Five strong alternatives to a pension
1 Start your ISA early
The most obvious alternative to a pension is an ISA. Last year's increase in limits, available to all investors in the current tax year, means a married couple can invest £20,400 a year between them and take out the proceeds tax-free.
That may not sound like much of a benefit, given that following the recent Budget, each individual can realise annual gains of £10,100 free of capital gains tax, and even gains that are subject to tax are charged at 18% for basic-rate taxpayers and 28% for higher-rate taxpayers.
But, while CGT allowances are safe for now, many experts fear this generosity cannot continue indefinitely, given the parlous state of the UK's finances.
Using their ISA allowance every year means investors will quickly build up a significant portfolio.
Killik & Co calculates that anyone who had invested the full amount permitted in ISAs and their personal equity plan (PEP) predecessors since they were introduced in 1987 – a total of £171,000 – would have built up a nest egg worth £302,000, assuming investments grew by 5% a year.
Even those who have not started using their allowances still have time to build a sizeable portfolio.
Killik calculates that a couple who each use their annual allowance for 20 years would amass a portfolio worth £708,000, assuming a return of 5%, which could generate a tax-free income of £35,000 each year.
Justin Modray, founder of candidmoney.com, says those planning to use an ISA for retirement should have a plan for the funds they invest in.
Those who are 30 years or more away from retirement can afford some risk, choosing equity funds and including some emerging markets and commodity funds, which will be higher risk but have potentially higher returns.
As retirement approaches, he says, risk should gradually be reduced. "You should move to less volatile funds like corporate bonds, property or cash, as you do not want to run the risk that 20% to 30% of your fund will disappear overnight."
2 Stay the distance with a maximum investment plan
Investors could also consider a maximum investment plan (MIP), a life assurance-based product that was popular in the 1980s, but was discredited because of its high charges and poor performance.
However, Small says some of the new schemes being launched are better value. Skandia is among those offering these plans, which require regular contributions for 10 years.
The income within the plan is subject to life assurance tax, but proceeds are paid tax-free.
Investors can extend the contract beyond 10 years and take a regular tax-free income, but if they are cashed in early the returns could be very poor and you may even lose some of your investment.
As with the original MIPs, performance will depend on the underlying investments, although the new plans allow a broader selection of funds than in the past.
3 Use your CGT allowance
It is worth investing in shares and other assets that are potentially liable to capital gains tax (CGT) even if you have used up the full ISA allowance, says Small.
The annual exemption of £10,100 on gains and low tax rates means it should be possible to time investment sales to avoid paying tax completely, or to pay it at a low rate.
4 Take your assets offshore
Offshore bonds may be worth considering for wealthy investors who have used up the alternatives already mentioned. As they are based outside the UK, the bond does not incur any tax.
Investors can withdraw up to 5% of the amount invested annually without incurring tax because the HM Revenue & Customs treats this as a return of capital.
These can be especially useful for individuals who expect to pay a lower rate of tax after retirement, as the tax-free roll-up of income within the fund means they avoid having to pay the higher rate of tax that would be payable on bonds issued onshore.
But the charges can be high and performance will depend on the assets – investment funds or other assets – put within the bond.
5 Opt for planned exit VCTs
If you have used up all these ideas and have the stomach for risk, you could consider a VCT. You can invest up to £200,000 a year into a VCT and get 30% tax relief – assuming you have paid that much tax in the first place.
When the funds are sold the proceeds will also be free of CGT provided they have been held for at least five years, and there is no need to pay higher-rate tax on any dividends from the fund.
These are high risk: many of those launched in recent years ended up making big losses for investors, so you have to choose carefully.
Also, it can be difficult to realise your investment when you need to, as buyers of VCT shares can be hard to find.
To get over this, you can opt for "planned exit" VCTs which, as their name suggests, are wound up at a specified time.
Downing, one of the VCT managers which is highly rated by advisers, offers a number of these type of schemes.
This article was originally published in Money Observer - Moneywise's sister publication - in May 2010
The practice of locating your financial affairs (banking, savings, investments) in a country other than the one you’re a citizen of, usually a low-tax jurisdiction. The appeal of offshore is it offers the potential for tax efficiency, the convenience of easy international access and a safe haven for your money. However, offshore is governed by complex, ever-changing rules (such as 2005’s European Union Savings Directive) and, as such, is the exclusive province of the wealthy and high-net-worth individuals.
Venture Capital Trusts were introduced in 1995 to encourage private investments in the small-company sector by offering tax relief in return for a minimum investment commitment of five years. A VCT is a company, run by a fund manager, which invests in other companies with assets of no more than £7m that are unlisted (not quoted on a recognised stock exchange) but may be listed on the Alternative Investment Market (AIM) or plus with the aim of growing the companies and selling them or launching them on the stock market. Investors in new VCTs are offered desirable tax advantages and VCTs themselves are listed on the London Stock Exchange, with strict limits laid down by HM Revenue and Customs on what they can invest in and how much they can invest.
There are limits to how much you can invest in any tax year. For 2011/12, the limit is £10,680. Of that, the maximum you can invest in cash is £5,340 and the balance of £5,340 can be invested in shares (individual company shares or investment funds). If you don’t take the cash ISA allowance, you can invest up to £10,680 into a stocks and shares ISA.
Generic, loosely-defined term for markets in a newly industrialised or Third World country that is in the process of moving from a closed economy to an open market economy while building accountability within the system. The World Bank recognises 28 countries as emerging markets, including Argentina, Brazil, China, Czech Republic, Egypt, India, Israel, Morocco, Russia and Venezuela. Because these countries carry additional political, economic and currency risks, investors in emerging markets should accept volatile returns. There is potential to make large profit at the risk of large losses.
Capital gains tax
If you buy an asset – shares, a second home, arts and antiques – and then sell it at a later date and make a profit, that profit could be subject to CGT. You don’t pay CGT on selling your main home (which is why MPs “flipped” theirs so regularly) or any securities sheltered in an ISA. Individuals get an annual CGT allowance (£10,600 in 2010/2011) but if you have substantial assets it’s worth paying an accountant to sort it for you.
Generally thought of as being interchangeable with insurance but isn’t. Assurance is cover for events that WILL happen but at an unspecified point in the future (such as retirement and death) and insurance covers events that MAY happen (such as fire, theft and accidents). Therefore you buy life assurance (you will die, but don’t know when) and car insurance (you may have an accident). Assurance policies are for a fixed term, with a fixed payout, and unlike life insurance have an investment aspect: as a life assurance policy increases in value, the bonuses attached to it build up. If you die during the fixed term, the policy pays out the sum assured. However, if you survive to the end of the policy, you then get the annual bonuses plus a terminal bonus.
Invidivual Savings Accounts were introduced on 6 April 1999 to replace personal equity plans (PEPs) and tax-exempt special savings accounts (TESSAs) with one plan that covered both stockmarket and savings products, the returns from which are tax-exempt. The ISA is not in itself an investment product. Rather, it’s a tax-free “wrapper” in which you place investments and savings up to a specified annual allowance where the returns (capital growth, dividends, interest) are tax-exempt (you don’t have to declare ISAs and their contents on your tax return). However, any dividends are taxed within the investment, and that can’t be reclaimed.