The tax wrapper has even greater potential for capital growth, but pension tax relief will still prove decisive
Much of the reaction to George Osborne’s “Budget for savers” has focused on the freeing-up of pensions. And while a loosening of drawdown restrictions will no doubt be a boon for retirees, radical Isa reforms have important implications for current savers. The annual allowance will rise to £15,000 from 1 July (up from £11,520 for the current tax year), and rules on the amount that can be held in cash (as well as the prohibition of transfers from investment to cash Isas) will be removed. With the deadline for this year’s Isa contributions on 5 April, Danny Cox of Hargreaves Lansdown says the changes will prompt some to reconsider how they are saving.
BUILDING A GIANT SAVINGS POT
“We now have more conversations with clients about saving through Isas than pensions, and the reforms may accelerate this trend,” says James Robson of Plutus Wealth. The capacity for long-term capital growth (long one of the Isa wrapper’s key selling points) has been given a boost by the new £15,000 allowance. Brewin Dolphin has calculated that, assuming 5 per cent annual growth, maximum annual contributions starting this tax year would see an Isa pot pass £1m by 2039, three years earlier than under pre-Budget projections.
And as Jason Witcombe of Evolve Financial Planners points out, building up a pot of this size in an Isa has the added benefit of getting around the lifetime allowance on pensions. In recent years, the allowance (beyond which savings are subject to a charge of either 25 or 55 per cent, depending on how they are withdrawn) has fallen from £1.8m to its current level of £1.5m, and is set to fall again to £1.25m from 6 April, catching an estimated 360,000 more pensions. No such cap currently exists on the size on Isa pots.
THE FLEXIBILITY FACTOR
An end to the restriction on moving money from a stocks and shares to a cash Isa, meanwhile, is a “major enhancement”, says Rebecca O’Keeffe of Interactive Investor. Currently, savers can transfer from a cash Isa into a stocks and shares Isa, but can’t reverse this. But with the merger of the two, those approaching retirement (or anyone wishing to liquidate their equity holdings in times of market volatility) will be able to transfer to the more stable cash option. And this adds to the existing flexibility advantages of Isas, says Witcombe. “For younger savers, or those who may need access to their pots for a house deposit for example, there is really no reason to tie money up into a pension quite yet.”
But this is not to say that Isas should be the automatic choice. Jason Hollands of Bestinvest points out that the decision between pensions and Isas has long been dominated by their tax treatment. Isas shelter investments from income and capital gains tax, and unlike pensions, you can withdraw all the money tax-free at any time. “But for those in the higher income tax bands, the case for pensions gets stronger,” Hollands says.
Higher or additional rate tax payers, who are comfortable with their capital being tied up until they are 55, can use pension tax relief to effectively defer taxation until they are a basic rate payer (as most are in retirement). “In effect, a 40 per cent taxpayer will be able to get £10,000 of investment at a net cost of £6,000,” says Hollands. Since tax relief is upfront, the money gained will compound as part of the pot. You can also take up to 25 per cent as a lump sum tax-free on retirement. Cox, meanwhile, says it makes little sense to forego employer pension schemes that match contributions. Basic rate tax payers, however, have less to gain from pension tax relief, and should prioritise maximising the new Isa allowances, says Witcombe.