David Prosser explains the latest budget changes and why the closed-ended sector is worth a look.
Retirement planning is about to get trickier for financial advisers with clients on high incomes – this week’s Budget imposed new limits on pension contributions in a raid on high earners that went much further than had been expected.
The Conservatives’ plan to limit the annual contributions allowance on which wealthier savers get tax relief had been well trailed. As forecast, next April, those earning more than £150,000 will see their allowance tapered down from £40,000 to £10,000 at a rate of £1 for every £2 over the limit. Crucially, however, pension contributions – made by both individuals and employers – will count towards the cap. So in theory someone earning £110,000 and using their full £40,000 pension allowance could be affected by the change.
Advisers now face two questions as they consider the best way forward for clients affected by this reform. First, how do they take advantage of the grace period between now and next April, when the changes come into force? And second, how should clients invest for retirement thereafter?
With both questions, there’s a couple of issues to consider. There’s the most tax efficient structure to identify, but also the assets investors should be holding within those structures.
On structures, it’s clearly worth using every last penny of this year’s £40,000 investment allowance if you possibly can. And don’t forget the carry forward rules, which allow investors to mop up unused allowances from the past three tax years. In theory, someone who hasn’t made any pension contributions yet this year, or saved at all in the past three years, has up to £180,000 to play with before next April – that’s £81,000 worth of tax relief for a 45% taxpayer.
From 2016-17 onwards, the strategy will need to change. Investors will need to assess their annual income carefully well before the year ends in order to work out what their allowance actually is. And for contributions above the new ceiling, they’ll need to consider other tax-efficient vehicles, including individual savings accounts (ISAs). Assets held outside a tax wrapper will need to be planned for carefully given the income and capital gains tax rules.
So where are investors going to put their retirement savings going forward, both inside and out of pension wrappers? Enter the investment company sector.
For many savers, low-cost investment company savings schemes represent an excellent way to save for retirement, offering strong performance track records and valuable diversification. They can be held inside and out of pension plans and ISAs, so investors don’t have to worry about different pots of assets. And they’re portable and flexible, offering good value dealing services that may be useful as investors juggle tax allowances.
The other important advantage the investment company sector offers pension savers is that many funds work very well in the context of the pension freedom changes introduced earlier this year. With many savers now looking forward to drawing an income directly from their savings rather than buying an annuity – something the reforms make much easier – they need investments that are good vehicles for both wealth accumulation and income withdrawal. The inflation-beating record of investment companies over many decades of dividend increases makes the sector an obvious place to start looking for that combination.