If you’re not currently saving for retirement, you should make it a priority for 2018. Research published by the OECD club of mostly rich countries in December showed that the UK now has the least valuable state pension of any developed economy in the world, leaving those who haven’t made private provision facing an uncomfortable retirement. The good news – for those who have put off the process through dread or boredom – is that making a start is probably a lot easier than you think.
Grab what your employer offers
If you’re employed, make sure you have joined your employer’s pension scheme. It’s a no-brainer. Under auto-enrolment, all employers must now offer a pension scheme and you will have been signed up automatically unless you have specifically opted out. Choosing not to join means missing out on a pension contribution from your employer, worth a minimum of 1% of your salary, rising to 2% in April, then 3% in April 2019.
Self-employed workers don’t get this assistance, but they still qualify for financial support from the government when paying into their own private-pension scheme. You get upfront income tax relief at your marginal rate of tax, so a £1,000 contribution, costs £800, £600 and £550 respectively for basic-, higher- and additional-rate taxpayers.
For most people, this tax relief is available on pension contributions of up to £40,000 a year (this annual allowance includes the value of the relief itself).
The exceptions to this rule are that you can’t contribute more than you earn (other than a basic £3,600 annual limit) and that those earning more than £150,000 see the annual allowance reduced on a sliding scale to just £10,000 for anyone earning more than £210,000.
Money paid into private pensions can’t be accessed until you are at least 55. At this stage, the pensions freedom reforms of 2015 give you a wide range of options: you can keep making contributions; move your money into an income-drawdown arrangement (where you’ll have the option of taking money straight out of your pension fund); or buy an annuity, which converts your savings into a regular income. You can also take up to 25% of your savings as tax-free cash; when combined with the upfront tax relief, this makes private pensions more rewarding, from a tax perspective, than individual savings accounts (Isas).
Keep your costs down
To make the most of this, you need to choose the right type of pension. Most importantly, look at charges and which investment funds you will be able to access via the pension. Self-invested personal pensions (Sipps) typically give access to a wider range of potential investments, which may be useful for those planning to take a hands-on approach to managing their pension fund. But even basic pensions should now offer a good range of choices, including funds managed by providers other than the company running the pension itself.
Over time, securing better returns and paying lower charges makes a huge difference. Paying £1,000 a month into a fund that costs 1% a year and returns 5% annually will generate £682,000 over 30 years. A return of 7% over the same period would deliver £968,000. Cutting the charge to 0.5% on that same higher return would produce almost £1.1m. There’s a limit to the size of pension pot you are allowed to build up – the lifetime allowance.
This cap, currently £1m (rising to £1.03m from April), applies to the total value of all savings you have in private pensions. Savings above this level are subject to punitive tax charges, so stay on the right side of the rules.
Tax-efficient alternatives to a pension
Investing in tax-free individual savings accounts (Isas) alongside your pension makes sense – returns on Isas are completely tax-free and you’ll also build up a pool of savings that is much simpler to access if needs be (and, so far at least, less prone to interference from successive governments).
Venture-capital trusts (VCTs) and the enterprise-investment scheme (EIS) are worth considering if you’re a high earner who’s concerned about breaching the annual or lifetime pension allowances.
VCTs and the EIS make similar types of investment, in small, early-stage businesses where the government believes investors need an incentive to provide what may be very risky support. But the schemes operate in different ways.
A VCT is a fund run by a professional manager who builds a portfolio of qualifying companies; investors get 30% upfront tax relief – so it costs only £700 to invest £1,000 – and income and profits are tax-free. You can invest up to £200,000 in VCTs in any one tax year.
The EIS has a higher annual investment allowance of £1m and can be used to invest in individual businesses or a managed fund. Like VCTs, the EIS offers 30% upfront relief and tax-free returns, but the scheme also enables you to defer paying tax on previous capital gains and to set any losses you incur against tax. EIS shares are exempt from inheritance tax once you’ve owned them for two years.
Tax tip of the week
In 2016, around 14,000 people filed their tax returns between Christmas Eve and Boxing Day. However, many more of us leave it to the last minute, which means a fair few of you probably have your own tax return for the 2016/2017 fiscal year still niggling away on your to-do-list. The deadline is 31 January to file online (you’ve already missed the paper deadline), but if you plan to pay by credit card, get your return in now – from 13 January HMRC won’t accept credit-card payments.
If you do miss the deadline, you’ll automatically be fined £100; after three months, you’ll be fined an extra £10 a day up to a maximum of £900; and after six months, either £300 or 5% of the tax due is added to your bill.