‘Out with the old and in with the new’ regimes
The Chancellor’s March 2014 Budget may well go down as one of the most radically overhauling game-changers since Lloyd George ushered in the state pension in the 1908 Pensions Act (at the time perceived as dangerously radical).
It has completely levelled the playing field as far as alternatives to the old pensions system is concerned. In summary:
- You are no longer obliged to buy an annuity when your pension plan matures under the new measures;
- Under the old regime, many savers invested in flexible ISAs instead of the rigidly constraining old pension schemes (ISAs allow savings to grow tax-free and can be cashed in any time);
- The new measures improve ISAs even more: raising the limit that can be invested to £15,000 (from £11,520) and making it easier to transfer your savings between cash and stocks & shares.
- So now that we all have the freedom to take all of our money on retirement to spend or re-invest as we wish, it is worth taking a closer look at the three key staging posts on the savings journey to help decide which is the best route to take.
Staging Post 1: keeping up-to-date
From 1 July, year 2014/15, ISAs will automatically become N(ew)ISAs, enabling you to add further savings up to the new £15,000 limit. You will be able to open one cash and one stocks & shares NISA each tax year. Crucially, the whole £15,000 allowance may be held in cash, stocks & shares or any combination of the two.
Staging Post 2: investments growth cycle
Pensions: the one thing both pensions and ISAs offer is a wide range of cash and investment options. While you are paying into your pension it benefits from tax relief coupled with compound interest – which can significantly increase the size of your total pot at retirement, notably so if you are a higher-rate taxpayer paying 40% tax on your ordinary income which is matched by 40% tax relief on your pension payments.
ISAs: ISA savers’ deposit money has already been taxed so does not benefit from tax relief on payments at source, as with pensions. However the new regime means that for the first time you will be able to transfer funds from stocks & shares into cash – previously, you could only move money from a cash ISA to a stocks & shares ISA but not the other way around. With NISAs, the transfer of cash/stocks/shares – whatever sort of NISA it is – between providers will be unrestricted.
Staging Post 3: drawdown time
From April 2015, you can access your pension pot in its entirety at any time after the age of 55. The first 25% will remain tax-free, the remainder being taxed at marginal rates.
Note: the minimum age for access is being raised to 57 in 2028 to keep pace with rises in the state pension age.
Example: From a £100,000 pension you can take £25,000 tax-free with the remaining £75,000 available to spend / re-invest as you wish. However, the £75,000 is treated as income for that tax year, pushing you into a higher-rate tax band.
Alternatively, draw the money down in small(er) annual lump sums which attract taxation at the basic minimum rate, currently 20% each year. You could keep your money invested in the stock market and go into ‘income drawdown’ – an attractive option if you were formerly a higher-rate tax payer benefitting from 40% tax relief on money paid into your plan.
If you are after the security of a guaranteed income for life, of course you can still buy an annuity: these are predicted to improve as providers are forced to offer better terms in the face of dwindling customers.
Even taking into consideration all the above, the attraction of the NISA still stands out. To conclude in the vein of the analogy of the title: two punishing jabs lead in to the knockout punch…regardless of how old you are (when you retire)…
- you can take the whole pot without penalty…
- and it is completely tax-free.
The famous movie line: ‘I could’a been a contender’ (Marlon Brando, in “On the Waterfront”) may well prove a fitting valediction for the (up to now) unchallenged old pension regime, in comparison to the upstart new NISA kid on the block.