Keep your eyes on the prize

Will the Chancellor really cut pensions tax relief in her first Budget in October? While Rachel Reeves needs to raise cash, taxing the axe to pension tax breaks is more complicated than is often realised, particularly given the impact on public sector occupational schemes that offer final salary benefits. Nor is it likely to be a terribly popular move.

Still, it’s a possibility that savers now need to consider. For higher-rate taxpayers in particular, reduced pension reliefs may necessitate more of an emphasis on individual savings accounts (ISAs) for retirement planning. Although ISAs come with a lower maximum annual contribution - £20,000 versus up to £60,000 in a private pension – they offer tax relief at your highest rate of marginal tax (albeit as you take money out rather than on the way in).

The right answers will depend on the nuances of the Budget announcement. But it’s also important not to be distracted by the debate over savings wrappers. Remember, pension plans and ISAs are not investments in their own right – rather they are shelters in which you place investments to protect subsequent income and gains from tax. It is a distinction that really matters because the investment choices you make are going to be what makes all the difference to your standard of living in retirement.

Enter investment trusts. Closed-ended funds are ideal pension investments – partly because they have an excellent long-term growth record, but also because of the variety of funds available.

To consider performance first, analyses repeatedly show that over the longer term, investment trusts have delivered superior returns to other types of funds. One recent study, published by Wealth Club in July, looked at investment trusts with sister open-ended funds – that is funds run by the same manager with a similar mandate. It found 75% of investment trusts had delivered higher returns than their sister funds over the previous ten years, outperforming by an average of 5.3 percentage points.

There are a bunch of different reasons for this outperformance. In particular, investment trusts are allowed to take on gearing – borrowing money to invest – which can super-charge returns when markets are doing well. For longer term goals – such as retirement planning – that can have a dramatic effect.

As for variety, the thing about retirement saving is that your priorities change over time. When you’re younger, you’re looking for investments with the best possible growth prospects because you know you have plenty of time to weather ups and downs if markets prove volatile. As you get older, you’re probably hoping for less of a rollercoaster ride, and your needs will also shift towards income.

Investment trusts provide plenty of options here. During the accumulation phase of your saving, funds in sectors such as UK All Companies and Global offer exposure to stock market assets. You can also diversify using asset classes such as infrastructure, property and private equity, where the structure of investment trusts really helps with the illiquidity of these otherwise attractive assets.

As you get closer to retirement, you’ll be starting to think about how to turn your pension fund into a regular income. Perhaps you’re planning to cash the fund in to buy an annuity paying a guaranteed pension. In which case, you’ll need to shift into less risky assets to avoid a last-minute shock from the markets in the run-up to your purchase. Here the Flexible sector of the investment trust industry could be a good option – managers are more focused on capital protection and have discretion to invest across a broad range of asset classes depending on market conditions.

Alternatively, you may be considering an income drawdown plan, where you continue to invest your pension savings, but take an income directly from your fund. For these arrangements, equity income investment trusts can work well; in particular, the dividend heroes, which have consistently raised their dividends over many years, could be a good option. Investment trusts are unique in being able to hold back dividend income earned on their portfolios in good years in order to support payouts to investors in leaner times; this smoothing effect can be really useful if you’re dependent on your investments for income.

The bottom line? In the run up to October’s Budget, you’re going to see endless speculation about tax-efficient savings vehicles and how the Chancellor might change them. The key is to keep your eyes on the prize: think about the investments – and the investment trusts – that are going to help you hit your savings goals, rather than getting too hung up on the wrappers in which they’re held.