TaxJul 15 2019

Young savers could turn to Isas to avoid tax charge

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Young savers could turn to Isas to avoid tax charge

Advisers and employers could turn to Isas for long-term saving if the lifetime allowance (LTA) is not scrapped, according to Dunstan Thomas.

The LTA was introduced in 2006 and is the limit on the amount that can be saved in a pension scheme without triggering an extra tax charge.

The LTA started at £1.5m and has previously been as high as £1.8m but it currently sits at £1.05m, which makes planning difficult for advisers and clients, according to Adrian Boulding, director of retirement strategy at the technology solutions provider.

There have been calls from the pensions industry for the government to scrap the LTA as individual face 55 per cent tax bills after exceeding the limit.

In the absence of scrapping the LTA, employers and advisers may need to consider recommending long-term saving in Isas for younger people, at least in their first few years, suggested Mr Boulding.

He said if individuals were going to run out of their pensions allowance anyway then it would be better to waive contributions early on when they would have received 20 per cent tax relief rather than later, when they might receive 40 per cent.

This is because younger individuals tend to be classed as basic rate taxpayers but as they earn more throughout their life they become higher rate taxpayers and therefore receive more tax relief on their savings.

In March 2019, a report from pension provider Royal London found that 290,000 pension savers approaching retirement had already breached the then £1.03m LTA limit with many savers continuing to pay in.

Mr Boulding also suggested that the Lifetime Isa (Lisa) may be a better option for younger savers looking to save to buy their first home rather than saving into a pension pot.

Colin Low, managing director at Kingsfleet Wealth, agreed that saving into a Lisa was a good idea for younger people but only if they were also saving into a pension.

Mr Low said: "For under 40s, Lisas are a really good idea, often to run in parallel with workplace pensions.  

"They work on a bonus arrangement at maturity but it does appear as though this is the direction of travel for the Treasury.

"It is obvious that they don't like the tax relief cost for pensions and would prefer to see the Isa model (tax free but no relief) expanded."

Tim Morris, independent financial adviser at Russell & Co also said a Lisa was not an adequate replacement for a pension and should be used to compliment rather than replace pension contributions.

On pensions the UK operates an EET system, where contributions are exempt from tax, investment returns are exempt from tax, but the proceeds of pension savings are taxable.

In the TEE Isa system, the contributions are taxable, but thereafter investment returns are exempt and the proceeds are not taxed.

Mr Morris said the Lisa was better for a basic rate taxpayer due to the TEE model as opposed to EET. 

He said: "It is mainly higher/additional rate taxpayers who are engaged in pensions for their retirement planning. This means that even if they pay some tax upon drawing their pension, for many it will be at a lower rate than the tax relief they received from the EET model. 

"In addition, while the Lisa has a savings bonus equivalent to basic rate tax relief, the tax free cash on a pension goes some way to negate the benefit of tax exempt withdrawals from the TEE model."

He added: "Many clients like the flexibility of withdrawing this as one lump sum, or phased in stages. However, if they could, many would withdraw more if they weren’t heavily penalised from a tax point of view. 

"Many unadvised clients still bite the tax bullet and do this anyway. This means the current retirement savings crisis we are facing will only get even worse."

However, other advisers have warned that younger workers should prioritise pension saving over Isas as many will never be affected by the LTA.

Kay Ingram, director of public policy at LEBC, said: "The employer contribution to a pension and tax relief doubles the employee’s auto enrolment contribution from 4 to 8 per cent. With many employers offering more than the minimum auto enrolment contribution and higher rate taxpayers getting double tax relief at 40 per cent of their pension savings, it provides a greater boost to the individual’s own contribution."

She added: "Younger workers should pay into pensions now and hope that a future government restores the real terms value of the £1.5m LTA introduced in 2006. That would mean its current value would need to be over £2m."

Similarly, Alan Chan, director at IFS Wealth and Pensions, said: "The LTA is not an issue for the vast majority of people, and even less of a concern for young people who will not be taking benefits for another 30-40 years’ time and it is only then that their pension benefits will be assessed against the LTA. Who knows what the LTA will be by then or if it will even be around anymore?  

"So in the absence of scrapping the LTA, it would change nothing and pensions are still the best long-term investment vehicle for young savers.  

"A Lisa may be considered in addition to a workplace pension where there are excess savings but they should not be mutually exclusive."

amy.austin@ft.com

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