When pensions change really does mean change

Greater flexibility in pension savings could mean savers alter the way they act

When pensions change really does mean change

It is now three months from what many described as the “biggest change to pensions in a generation”. We’ve also seen the raising of the individual savings account subscription limit to £15,000, effective from the 1 July. Two seemingly separate events, however for a great many consumers in the traditional savings bracket these changes could mean a significantly different direction of thinking.

I will try and explain. The savers I am referring to are those in the 45-54 age bracket who, according to the most recent government ISA statistics are the second largest group of ISA holders behind the 65 and overs.

It could be argued that those over 65 are using their accumulated ISA savings to supplement their income through investment return or drawing the capital down. It is very likely that the 45-54 year olds, and maybe those of a younger age, are still accumulating a capital sum and intend to use it in the same way or have a clear desire to buy a holiday home, new car, luxury cruise and so on, when they retire. One of the clear reasons given as to why pensions were seen as unattractive was that they locked your money away, with the major positives being you get tax relief at your marginal rate and 25% of the fund as tax free cash.

I believe that, if and when, the proposed flexibility in pensions becomes as widely available as announced in the Budget the balance of where to save will change as you get closer to age 55 or your aspirational retirement date. Much use is made of an ISA as you put your savings in, it grows in a very tax efficient environment (for income tax and capital gains) and the benefits are paid out tax free when you decide that you need to use it for your intended purpose. This is still very good planning, however, what about using a pension for this purpose instead in future?

One of the real positives is the attraction of tax relief on the amount you invest up front. This could be at 20%, 40% or higher depending on your marginal rate of tax. The fund then grows in a very tax efficient environment (for income tax, capital gains and inheritance tax). The benefits are paid out as 25% of the accumulated fund tax free and the balance subject to your tax rate at the time you withdraw the savings.

As an example what if you were investing the £15,000 available to subscribe in an ISA from the 1 July? If this was paid into a pension by a higher rate taxpayer looking to achieve the same net cost the amount invested would actually be £25,000, for a basic rate taxpayer it would be £18,750. The fund would then grow in virtually the same tax efficient environment – but remember the bigger fund in the pension. Then you need to look at the last step which is drawing the benefits. The ISA fund would be tax free and the pension fund would be 25% tax free and the balance taxed at your marginal rate in the future.

With the generous personal allowance available to everyone and some simple tax planning, if you were over 55 and retired or working less you may have moved from higher rate to basic rate tax or even into a non-taxpaying position. The differences of what you could get back could be quite significant.

There is a little while to go until we know exactly what the rules will be however the new flexibility in pension savings could mean traditional savers may need to change the way they think.

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About Author

Andy Zanelli

Andy Zanelli is head of retirement planning at AXA Wealth