Is it still worth saving into a pension scheme?
Many investors will have been asking themselves that question following the announcement in last year’s Autumn Statement of yet more restrictions on tax reliefs on annual contributions and the size of the pot that can be built up over a lifetime. It would, however, be foolish to write off pensions savings: they should remain a core part of planning for retirement, even though they are likely to be just one part of the investment mix.
Know your limits
The government announced that, as from next April, the annual allowance for pension contributions will be cut from £50,000 to £40,000, while the lifetime allowance – which sets the maximum, penalty-free, value for a pension pot – will fall from £1.5 million to £1.25 million.
Pensions tax relief is now substantially less generous since the lifetime allowance was introduced in 2006. Then, it was set at £1.5 million, but it rose annually to reach £1.8 million in 2010 before being cut back to its starting level in 2012. The fall in the annual allowance has been even more dramatic: set initially at £215,000, it peaked in 2010 at £255,000.
Even the reduced amount of tax relief available is worth using, however. The annual allowance may have fallen substantially, but it is available to everyone and applies to the highest marginal rate of tax. That brings the cost of a £40,000 pension contribution down to £24,000 for anyone paying the 40% higher rate of tax (although the extra 20% must be reclaimed via the individual’s tax return).
The lifetime allowance is also available to everyone, so a married couple can accumulate a pension pot of £2.5 million between them – enough to fund a reasonably generous annual pension. But everyone should also keep track of their progress towards the maximum allowance and take steps to avoid breaching it if that looks likely to be a risk.
Funding retirement tax-efficiently
The reduction in annual allowances and the lower lifetime maximum means using other types of savings, and particularly other tax-efficient schemes such as ISAs to help fund retirement, is likely to become more common. Such an approach may also be more suitable to the changing pattern of retirement.
Twenty years ago, many people retired in their early 60s and looked forward to spending the rest of their lives secure with an income from a final salary scheme, where pensions are based on earnings in the run-up to retirement.
But that option is now available to a dwindling number of people. Final salary schemes are closing, often both to existing and new members, while increasing life expectancy and falling annuity rates are cutting into the incomes available from defined contribution schemes (source: www.napf.co.uk), where pensions are based on the amount of money in the pension pot. That could mean people are more likely to phase their retirement gradually, perhaps working part-time for a while, and fund themselves through a range of investment vehicles.
Those who have used their full pension tax relief should then consider using the maximum ISA allowance. While there is no upfront tax relief on ISA contributions, the funds can be drawn out tax free – unlike pensions, where the proceeds are taxable.
For the current tax year (2013/14), the allowance is £11,520, giving a couple £23,040 between them; and the government has committed to increasing the ISA allowance annually in line with the Consumer Prices Index.
A change for the better
The tax changes have not been all one way, however. The Autumn Statement also included an increased limit to the amount of income that can be drawn down from a pension fund. Drawdown is an alternative to buying an annuity and can be a good option for those who want to maintain their fund rather than surrendering it all to an annuity – particularly when long-term interest rates, and therefore annuity rates, are so low. But the government has stipulated that investors could only draw down an income equal in value to an annuity that could be purchased by an equivalent pension fund. The sharp fall in annuity rates in recent years has led to some pensioners suffering a big drop in income from drawdown so the government has increased the limit to 120% of the relevant annuity as from March this year. (source: www.pensionsadvisoryservice.org.uk)
Keeping your pension fund in check
The changes in pension rules and tax incentives make it essential that arrangements for retirement are kept under regular review. That includes regular checks on the size of the pension fund to ensure that it will not breach the lifetime allowances, as well as making the maximum use of the tax incentives available for pension saving.
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 selected and the value may fall as well as rise. You may get back less than the amount invested