Posted on Thursday 25th February 2016
With the tempo of pension reform likely to increase, there will be new traps to avoid, but five retirement planning fundamentals remain.
It’s almost a year since the biggest shake-up in UK pensions in a generation greatly increased flexibility over when – and how – benefits can be taken. Yet at a time when the new freedoms are still bedding in, further radical change could be just around the corner.
Reforms to pension tax relief could be enacted as soon as March, and the new tax year will see increased restrictions on wealthier investors wanting to save into a pension.
Against this constantly shifting backdrop, financial advice will be the key to making informed choices. The following five ideas could be a good place to start for those who want to better understand the opportunities and traps in 2016.
1. Take advantage of tax relief whilst doubt remains over its future
Experts believe that tax relief for higher and additional rate taxpayers will be cut in an effort to tilt pension system benefits more towards basic rate taxpayers.
Pension tax relief means that, for every £1,000 paid into a pension, a basic rate taxpayer has to contribute £800, a higher rate taxpayer only needs to pay £600, and an additional rate taxpayer just £550. At a time when the Chancellor needs to make deeper cuts to public spending and to improve lower earners’ incentive to save, pension tax relief is a natural target for reform.
If reports prove correct, the Chancellor could be about to break the link between tax relief and marginal rates of Income Tax by introducing one flat rate of pension tax relief, instead of the tiered system in use today. The flat rate could be anywhere between 20% and 33% but, crucially, it could be put in place immediately after an announcement is made in the Budget on 16 March.
Higher and additional rate taxpayers, who can get up to 40% or 45% tax relief returned to their pension pot, may want to take the opportunity to accelerate pension saving while the existing – some would say ‘generous’ – system remains.
2. Use your available ‘annual allowance’ if you can
You can get tax relief on up to £40,000 of pension contributions made from earnings each year – this is the ‘annual allowance’ – but you could swell your pension pot significantly using the ‘carry forward’ rule. Can some smart financial planning help you maximise tax relief ahead of potential reforms?
The amount you can currently invest into a pension each year with tax relief is capped at £40,000. But if you have more cash designated for retirement, unused allowance from the three previous tax years can be carried forward and allocated to the present tax year.
By using the carry forward rule, you could add up to £180,000 to your pension this tax year and receive up to £81,000 in tax relief. That is good news if you have the necessary earnings to make such large contributions but, thankfully, smaller sums will benefit too.
From 6 April 2016, additional restrictions will come into effect which mean that those earning more than £110,000 a year could see their annual allowance tapered down from £40,000 to £10,000. For those at the top of the scale, the lost tax relief could amount to £13,500 a year.
With a reduction in the annual allowance from 6 April 2016, and potential cuts to the rate of available tax relief coming as soon as 16 March, top earners with the ability to carry forward pension contributions have a rapidly closing window of opportunity in which to benefit fully from the existing allowances and reliefs.
3. Be mindful of the ‘lifetime allowance’, even if you’re a younger saver
A million pounds may seem beyond the reach of most people, but a pension pot of this size is increasingly common. Moreover, from 6 April 2016, £1 million is the maximum the Chancellor will allow anyone to have in their pension before the excess is taxed at 55%. The limit is called the ‘lifetime allowance’ and it is, in effect, a ceiling beyond which pension savings should not be allowed to rise.
The lifetime allowance applies to the total of all the pension savings you have, including any final salary schemes you belong to, but excludes your State Pension. Obviously, the lifetime allowance doesn’t affect everyone; but for thousands of workers, including middle managers, teachers, and doctors, a combined pension value of £1 million is not unachievable at retirement. What’s more, responsible savers in their 30s and 40s with relatively modest pension pots could expect to reach the lifetime allowance by retirement, given a run of good investment returns.
If the lifetime allowance is a concern, there are alternative ways of saving for retirement. For example, rather than continuing to fund your own pension, you could think about using your income to fund someone else’s pot – for instance, that of your spouse or partner. Alternatively, ISAs can provide a tax-efficient home for surplus income and, for the more advanced investor, there are Venture Capital Trusts and Enterprise Investment Schemes to consider.
If the value of all your pension pots exceeds £1 million on 6 April 2016, then you should speak with your financial adviser about stopping contributions and applying for special protection that could shield the excess capital from tax charges.
4. Be smart when taking income
Unexpected tax bills are a potential pitfall of new pension freedoms and highlight the need for advice when preparing for retirement.
Since new pension freedoms were introduced in April 2015, retirees no longer have to buy an annuity with their pension pot, but can take benefits in a variety of ways. This includes the option to keep the pension invested in retirement and/or withdraw cash as required. However, freedom has given rise to hidden dangers and increased the likelihood of people making poor decisions.
One danger is that people find themselves unwittingly pushed into higher rate tax bands by cashing in too much of their pension in a single tax year. For example, if a £250,000 pension was taken as a lump sum in the current tax year, the tax bill would be over £70,000, even if the individual had no other earnings – and despite the fact that a quarter of the withdrawal is tax-free.
Retirement is a time to ensure that benefits accumulated over a lifetime are taken back tax-efficiently. The tax-free personal allowance – an amount of income you can have before you pay tax – can play a key role in keeping tax bills down. Most people in the UK get a personal allowance; this is currently £10,600, but it will be increased to £11,000 for the 2016/17 tax year, and to £11,200 for 2017/18.
Instead of taking a large withdrawal in a single tax year, you could spread it over two or more tax years, utilising more than one year’s personal allowance and reducing your overall tax bill. Better still, if you have a partner or spouse, you could have a combined tax-free allowance of £21,200 for 2015/16, and £22,000 for 2016/17.
Therefore, if you have the ability to do so, it’s prudent to ensure that your partner’s pension is fully funded, as well as your own.
On top of increases to the personal allowance, the basic rate tax limit will be increased to £32,000 for 2016/17 and £32,400 for 2017/18. Similarly, the higher rate threshold will be £43,000 in 2016/17, and £43,600 in 2017/18, providing more scope to obtain tax-efficient income.
If you’re thinking of accessing a large sum from your private pension in the near future, it could make sense to take part of the withdrawal before the end of this tax year and the remaining amount in the new tax year. If you have a partner or spouse, you could reduce the tax bill further by splitting withdrawals equally across both pensions.
You could end up paying 40% or 45% tax on a large pension withdrawal; but by careful planning you can keep your highest tax rate at 20%, or even zero.
5. Stay on track for the retirement you want
If people have not saved enough then, quite simply, the freedom to take benefits in a variety of ways is of little value.
Despite all the advantages of saving into a pension – and the freedoms for taking benefits – the stark truth is most Britons are still not putting enough aside for the retirement they expect.
According to BlackRock’s latest Investor Pulse Survey, people want on average £23,000 per year in retirement income, but believe that a pot of £204,000 will achieve this. In fact, it would require a pot of £407,0001.
More than half of people in the UK have never checked the value of their pension savings. Two in five don’t know how much they are paying into their pension pot, and three out of five don’t know how much their employer is contributing2.
Furthermore, people tend to underestimate how long they will live; those in good health at age 65 are expected to live well beyond the age of 80, meaning that retirement will last 20 years or more3.
Increased flexibility in pension income is welcome. But the most important thing is to build a fund that gives you the retirement you want for the rest of your life.
The levels and bases of taxation, and reliefs from taxation, can change at any time and are generally dependent on individual circumstances. The value of an investment with St. James’s Place will be directly linked to the performance of the funds you select and the value can therefore go down as well as up. You may get back less than you invested.
Tax year-end planning... it's time for action
Posted on Thursday 25th February 2016
The last year has seen huge change in the personal savings landscape and increased still further the need for individuals to understand their options, and take responsibility for securing their own financial future. That responsibility includes making time to explore the tax-saving and investment opportunities presented by the end of the tax year.
Your annual ISA allowance is one of those valuable opportunities to provide capital and income for the future, yet many savers will fail to take full advantage of it.
Although the Chancellor left the annual ISA allowance unchanged in his Autumn Statement instead of applying an inflation-linked increase, the opportunity to shelter up to £15,240 with no further tax to pay on income, and growth free from Capital Gains Tax, is still a very attractive and valuable one. What also hasn’t changed is that your allowance will be lost forever unless you invest before the end of the tax year.
Yet the majority of ISA savers still fail to make the most of the opportunity.
A recent survey conducted by BlackRock explored the savings views and habits of 4,000 individuals in the UK. While it revealed an encouraging increase in the number of people saving for retirement, it also confirmed that Britain’s cash-centric savings culture remains a problem. Around two thirds of all personal savings and investments are stuck in cash, compared to an average of 12% invested in equities; and this is despite those surveyed acknowledging that the figure is too high¹.
The trend is equally concerning when it comes to how people are utilising their ISA allowance. Figures from HMRC show that over £79 billion was saved into ISAs in the last tax year, of which a staggering 80% was deposited in Cash ISAs². This figure was backed up by BlackRock’s research, in which 70% of respondents said they held a Cash ISA, whereas just 11% had invested in a Stocks & Shares ISA.
Consequently, over £240 billion is languishing in Cash ISAs on which, according to the Bank of England, savers are receiving an average interest rate of just 0.85% – lower than the 0.99% reported in December³. Many banks are now paying higher rates of interest on current accounts than savings accounts⁴.
Based on the average figure, savers depositing their full allowance in a Cash ISA would save themselves tax of just £26 on the interest if they were a basic rate taxpayer; and £52 if they paid tax at the higher rate.
The introduction of the Personal Savings Allowance from April makes the real value of such tax savings even more questionable. The new allowance applies to standard current and savings accounts and will enable basic rate taxpayers to earn tax-free interest of up to £1,000. For higher rate taxpayers the tax-free limit is £500, whilst those with total income of over £150,000 a year will not get an allowance.
If you can deposit cash in an instant access account earning tax-free interest, why would you need a Cash ISA? In theory, you might if you would exceed the tax-free limit in earned interest.
The average instant access rate is currently 0.48%³: at that level, a basic rate taxpayer could deposit over £208,000 in a regular savings account and receive all their interest tax-free. For higher rate taxpayers the figure is just over £104,000. Of course, for those who secure a more attractive rate, these amounts would be reduced.
The primary role of cash is as a home for emergency funds. It seems unlikely that many people would need a larger emergency pot than they can now save tax-free in an instant access account.
BlackRock’s survey also offered an insight into why the cash saving habit is proving hard to kick. Participants said they feel “responsible” and “purposeful” when they opt for cash saving, but “anxious” and “cautious” when they invest in other assets, such as stocks and shares. But faced with the prospect of record-low returns on cash, and little likelihood of a significant rise in interest rates, some might question whether this confidence is justified if the money saved in ISAs is intended to help secure their financial future.
BlackRock’s research reaffirmed that ISAs have a major role to play in encouraging retirement savings. Over half of those aged 55–64 said they were using ISAs to help fund their retirement; and across all age groups, 36% are saving with that objective in mind.
Pension changes due to be introduced in April will see a reduction in the annual allowance for higher earners, and a lower lifetime allowance for pension savings. It is therefore anticipated that the flexibility offered by ISAs will see them used even more widely as part of a well-structured retirement planning strategy.
The long-term benefits of ISAs were further enhanced by changes introduced last year, which enable spouses to inherit an additional ISA allowance equal to the value of their deceased partner’s ISAs, so preserving the tax benefits that would previously have been lost.
The reality is that the tax benefits of an ISA can only be maximised by investing for the long term in assets that offer the scope for attractive levels of income and capital growth.
There is still time for those looking to take advantage of the tax-saving and investment opportunities presented by the end of the tax year. Making the best use of your ISA allowance before it’s too late would be a good start.
The value of an ISA with St. James's Place will be directly linked to the performance of the funds selected and may fall as well as rise. You may get back less than invested. An investment in a Stocks and Shares ISA will not provide the same security of capital associated with a Cash ISA. The favourable tax treatment of ISAs may not be maintained in the future and is subject to changes in legislation.
¹ BlackRock Investor Pulse Survey, December 2015
² HMRC, August 2015
³ Bank of England, January 2016
⁴ BBC website, January 2016