Savers scrambling to top-up their ISAs before tax year-end would do well to remember that, when it comes to long-term savings, pensions are difficult to beat.
Tom Selby, senior analyst at AJ Bell, provides some top tips for savers ahead of the tax year-end.
Make the most of pension tax relief
“Pensions benefit from upfront tax relief, providing an immediate boost to the value of your fund. This is granted automatically at 20% (meaning a 25% boost to your contribution), while higher-rate taxpayers can claim back an extra 20% and additional rate taxpayers 25%.
“So if you pay £80 into a SIPP that will be topped up to £100 regardless of how much income tax you pay. A higher-rate taxpayer could then claim back £20, while an additional-rate taxpayer could claim £25. In effect, getting £100 in a pension can cost as little as £55.
“Over the long-term tax relief can make an enormous difference to the value of your retirement pot. If a basic-rate taxpayer pays £2,400 a year into their pension, that would be topped up to £3,000 through tax relief.
“Over 40 years with investment growth of 5% (after charges) that could generate a fund worth over £400,000, with a whopping £80,000 boost provided through the annual tax relief bonus.
“While clearly everyone can afford different levels of contributions, the boost of tax relief combined with 25% tax-free withdrawals from age 55, flexibility and a generous death benefits regime make pensions a great investment for whatever spare cash you can afford.”
Boost your pension annual allowance to £160,000
“The amount you can save in a pension each year has been eroded from a high of £255,000 in 2010/11 to £40,000 today. This is still double the ISA allowance, and there is a tax trick you can use to boost it even further.
“Pensions ‘carry’ forward’ rules allow you to use up to three years of unused allowances in the current tax year. So if you didn’t pay anything into a pension in the 2015/16, 2016/17 or 17/18 tax years, you could carry forward £120,000 of unused allowances and add them to this year’s £40,000 allowance.
“This flexibility is particularly useful for business owners or anyone who is trying to make up for lost time saving for retirement.”
Beware the pension freedoms tax trap
“Around 1 million people have flexibly accessed their retirement pot since the pension freedoms launched in April 2015.
“All those who made a taxable withdrawal (i.e. more than the 25% tax-free lump sum) have had their annual allowance savagely cut, from £40,000 to just £4,000 – and there is no going back
“The Treasury introduced this measure to stop people recycling large sums of money through pensions to benefit from extra tax-free cash.
“People planning to access their pension flexibly needs to think carefully about the impact it will have on their ability to save in the future.
“Anyone wanting to access their pension but concerned about triggering the MPAA should consider whether just taking their tax-free cash could be sufficient, particularly where they are planning a one-off purchase rather than taking a regular income.”
Get your affairs in order
“The pension freedoms weren’t just about flexibility in retirement - changes to the way your retirement fund is taxed on death mean pensions are now attractive tax planning vehicles. If you die before age 75 your fund can be passed on to your beneficiary tax-free, while if you die after 75 it is taxed in the same way as income.
“Furthermore, if your beneficiary dies before age 75 they too can pass on any untouched funds, even if you died after age 75.
“This makes it even more important to make sure your pension goes where you want it to go should the worst happen. Changes in life circumstances such as the birth of a child, marriage or divorce could affect who you want to receive your pension if you die, so the tax year-end provides a useful opportunity to review and revise your death benefit nominations.”
Reclaim any overpaid tax on pension freedoms withdrawals
“The first flexible payment you take from your pension in the tax year will be taxed on an emergency basis, referred to in HMRC jargon as ‘Month 1’.
“This means HMRC assumes you are making 12 withdrawals rather than just the one, with the upshot being you are likely to be significantly overtaxed – potentially by thousands of pounds.
“If you want to get this money back you can do it through your self-assessment tax return, or by filling out one of three forms:
• P50Z – If the payment used up your pension pot and you have no other income in the tax year
• P53Z – if the payment used up your pension pot and you have other taxable income
• P55 – if you have withdrawn only part of your pot and you’re not taking regular payments
“HMRC says this should get sorted within 30 days. At the last count over £400 million had been reclaimed by savers who had filled out these forms.”