Should I redirect pension savings into an ISA?
"I am looking to retire in 12 years’ time and I’m keen not to be a higher-rate taxpayer in retirement. What is the higher-rate tax threshold likely to be then?
"Obviously no one has a crystal ball and tax rates can change. I’m
currently paying 15% of my salary into a money purchase scheme and I wonder whether I should redirect some of my pension savings into an individual savings account.
I know about the tax benefits on pensions, but I’m keen not to pay any more tax than I have to in the (hopefully) long years of retirement ahead, so any advice would be most beneficial."
Ask the Professionals: Philip Pearson, a partner at P&P Invest in Southampton and an investment portfolio specialist, says:
Contributions into a pension will benefit from tax relief at your highest rate. The income from pensions in retirement, however, is subject to income tax. So the tax advantages of saving into a pension are marginal if you are a basic-rate taxpayer and are likely to remain so in retirement.
A guide as to whether you could potentially be a higher-rate taxpayer in retirement is to consider the current higher-rate tax threshold – £43,875 in the current financial year. This takes into consideration your personal allowance, which enables the first £6,475 of income to be tax-free.
If benefits are being taken at state retirement age and you have a full credit over your working life then the state pension is likely to be similar to your personal allowance in value.
Should tax bands remain the same over the next 12 years and merely increase in line with inflation, then as a guide you need to consider whether your total taxable income in retirement is likely to exceed £43,875 gross a year (in today’s terms). If not then you are unlikely to be a higher-rate taxpayer in retirement.
All sources of income, however, are assessed for income tax. It’s important to shelter your savings from taxation in order to minimise the effect. If you’re a basic-rate taxpayer during your working life then saving into a pension has only marginal tax benefits when compared with an ISA, which provides relief on any interest you accrue.
An ISA also provides a higher degree of flexibility enabling access to the total value of the capital at any time, whereas a pension has far more restrictions applied in running the plan and drawing benefits.
By making use of your ISA allowance each year and monitoring carefully the potential benefits available from your pension, it should be possible to remain a basic-rate taxpayer in retirement.
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.
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.
An increase in the general level of prices that persists over a period of time. The inflation rate is a measure of the average change over a period, usually 12 months. If inflation is up 4%, this means the price of products and services is 4% higher than a year earlier, requiring we spend and extra 4% to buy the same things we bought 12 months ago and that any savings and investments must generate 4% (after any taxes) to keep pace with inflation. Since 2003, the Bank of England has used the consumer prices index (CPI) as its official measure of inflation (see also retail prices index).