Young savers could turn to Isas to avoid tax charge

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.

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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.