Amongst all the talk of Brexit in the news at the moment there is also the small matter of the Budget, which Philip Hammond delivers to parliament on Monday 29 October.
The Budget speech is a useful update on the state of the UK economy as well as providing information on the government’s plans for income (tax) and expenditure over the coming months and years.
There are several commentators speculating on whether the Chancellor will raid pension tax relief or reduce the Annual Allowance and Lifetime Allowance in order to generate more tax revenue to help balance the books.
Pension tax relief represents a large cost to the country. An estimate by the Financial Times in January suggested it could cost as much as £41bn in 2017/18.
So, with these potential threats to pensions do they still represent a good option to grow wealth?
I do not know whether the Chancellor will reduce allowances or tax relief on pensions next Monday but even if he does I believe pensions still represent one of the best strategies for providing for our needs in later life.
The main benefits of pensions can be summarised as follows:
- Tax – Unless the Chancellor chooses to remove all tax incentives from pensions in the budget (unlikely) you will still benefit from making contributions to pensions
- Income tax relief – for a basic rate taxpayer the cost of investing £100 in a pension is £80 (HMRC pays your pension fund £20 in tax relief). For a higher rate taxpayer, the cost is £60 for a £100 contribution.
- No capital gains tax on pension investments – this may be more relevant if changes are introduced to narrow the gap between the rates of income tax and capital gains tax
- Normally exempt from inheritance tax – unless you are in serious ill health before drawing your pension.
- Discipline – it’s easy to set up a regular pension contribution either individually or through your employer. After a while you don’t tend to notice the monthly cost and as you can’t access the fund until age 55 there is less chance of squandering your hard-earned savings. (Old fashioned but effective!)
- Flexibility – You can access as much of your pension fund as you want after age 55. Bear in mind you may pay tax on this income and the fund may run out before you.
- Investment Returns – You participate in the stock market which typically produces a higher level of investment growth over the medium to longer term than most other investment assets.
- Employer Contribution – If you are a member of your employer’s pension scheme you will benefit from their contribution as well as your own.
- Legacy – Any value left in your pension when you die can be passed on to your loved ones, usually free of inheritance tax.
Setting up a pension is easy, particularly if your employer has a scheme on place – this is mandatory for most employers.
Some tips for getting the most out of your pension scheme:
- Work out a minimum monthly amount you can afford to save and set up a direct debit or agree a deduction from your salary with your employer
- If you get a pay rise or bonus increase your contribution amount or make a special one of contribution as a proportion or any bonus.
- Don’t be too risk averse if you are more than 10 years away from retirement – the stock market is your friend and will work in your favour over the medium to long term. You can protect what you’ve got nearer retirement.
- Keep an eye on costs – there is no need to pay more than 0.75% per annum for the cost of the pension product and funds combined.
- Get independent financial advice – a competent independent financial adviser or planner who understands your circumstances and goals is likely to add far more value than the costs of their advice.
So no matter what the Chancellor decides next week about pension tax relief and allowances it is still an option worth considering.