Lifetime Allowance for Pensions

[hiriskpaul]

Going off topic here, but I think it is worthwhile pointing out what a great deal pensions are for higher rate taxpayers who only pay basic rate tax in retirement. In those circumstances higher rate taxpayers pay an effective tax rate of 15% by routing money through pensions, but gain an additional 20% tax relief on the gross pension contribution. So compared with investing after tax money in an ISA, the uplift is 25/60 = 41.7%.

[Kantwebefriends]

"

I just wanted to set out that the tax relief was still of benefit to basic rate taxpayers.

In my view the pension uplift is too small to compensate for the inflexibility of pensions for anyone who is not at or close to age 55, hence my suggested tests which I stand by.

And as Urbandreamer pointed out the pension contributor is exposed to a great deal of political risk. Suppose, for example, he will face Basic Rate income tax at 25% in retirement. That's virtually all the advantage vanished. Perhaps a cap will be imposed on TFLSs - that's been proposed often enough. Perhaps pension income will become subject to NICs. And on and on.

There are exceptions: a 55 year old 20% taxpayer who has good reason to expect to die before age 75 and wants to form a tax-efficient investment for his widow might find it attractive to gamble on pension contributions. ( Until the current law is changed, as it doubtless will be - perhaps quite soon.)

[hiriskpaul]

"

I just wanted to set out that the tax relief was still of benefit to basic rate taxpayers.

In my view the pension uplift is too small to compensate for the inflexibility of pensions for anyone who is not at or close to age 55, hence my suggested tests which I stand by.

And as Urbandreamer pointed out the pension contributor is exposed to a great deal of political risk. Suppose, for example, he will face Basic Rate income tax at 25% in retirement. That's virtually all the advantage vanished. Perhaps a cap will be imposed on TFLSs - that's been proposed often enough. Perhaps pension income will become subject to NICs. And on and on.

There are exceptions: a 55 year old 20% taxpayer who has good reason to expect to die before age 75 and wants to form a tax-efficient investment for his widow might find it attractive to gamble on pension contributions. ( Until the current law is changed, as it doubtless will be - perhaps quite soon.)

I agree that political risk with pensions reduces as one gets closer to crystallisation. I also agree that by itself, the 6.25% uplift for basic rate taxpayers is barely worth the risk. However, there are other benefits pensions have that ISAs do not, such as IHT savings. An additional benefit for some people is the potential to draw an amount free of tax. The state pension does not fill up the personal allowance, so basic rate taxpayer with a £100k pension pot (25k PCLS + 75k drawdown) being drawn at say 4% would pay no tax on the pension withdrawals. The uplift to someone getting basic rate tax relief on contributions and paying no income tax on drawdown equates to 25% on the untaxed proportion. For those able to retire before state pension age, that could amount to a considerable saving.

It is all these benefits taken together that need to be weighed up. The value will vary from person to person - there is no one size fits all here.

ISAs are not without political risk either of course. There was a time when, far from giving ISA tax breaks, people paid more tax on "Unearned" investment income than they did on income from employment. I would not be at all surprised to see ISAs capped and/or the tax saving watered down in the future.

I think the best solution when it comes to political risk it to invest in both pensions and ISAs.

[PinkDalek]

However, there are other benefits pensions have that ISAs do not, such as IHT savings.

My ISA does, potentially. Mainly invested in Business (Property) Relief qualifying shares on AIM. Until the Law changes and/or I lose the 40% possible saving.

[hiriskpaul]

However, there are other benefits pensions have that ISAs do not, such as IHT savings.

My ISA does, potentially. Mainly invested in Business (Property) Relief qualifying shares on AIM. Until the Law changes and/or I lose the 40% possible saving.

I was considering the risks and benefits of investing in pensions vs ISAs, all else (ie the investments themselves) being equal. Quite right though, there are some investments that attract IHT relief, including some that can be held in ISAs.

[swill453]

An additional benefit for some people is the potential to draw an amount free of tax. The state pension does not fill up the personal allowance, so basic rate taxpayer with a £100k pension pot (25k PCLS + 75k drawdown) being drawn at say 4% would pay no tax on the pension withdrawals. The uplift to someone getting basic rate tax relief on contributions and paying no income tax on drawdown equates to 25% on the untaxed proportion. For those able to retire before state pension age, that could amount to a considerable saving.

Yes, in the decade+ between my wife and me retiring, and being able to get state pension, we can take twice the personal allowance out in drawdown, entirely tax free. This is £25,000 this year.

The earnings in the pension pots have had variously basic and higher rate relief on the way in.

Scott.

[TUK020]

Going off topic here, but I think it is worthwhile pointing out what a great deal pensions are for higher rate taxpayers who only pay basic rate tax in retirement. In those circumstances higher rate taxpayers pay an effective tax rate of 15% by routing money through pensions, but gain an additional 20% tax relief on the gross pension contribution. So compared with investing after tax money in an ISA, the uplift is 25/60 = 41.7%.

Gets even more fun if you earn over 100k/annum. Withdrawal of personal allowances means that between 100-123k, your effective marginal tax rate is 62% (inc NI). Anything over 100k should be stuffed into a SIPP unless you hit the pensions contributions limit.