rate taxpayers are then able to reclaim the difference between basic and higher rate income tax (currently an additional 20%) as additional tax relief.

This income tax relief on pension contributions gives the pension route to retirement planning a big head start. It means that a pension investor can afford to take more risk with their money, as a 20% or 40% short-term fall in fund values would simply take them back to the starting point equivalent to an ISA investment. Of course these tax breaks on contributions come at a price.

Contribution limits

With pensions, you can contribute up to 100% of your earnings in a given tax year and receive income tax relief on the whole lot. This is subject to a couple of restrictions.

There is an annual allowance which limits the maximum pension contribution you can make in a tax year. This is £245,000 for the 2009/10 tax year, so unlikely to bother the vast majority of investors.

Since the 2009 Budget there has also been a special annual allowance which applies to pension contributions made by ‘high earners’; people with ‘relevant earnings’ of more than £150,000 in this or either of the previous two tax years. This is a basic allowance of £20,000 or an enhanced allowance of up to £30,000 where previous pension contribution levels can justify this higher amount.

Investors with no income can still contribute up to £3,600 each year into a pension and receive basic rate income tax relief. Remember that these figures are all ‘gross’ contributions after the addition of basic rate income tax relief.

The investment limit for ISA investors is currently £7,200. This is set to rise to £10,200 each tax year from 6th April 2010, or from 6th October 2009 for people who are 50 or older by the end of the 2009/10 tax year.

Of this ISA allowance, up to half (so £3,600 or £5,100) can go into the cash ISA component, with the balance available to invest in the stocks & shares ISA component. You can choose how much of the overall ISA allowance (up to half) to invest in cash.

Tax treatment of the fund

This is one area where pensions and ISAs are broadly neutral.

The money invested within a pension fund or an ISA fund is generally free of income tax and capital gains tax. The one exception to this is the dividend income from UK company shares. This dividend income comes with a 10% tax credit (which means it has already been taxed). You cannot reclaim this tax credit within the pension or ISA.

A difference in tax treatment of the funds does exist when it comes to inheritance tax (IHT). In the event of your death before taking retirement benefits, a pension fund is generally free from inheritance tax at 40% because it can remain outside of your estate for tax purposes.

The ISA tax wrapper ends automatically on death and the assets are included within your estate for IHT purposes. This means that if your total assets exceed the nil rate band (£325,000 for the 2009/10 tax year) then the balance is subject to tax. Married couples can effectively double this nil-rate band on the second death, if the first spouse to die does not utilise their own nil-rate band.

Range of funds

This is another area where pensions and ISAs are broadly similar, although much will depend on the particular product you select. Some pension plans, including many Stakeholder pensions, will offer only a limited range of investment funds from which to choose. Personal pensions now increasingly offer access to a wider range of funds from third-party external fund managers.

The widest range of pension investment options comes from using a Self Invested Personal Pension (SIPP). These enable to you access any investment permitted by HM Revenue & Customs rules, although some pension providers impose additional restrictions on investment choice.

With an ISA, the main choice in ‘product’ is between an ISA from an individual fund manager or an ISA from a fund supermarket. The former might only offer funds from that single fund manager whilst the fund supermarket will offer access to investment funds from a wide range of fund managers. Self Invested ISA products are also available, offering similar investment choice to a SIPP.

Access to the money

Actually getting your hands on your money again is an area where pensions differ quite a bit from ISAs.

Starting with ISAs, there are effectively no rules or restrictions to prevent you from accessing your money once invested. When you take money out of an ISA, you cannot replace it without using up whatever remains of your ISA allowance for that tax year. There might also be planning considerations when it comes to removing money from ISA funds if investment values have fallen.

Pensions come with a number of restrictions in terms of accessing benefits. Firstly, there is an age restriction. At present this is a minimum age of 50. From 6th April 2010 the minimum age at which you can access pension benefits goes up to age 55.

Secondly, there are rules about how much of your pension fund you can access as cash and how much of the fund has to be used to provide an income in retirement. Generally the rules enable to you take up to 25% of the pension fund value as a cash lump sum with the balance reserved for the generation of income.

Some older pension plans offer the possibility of taking more than 25% of the fund as cash, reducing the amount left over to provide an income. This is worth checking, particularly if you are thinking of moving your pension fund to a new provider when your entitlement to greater than 25% cash benefits could be lost on transfer.

Tax treatment of benefits

Capital withdrawals or income generated from an ISA are largely free of tax. With a pension, the cash entitlement is tax-free but the income generated by the remaining pension fund is subject to income tax.

Some people, when they start to take retirement benefits, use their tax-free cash (more accurately described as a pension commencement lump sum) as ‘income’; gradually phasing the taking of pension benefits to produce tax-free ‘income’ for the first few years of their retirement. This can be a particularly helpful strategy if there is no immediate need for a cash lump sum or if you are gradually phasing in your retirement and have other sources of taxable income.

Summary

Pensions and ISAs are two very different tax-wrappers used for retirement planning, but they do share some similarities. It is rarely a case of one being ‘better’ than the other.

Often people planning for their income requirements in retirement will use a combination of pensions and ISAs to create a total retirement fund that has the right balance of tax breaks (but access restrictions) and easy access.

Martin Bamford is a Chartered Financial Planner at Informed Choice and site editor of BrilliantWithMoney.