In the public eye, the traditional pension is not as dependable an ally as it once was. So-called ‘lifestyling’ of funds into investments such as bonds, which fall in value when interest rates rise, have seen pots plummet in value at even some of the largest providers. At the same time, economic uncertainty has made savers think twice about putting all their eggs in one basket – or even in the traditional basket at all.
Asked which alternative avenues to pensions are currently proving particularly attractive to savers, Hargreaves Lansdown Head of Retirement Analysis Helen Morrissey cites individual savings accounts (ISAs), lifetime ISAs (LISAs) and property.
“Some people – for example, the self-employed – may be put off pensions by the fact that they cannot access them until age 55,” she says. “So, they may welcome the flexibility of an ISA, which enables them to withdraw income as needed.”
While ISA savers may not obtain the upfront tax relief they would typically receive on a pension – or the employer contribution that comes with a workplace pension – the income is tax free, Morrisey explains. Plus, there is the option to utilise either a cash or a stocks and shares ISA.
Meanwhile, the LISA was developed specifically for young people looking to save for retirement, or their first home. LISA customers can save up to £4,000 per year and receive a 25% government bonus that works in the same way as basic-rate tax relief on a pension. That bonus could make a real difference to how much savers end up with, Morrisey says. As with an ISA, there is no employer contribution – but a LISA could prove a useful supplement or alternative to a standard pension.
“Groups such as the self-employed may find a LISA extra useful,” Morrissey says, “given that they wouldn’t receive an employer contribution to their pension anyway and, in times of financial stress, could access the money earlier than age 55.”
However, if you access funds for any reason other than to buy your first home or for retirement, you must pay a 25% penalty, which removes not only the bonus, but some of your own savings, too. “Also, you can open a LISA only between the ages of 18 and 40 – and will receive a bonus on contributions only until the age of 50,” Morrissey explains.
At a time of soaring house prices, many people would say that property is their pension. However, Morrissey warns that there are important issues to consider before relying upon that asset class in retirement.
First, there are costs associated with buying and selling property, such as stamp duty, solicitors’ fees and capital gains tax. Then, if you are running buy-to-lets, you must factor in ongoing maintenance costs and the expense of paying bills for any tenant-free spells.
But even more crucially, what goes up can come down, Morrissey warns. “The property market is under pressure at the moment,” she says, “and we expect prices to fall. So, not only could that take a bite out of expected profits – you may find that a sluggish market makes it harder to sell when you need to. And that could unravel your retirement plans.”
In the assessment of Moore Kingston Smith Head of Tax Tim Stovold, one perhaps lesser-known option – the Venture Capital Trust (VCT) – is currently enjoying a dramatic surge of interest. Stimulated by a trend of high earners looking for an alternative berth for their pension contributions, VCTs are listed investment companies set up to back SMEs.
Published in January, a UK Government study revealed that in the 2021/22 financial year, VCTs issued shares to the value of £1.12bn: a 68% jump on the £668m for 2020/21.
“As the highest earners are limited to making pension contributions of just £10,000 per year, there is a significant amount of wealth to be invested that can’t find its way into a pension. A VCT resembles a pension – with 30% income tax relief on investments made and tax-exempt dividends flowing from that investment,” Stovold says.
However, that is where the similarity ends: VCTs are high-risk and often illiquid investments – so an overt reliance upon a VCT portfolio could potentially lead to a diminished retirement fund.
Stovold is keen to highlight certain ‘buyer beware’ aspects of pension alternatives, as compared to the more traditional routes. Under the current rules, an undrawn pension is an asset that can be passed to beneficiaries upon death without an inheritance tax (IHT) charge.
But that does not apply to ISAs or VCTs – unless the ISA in question is invested in shares that qualify for Business Property Relief. And in light of the liquidity and risk issues, he stresses: “A VCT investment should not be confused with an investment in a pension.”
Stovold also warns that the tax regime covering buy-to-let properties has made that particular asset class less appealing as a pension alternative: “With upfront income tax relief on pension contributions, the exemption of tax on income and gains within the pension scheme, the ability to draw a tax-free lump sum equal, for most customers, to 25% of total fund value and, finally, the scope to transfer an undrawn pension to the next generation free of IHT, pensions remain a very tax-efficient way of saving for retirement.”
He continues: “Most individuals will make the maximum pension contribution they are able to make up to their annual allowance. Only once the annual allowance has been utilised would an individual normally consider alternatives.”
Morrissey agrees. “Pensions are a hugely tax efficient way to prepare for retirement,” she says. “Pension tax relief and the employer contribution for workplace schemes can make a significant addition to your own contributions.”
She notes: “The fact that you can’t access the money until the age of 55 – rising to 57 in 2028 – also means a pension benefits from long-term investment growth, which is hugely important. ISAs and property have a role to play as part of a retirement-planning strategy – but in most cases, a pension should form the key part.”
In Stovold’s view, accountants have a valuable steering role to play on how individual clients manage their retirement strategies. “We must take great care not to provide clients with investment advice, as that is a highly regulated area,” he says.
“However, we can still help them navigate the alternatives. We can explain how upfront tax relief – if any – applies, how investments are taxed in the period leading up to retirement, how they are taxed when clients draw a pension income and how the IHT regime will apply.”
Overarching all of those considerations is a political health warning. Stovold adds: “If we have a change of government in 2024, the Labour Party has already indicated that it would reverse some of the recent changes to the pension rules. So, any advice sought must be revisited if the rules change – with an expectation that the pace of change would accelerate with a new government.”
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