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Weekend reading: Pensions in perspective

Weekend reading

My regular weekend ramble, then it’s on to a list of great reads.

Every morning seems to bring a new personal finance headline these days.

Last week it was high-earning sole breadwinner families and those on excessive benefits who saw their handouts cutback. This week it was the turn of super high-earners, who now face a cap on their pension contributions:

Tax relief on pensions will be limited to contributions of £50,000 a year, down sharply from the current ceiling, which is five times that. However, there had been suggestions that the limit would be nearer £30,000 a year, which would have hit many on relatively modest incomes who had many years of service with their employer.

Higher-rate taxpayers will also be allowed to keep tax relief at their highest rate on pension contributions up to the £50,000 limit. There had been fears that the Government would restrict tax relief to 20pc for everyone.

I think on balance the move is perfectly sensible, even if it is odd coming from a Conservative-dominated Coalition. Liberal Democrat voters should stop bleating and be proud of the difference their party is making to the deficit-reduction balancing act.

As for the £50,000 cap, well the idea of tax relief for pensions is to stop people being a burden on the State in their old age, NOT to enable Fat Cats and Cityboys to stash away absolutely enormous amounts of money free from the tax man’s grasp. The move doesn’t cap the ultra-rich person’s ability to invest for their future, just the tax rebate the State gives them for doing so.

But it would be unwise to be too smug. Only 100,000 high-fliers are estimated to be affected by this new rule (and the FT is already pointing out ways around it) but you don’t have to wait for long for something else to come along to clobber you in the current climate.

I had feared ISA limits might no longer go up with inflation, but the Treasury has clearly decided it’s a cheap middle-class perk, and thanks to runaway CPI inflation it will raise the limit to £10,680 next year.

That’s good news if you aspire to be one of the emerging band of ISA millionaires. This week’s pension cap move does introduce a niggle into the idea of using ISAs to fuel a pension, however.

Currently you can transfer ISA savings into a pension pot at a later date if the rules or your circumstances make it sensible, and pick up 20% or 40% tax relief on the way. But the new £50,000 cap will limit that traffic.

New investors might smirk at the idea of a £50,000 a year transfer being ‘limited’, but money invested in equities can grow like Topsy over time – whatever our recent history indicates!

I also fear the pension cap will hurt small-scale entrepreneurs, who sell their businesses and put the capital gain towards a one-off boost to their retirement pot. Unlike fat cats, they take genuine risks – and they’re the lifeblood of the economy.

Ultimately, the constant fiddling with pensions and ISAs proves the futility of fine-tuning a retirement investment strategy based on current legislation. You simply don’t know how the rules will change.

The best approach is to keep some money in an ISA, some in a low-cost pension (a must if you are offered employer’s contributions – it’s free money), and some cash outside these wrappers entirely.

Oh, and don’t ask who the deficit reduction bell tolls for, because sooner or later it will inevitably toll for thee!

From the money blogs

From the big money sites

  • Annual ISA allowance to rise to £10,680 – FT
  • Analysts predict bumper year for VCTs – FT
  • Meet Mr and Mrs Average – This is Money
  • Beware of rolling over utility bills – Telegraph
  • Return of gazundering as house prices fall – Telegraph
  • Rents soar as first-time buyers struggle – Independent
  • Dividends rising, notes a contrarian fund manager – Independent
  • This week’s dubious new investment: Cemeteries – The Guardian
  • Should UK investors worry about house prices? – Motley Fool
  • Studying the rich – New York Times
  • Israel’s market versus its 1980s hyperinflation – Business Insider
  • Another day, another miss-sold structured productBloomberg
  • Currency war: America versus China – Flanders / BBC
  • Equitable Life compensation to total £1.5 billion – BBC

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{ 9 comments… add one }
  • 1 Tyro October 16, 2010, 11:04 am

    Re your point about the pensions cap hitting entrepreneurs’ ability to put the profits of selling their businesses into their pensions: the new arrangements will supposedly allow for one-off spikes like this by permitting the use of under- or unused allowances in previous years, over a 3 year timeframe.

  • 2 ermine October 16, 2010, 11:11 am

    > Currently you can transfer ISA savings into a pension pot at a later date

    Really? Once again you bring to my attention a curious detail which could be greatly to my advantage! I had no idea this was possible, and I may prioritise ISA over AVC savings if that’s the case, since the flexibility of ISAs is attractive if it is possible to get the last year’s tax back afterwards 🙂
    .-= ermine on: we’re entering a family-unfriendly economic system =-.

  • 3 The Investor October 16, 2010, 12:45 pm

    @ermine – Under current rules you can transfer in £235,000 a year into a pension, which will be coming down to £50,000 with the new rules.

    This lump sum can come from anywhere – it’s not an official ISA-to-pension scheme, it’s just a matter of withdrawing your untaxed ISA money and putting it into a pension, collecting tax relief as you go.

    As I see it it’s a good strategy for people in their 50s and early 60s who find themselves well into the higher-rate tax bracket. Transferring ISA money over gets tax relief at 40% in such circumstances.

    Not so attractive if you’re a basic rate payer and always will be, since you get taxed on the pension cash at the basic rate again when you come to withdraw anyway, as I covered in my post showing the similarities and differences between ISA and pension tax relief.

  • 4 The Investor October 16, 2010, 12:50 pm

    @Tyro – Unless I’m missing something, that will only be of limited help.

    At current annuity rates (which are a decent guide to returns in old age however you actually invest) a 65-year old man would do well to get a level £6,000 a year from £100,000.

    To get a pension of say £30,000 a year is going to require £1/2 million.

    If I sell my cornershop or florist or direct mail or insurance businesses or whatever for say £1,000,000, I might sound rich but that’s still only going to buy £60,000 of pension — a lot, but hardly a millionaire lifestyle. Moving £50,000 over a year is going to take an age.

    Perhaps I’m missing something, but as far as I can see small-scale entrepreneurs now need to think even harder about whether they should wrap up all their eggs in the one basket, or whether they should take out money to fund a pension long before retirement.

    “Of course they should” we may say, but it’s not always easy to find lumps of cash from cashflow as a small business, and it comes at the cost of expansion etc.

  • 5 Thomas Jones October 16, 2010, 2:44 pm

    I think it’s important to mention that you are no longer forced into an annuity at retirement. Unsecured pension, also known as drawdown is increasingly seen as a far better option for some. You can take out more money than current annuity rates, up to 120% maximum GAD (Government Acturary’s Department) rate.

    A trend is to phase into an annuity and take some of the cash combining both to gain a fixed income whilst retaining some flexibility. Of course there, is investment risk with this approach, not so with the annuity element. On the other hand, most annuities are level and therefore, subject to inflation risk. This hybrid approach is meant to balance the two.

    Note. there is no limit on how much you can contribute to a pension, the limit is on tax relief. Naturally, contributing without tax relief starts to lose its appeal.

  • 6 The Investor October 16, 2010, 2:58 pm

    @Thomas – Thanks as ever for the extra detail. I appreciate you’re not forced into an annuity, but annuities do provided a decent starting point for seeing what income chunks of £100,00 might buy. Pension pots need to be much bigger than the average person realizes. (Not you I know!)

  • 7 Neil Wilson October 16, 2010, 8:29 pm

    ” Unlike fat cats, they take genuine risks – and they’re the lifeblood of the economy.”

    That they might be, but I’ve yet to meet a genuine entrepreneur who refused to do something because the tax breaks weren’t good enough. That’s not how real entrepreneurs think. If there’s a sniff of a profit, they are in like Flynn.

    Tax breaks encourage ‘pretend’ business startups, asset stripping and ‘schemes’ (such as most Venture Capital Trusts). Better to scrap them and spend the money lowering barriers to entry everywhere so that the real entrepreneurs can get on with the job of making the world a better place.
    .-= Neil Wilson on: The Monetary System is just a Spreadsheet =-.

  • 8 Niklas Smith October 18, 2010, 10:48 am

    You’ve forgotten an important point – the £50,000 annual limit applies only to contributions eligable for tax relief. As you said yourself, you can put in as much as you like without tax relief. Moreover, tax relief is meant to compensate for income tax levied at 20% or 40%: given that CGT for entrepreneurs selling a business is only 10% for the first £1,000,000 they would actually be making a profit from the taxman if they got even 20% relief on all of that!

  • 9 The Investor October 18, 2010, 11:18 pm

    @Niklas – I agree the entrepreneurs relief does supply some element of tax relief compensation. But beyond that I don’t really agree, because I’m looking at it from the point of view of a small business owner, who to stay in business and to grow the business (and ultimately to grow the economy and employ more people, but that is invisible hand stuff – he is obviously interested in his piece of the pie ; ) ). He or she hasn’t taken the salary they could, often, whether at 20% or 40% because they have instead ploughed the money back into growing the business.

    If I was a small business owner now and I thought pensions were a good idea, I’d be more likely to try to draw a bigger income sooner, rather than reinvesting, to capture the tax relief. (It’s even greater for small business owners in fact because they can avoid NI payments or similar on pensions – I forget the precise details (apols – was a friends birthday this evening! hic! 😉 )).

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