I have written several articles about Pensions following the dramatic changes Pensions Freedoms have made. To recap personal pensions are now much more simple, and very flexible long-term savings accounts. The only limitation for most is that they can’t currently be accessed until age 55, but if you could access it earlier you might end up with no pension!
Tax relief is given on contributions at your marginal rate of tax, for high earners this is simply too attractive to miss, and for basic rate taxpayers, there are still long-term advantages. Pension funds accumulate free of capital gains or income tax, 25% of the total fund can be accessed tax-free, the balance is taxed as income when you draw it, but most should be earning less in retirement so the income tax due on it should be less than the tax reliefs given. In addition, pensions are normally free of inheritance tax. If you run your own business and your business pays your pension contribution this is normally all set off against corporation tax as well, so you can extract money from your business into your own pension account free of corporation tax, income tax and national insurance. If you are happy to tie the money up to age 55 it really is a ’no-brainer’ mathematically.
Remember that after 55 (57 after 2028) you can access as much of your pension as you wish and when you wish. You can use the 25% tax-free part as ‘income’ and draw it down without any tax until it is exhausted, and you could draw up to your income tax allowance from the taxed part of the pension if you don’t exceed the allowance this will also be free of income tax. Pensions now really are just too good to miss out on, especially if you are a higher rate or additional rate taxpayer.
There is some confusion in the savings market, however, as a Lifetime ISA broadly replicates a pension for basic rate taxpayers. There is no tax relief on contributions, but the entire fund can be withdrawn without income tax and you can access them earlier than a pension. They are subject to certain limitations, but they do make sense as a form of long-term savings.
However, things may be about to change. The Government are looking to raise more money and are unlikely to want to borrow further. As economic growth is somewhat slow at the moment it is almost certain they will raise it from taxation but will want to limit direct tax increases so tax-preferred savings may well be in for a change. In fact, the Treasury Committee has very recently suggested simplifying the savings market by scrapping Lifetime ISA’s and limiting the attractiveness of personal pensions as they spend £billions on tax reliefs, mainly for higher earners.
At the moment you can pay up to £40,000 a year into your pension if all your earnings total less than £150,000 per year and get tax relief at your marginal rates. The Treasury Committee are also proposing to reduce the £40,000 and to have a flat rate of income tax relief, (maybe 25%?).
This will be fairer to lower earners as they will have an increase in tax relief and should encourage more to save, yet 25% tax relief is still attractive enough for higher earners to want to continue saving for later life, albeit with less available allowance if the £40,000 is reduced.
Currently, if you have not used your full pension allowance you can claim it back for three previous years, so potentially you could pay £160,000 in this year if you have made no pension funding. This facility could also be reined in by either limiting the years or limiting the carry forward amount to whatever the new reduced annual limit may become. Or by scrapping it all together!
This proposal, or similar have been kicked around for some while now and look increasingly likely, as they are getting more support within the Government.
So if you have any spare cash to invest to age 55, especially if you run your own business and are sitting on more cash than you need to trade and are limiting your drawings to reduce income tax, now may be an opportunity to extract money from your business more tax efficiently than any other method. Don’t wait until the Autumn statement if this is the case, seek advice or this massive tax saving opportunity may well be lost.
Martin Lamb – Joseph Lamb