Taxation should always be a secondary consideration to investment and your personal appetite for risk. Whilst this is a core principle for most independent advisers we should all have a realisation of the longer-term effects of any particular savings strategy we plan today.
The world of pensions is going through yet more changes in the coming years, with the gradual roll-out of work place pensions in the form of the new “Nest” scheme. Through time we will all see an ever increasing state retirement age, with the likelihood that the extra funding period as a consequence of working longer should provide a higher level of retirement income in the future, all of which will provide a welcome and increasing tax take for the exchequer.
It should surprise no-one that the smart money has recognised ISAs as the cornerstone of their wealth creation plans. With maximum annual subscription limits of £11,280, of which £5,640 can be held in cash, the funding limits are more generous than they have ever been. Pensions, on the other hand, have mostly had a negative press, be it for over-charging, perceived poor returns, endless debates on gold-plated public sector schemes, not forgetting the increasing retirement age. It’s no wonder there is a natural aversion to funding pensions?
The dilemma of where to invest hard-earned disposable income would in the current climate point to ISAs as the answer, but careful thought on the eventual outcome in retirement income terms would suggest a strong case for both ISAs and pensions. For example, if you were retiring tomorrow with savings value of £200,000 from which you wish to draw down retirement income, the ISA would provide this income entirely free from tax. The same value held in a pension fund, leaving aside tax free cash, would provide £10,000 per annum gross, assuming the same 5 per cent yield. The difference, of course, is that pension income is taxable. For basic rate taxpayers this means £8,000 of spendable income rather than the more generous ISA income.
On the face of it, ISAs look like a much better deal, but what is often missed is the significant tax relief on contributions to pensions – where else will you receive a minimum of a 20 per cent uplift on contributions due simply to tax relief at source, in addition to having access to 25 per cent of the value of the fund tax-free, when you retire.
That looks like it takes some beating, until you realise that you benefit only once from tax relief on contributions – the income you eventually secure from your pension pot will be taxed every year in retirement once you use up your personal allowance.
The real benefits of forward planning, particularly if you wish to maximise tax-efficient retirement income, is to consider your personal allowance. This is particularly true for married couples where, on many occasions, taxable income for one of the partners is insufficient to use up both allowances, which cannot be transferred to the partner. So it makes a great deal of sense to ensure you have sufficient taxable income in retirement to use up these valuable allowances.
An adequate level of income in retirement should not be viewed simply in pension terms – for most, retirement income comes from a number of sources. It seems to make sense, therefore, to shelter more income from tax when the time comes, which can be achieved with a little bit of forward planning. The old adage that it’s “worth more than the sum of its parts” has never been more relevant.
Alex MacLean is managing director
of Aspire Wealth Management
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