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In the UK, pensions continue to be one of the most tax-efficient ways to save for retirement. Yet there is growing concern that benefits, in their current form, may not survive future government policy changes – especially as savings are sought to balance the books, after the damage from COVID-19. Below, our team at Bure Valley Group explains how pension tax reliefs work, how these might change in the future and ideas about what to do about it.
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Pensions & tax reliefs
Using your pension to invest can be a powerful way to save on tax in the short term, whilst also boosting your net worth in the future. In 2021-22, you can put up to £40,000 into your pension(s) or up to 100% of your annual earnings (whichever is lower), via your “annual allowance”.
As long as you are UK resident and have not triggered the Money Purchase Annual Allowance rules (MPAA), you should be entitled to this. Moreover, you can also utilise any unused pension allowance from the previous three tax years. So, suppose you earned at least £40,000 over this period but made no contributions at all. Provided you met the relevant criteria, this means you could put up to £160,000 into your pension within a single tax year.
Why commit funds to a pension instead of a general investment account (GIA)? Perhaps the most powerful reason is to access the powerful tax benefits. In 2021-22, you receive tax relief on your contributions equivalent to your highest rate of income tax. So, a Basic Rate taxpayer gets a 20% “boost” to their contributions whilst someone on the Higher Rate gets 40%.
There are limits to this, however. Since April 2016, a taper has applied which means that for every £2 of adjusted income over £240,000, your annual allowance is reduced by £1 (down to a minimum allowance of £4,000).
Possible future changes
The Government is keen to explore ways to balance the public finances after soaring spending and borrowing during the COVID-19 pandemic. So far, pensions have survived the Chancellor’s various policy changes announced in his 2020 budgets. However, it remains possible that your pension could be targeted in the future. After all, the net cost of pension tax relief cost £42bn in 2019-20 for the Treasury. Here are some possible scenarios:
- Tax relief is abolished altogether. This could save the government a lot of money in the short term, but is extremely unlikely. It would be politically unpalatable to their voters, and would likely exacerbate pensioner poverty – putting strain on other state benefits.
- Higher-rate tax relief is scrapped. Many people question why higher earners should be “rewarded” more by the government than Basic Rate taxpayers. To address this (and save public money), an idea has been floated for a “flat rate” of pension relief for all taxpayers – e.g. 25%. An outcome like this seems more likely, and an announcement by the Chancellor may be forthcoming later in 2022.
Ideas for protecting yourself
Whilst the latter scenario would likely benefit Basic Rate taxpayers, many higher earners could see themselves £100,000S worse-off in retirement due to the lower tax relief. Whilst you cannot predict the future, what can long-term investors do to ensure their portfolios do not suffer due to possible policy changes? Here are some ideas to discuss with your financial adviser:
- Stay well within the lifetime allowance. There is a total “cap” on the amount you can save into your pensions(s) before extra tax charges apply on the withdrawals. This “lifetime allowance” is set at £1,073,100 in 2021-22. Just ten years ago, this threshold was set at £1,800,000, but it has gradually come down over time. Future decreases could happen in the future. So, consider not approaching this limit to avoid tax penalties.
- Consider the lifetime ISA. Whilst it comes with its drawbacks, the lifetime ISA (LISA) can be another tax-efficient vehicle for retirement saving. Here, you can get a 25% “bonus” from the government on your contributions – up to £1,000 per year. Contributions cannot exceed £4,000 per year, and you must be under 40 to open a LISA. You no longer get the bonus once you turn 50, and you can start accessing the money once you turn 60.
- Maximise ISAs in general. In 2021-22 you can put up to £20,000 into your investment ISAs (e.g. stocks & shares and innovative finance ISAs), and any interest, capital gains or dividends you earn from them will be tax-free. This can be a great option for building tax-efficient investments over time (e.g. a £200,000 ISA portfolio over 10 years).
- Other options. The UK offers other powerful ways to invest whilst saving on tax. One is the Enterprise Investment Scheme (EIS), which lets investors access powerful benefits such as (up to) 30% income tax relief, inheritance tax relief and loss relief on exit.
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