What is the best home for your long-term savings?
What is the best home for your long-term savings?
Pensions found themselves down the pecking order in terms of value and importance as, despite the clearly advantageous tax incentives, having to wait until age 55 and then being only able to access a relatively small lump sum as income was hardly appealing.
However, the pension’s landscape went through a tectonic movement, almost overnight on 19 March 2014, when the Chancellor delivered his Budget. The newly announced Pension Freedoms would allow pensioners to access their pension pots without restriction, once they reached age 55. Furthermore, death benefits for pensioners’ beneficiaries became more attractive than ever and created the potential for huge tax savings when passing assets over to the next generation. These changes have led to a radical reappraisal of the relative attractions of pensions compared to other long-term savings.
At a glance:
Savings Account | Unit Trust/OEICs | ISA | Pensions | |
Instant access? | Yes | Yes – although several days for funds to be sold | Yes – again, may be several days for any funds to be sold | Yes, from age 55 onwards in most cases – No access before age 55 unless due to severe ill health / or protected retirement age |
Limits | No maximum | No maximum | £15,240 p.a. (tax year 2015-16) | £3,600 gross or 100% of net relevant earnings (whichever is higher) subject to annual allowance |
Tax environment | Taxable at marginal rate of savings tax. £5,000 savings rate band available | Income /dividends subject to marginal rate of tax. Gains on funds assessable to Capital Gains Tax, but transactions within funds do not give rise to a Capital Gain | Tax free with effect from April 2016 (Dividend tax credits are non-reclaimable for tax year 2015-16) | Tax free with effect from April 2016 (Dividend tax credits are non-reclaimable for tax year 2015-16) |
Tax relief | None | None | None | 20% immediate relief available. Higher / additional rate taxpayers obtain further relief via self assessment |
Death Benefits | Potentially subject to Inheritance Tax | Potentially subject to Inheritance Tax | Potentially subject to Inheritance Tax | Tax free on lump sum death benefits paid before deceased’s 75th birthday. Subject to beneficiaries marginal rate of tax if deceased was over 75 at date of death |
The above table is not exhaustive; there are many other investment vehicles out there, some of which may be more suitable than a pension depending upon individual personal circumstances, but it is clear to see that pensions are unrivalled for many. However, the ‘next best’ choice for most are ISAs; they don’t offer the initial boost of an upfront top-up by the State as does a pension but returns on the investment are within a tax efficient environment. ISAs cannot stand-up to pensions when it comes to potential returns, thanks to pension’s tax relief.
Tax relief within a pension effectively provides the saver with an immediate 25% uplift in value**; an ISA or indeed any other investment could take years to get to the same value.
Some dissenters may still argue that a pension is not attractive as any income is potentially taxable, however, with 25% of a pension fund being available tax free and by carefully using any available tax allowances, income can be taken relatively tax efficiently. In addition, many pensioners are likely to pay lower rates of income tax than they did whilst working, so the percentage tax paid on the way out may well be less than tax relief on the way in.
This then begs the question, what should I do with my current savings? Well, there certainly is an argument for many to use exiting savings / ISAs / investment fund holdings etc. to fund a pension contribution – and before income tax relief is reduced for those subject to the higher rates which is on the cards. Remember, you can contribute up to 100% of earnings or £3,600 gross per annum, whichever is higher, subject to a maximum of £40,000 in a year. Savings will immediately benefit from the 25% uplift and invariably, you can access equivalent – if not the same – investments in a pension as you can in directly held portfolios or ISAs. More than ever, now is the perfect time to start reviewing your portfolios – and more importantly your pension.
*As of 6 October 2015
**25% uplift is referring to tax relief on personal pension contributions. Any individual making a pension contribution personally (within their appropriate limits) is entitled to 20% tax relief on that contribution. I.e. a person contributing £80 to a pension will get £20 tax relief put into the pension as well. £20 as a percentage of £80 is a 25% uplift. Example is for illustrative purposes only
Disclaimer
This article was previously published on Tilney prior to the launch of Evelyn Partners.
