We’ve often written about our preference for Isas over pensions as a savings vehicle. The removal of the requirement for anyone to buy an annuity and of the cap on drawdown at retirement changes the equation a little (more flexibility is good).
But Ian Cowie, writing in the Sunday Times, makes a reasonable point about the treatment of dividends inside pensions once drawdown has begun.
If you get paid a dividend outside a pension, you are assumed to have made a 10% tax payment already (via the corporation tax the business has paid). Basic rate tax payers then have no further liability, and higher rate payers have only another 25% to pay.
But if you get paid a dividend inside a pension and then draw down the income, you end up paying more. You pay the 10% (or rather, you aren’t effectively reimbursed the notional 10% via reduced dividend tax rates as you are outside a pension) and you also pay your marginal rate of income tax (rather than the lower dividend tax) on withdrawals.
“As a result,” says Cowie, “equity based income is taxed first inside the fund and a second time in the hands of savers”. I can see the point he is getting at here.
The notional 10% tax is a bit of a red herring, but it is true that dividends earned inside a pension wrapper in drawdown are generally taxed more heavily than those earned outside a pension (20% or 40% in a pension, 0% in an Isa and 0% or 25% outside a wrapper) but that – obviously – needs to be set against the full income tax relief you get when you put money in a pension. Relief on the way in. Tax on the way out.
Still, if it is a tax-free retirement you want, this tax set-up is another argument for filling your Isa every year before you spend too much time working on pension contributions beyond your occupational pension.
Make sure you take advantage of the pensions revolution
The entire landscape of retirement and saving has changed radically.
To help you make the right decisions for your future, we've produced a FREE "Pensions Survival Guide". It'll show you everything you need to know to make the new rules work for you.
To get your guide, just enter your email address below. You'll also start receiving our Money Morning newsletter – so whenever the financial landscape starts to shift, you'll be the first to know.