Martin Lewis advises on moving your savings into ISAs
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Like Isas, pensions offer highly tempting tax benefits and are a lot more flexible than they used to be.
That’s the view of Sean McCann, chartered financial planner at NFU Mutual, who reckons pensions now offer the over-50s a more tax-effective way of investing than Isas.
He wants to get the message out there as millions of Britons prepare to invest this year’s tax-free Isa allowance before the annual deadline of midnight on April 5.
Isas allow every adult to invest up to £20,000 this tax year, and take all their returns free of income tax and capital gains tax for life.
On death, you can even pass on any unused Isa savings to a spouse or civil partner, again, totally free of tax.
However, after they die, the money will become liable for inheritance tax.
These are brilliant benefits yet pensions also offer generous tax advantages and the over 50s are best placed to take advantage of them, McCann says.
“Millions of investors in their 50s and 60s could be thousands of pounds better off prioritising pensions over Isas in the final days of the tax year.”
Pensions are a lot more flexible than they used to be, he says, thanks to 2015’s pension freedom reforms. “Investors can now access their pension pot from age 55, which rises to 57 from 2028. So the over-50s will not have to wait long to access their money.”
HMRC offers tax relief on pension contributions as an incentive to invest, kick starting your savings.
Basic rate tax relief of 20 percent is paid automatically to everyone. Higher rate 40 percent taxpayers and those paying the additional 45 percent rate must claim the extra relief via their self-assessment tax return.
McCann gives the example of a basic rate taxpayer who has £6,000 to invest. If they paid that into a pension, tax relief would instantly lift its value to £7,500, courtesy of HMRC.
Isas don’t get tax relief so the pension saver would be £1,500 ahead from day one.
A higher-rate taxpayer who paid £6,000 into a pension would get an even bigger boost, as tax relief would increase their contribution to £10,000.
That’s £4,000 more than if they had invested the same sum in an Isa.
After that, both the pension and Isa money will enjoy tax-free growth, although the pension savings would begin from a much higher starting point.
In contrast to Isas, pension withdrawals may be subject to income tax. So while you get a tax uplift when you pay money in, you may return some of this to HMRC.
However, McCann points out that many pensioners will pay a lower rate income tax than they did while working and making pension contributions.
A pensioner whose total income is below the personal allowance of threshold £12,570, including pension withdrawals, would pay no income tax at all.
Someone who got 40 percent tax relief on their pension contributions but paid 20 percent income tax in retirement would also do well out of investing in a pension, McCann says.
Even someone who pays 40 percent income tax both while working and in retirement could win out, because 25 percent of pension withdrawals can be taken as tax-free cash
The clincher for many is that pensions can also be passed on to loved ones free of inheritance tax on death.
In my view, this doesn’t mean savers should forsake Isas. Pensions and Isas offer complementary tax benefits, the former when you pay money in, the latter when you take it out.
A blend of them both should keep your exposure to HMRC to the minimum. It’s all a bit complicated so consider taking independent financial advice if stuck.
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