Where to stash your retirement savings

published 9 March 2018

886-pensions-634 — Find out what fraction of your savings it makes sense to put in a pension

If you've hit your pension allowance limits, you'll need to find another home for your cash.

With tougher rules on how much it is possible to invest in private pensions continuing to prove a challenge, savers are increasingly turning to alternative tax-efficient schemes to put money by for their retirement years.

The trend reflects a double dilemma now facing many pension savers. The first problem is that the annual allowance governing how much people may put into a private pension in each tax year has been cut several times in recent years it now stands at £40,000, down from £255,000 in 2011. In addition, savers are also running up against the lifetime allowance, which imposes tax penalties on those who have private pension funds worth more than £1m; this figure has been reduced from £1.8m in 2012.

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High earners face a further complication, because since 2016-2017 the annual allowance has been lower for anyone with an income of more than £150,000 a year. Above this level, savers lose £1 of allowance for every £2 extra they earn, up to an annual income of £210,000; thereafter, savers are limited to just £10,000 a year of private pension contributions.

The combined effect of these lower allowances appears to be causing difficulties for many people. In the individual savings ac count (Isa) market, the proportion of investors using their full Isa allowance continues to rise, even though the maximum £20,000 Isa contribution in the current tax year is significantly higherthan last year's £15,240. For example, one in five customers running a pension through Interactive Investor has already met the £20,000 threshold for this tax year.

These reports reflect a continuation of a trend noted in data from HM Customs & Revenue. It says around 40% of investors used their full Isa allowance last year, but that this figure was above 60% for those on the highest incomes. Isa providers such as Hargreaves Lansdown also report that more savers are opting for regular savings schemes in which people make monthly contributions to their funds, in the same way as they would contribute regularly to private pensions. Hargreaves has seen the number of regular Isa savers rise by 40% in less than two years.

Providers of VCTs (see below) say they sold £483m in the first nine months of the 2017-2018 tax year, more than double the sums raised in the same period of 2016-2017. It is now possible that the sector will beat its previous record for fundraising, even though the £779m raised in 2005-2006 came during a period when the tax breaks on that scheme were more generous than today.

Alternative pots for your retirement

While pensions offer upfront income tax relief at a saver's highest marginal rate of tax, as well as tax-free income and growth, there are other generous schemes available.

Individual saving accounts (Isas) allow savers to invest up to £20,000 a year, with all income and profits tax-free. Unlike private pensions, there is no tax to pay on withdrawals from Isas.

Venture-capital trusts (VCTs) offer 30% upfront tax relief on investments in new shares as well as tax-free income and growth. The annual limit is £200,000.

The enterprise-investment scheme (EIS) also offers a 30% upfront relief and other benefits including exemption from inheritance tax and capital gains tax. The annual investment limit is £1m.

VCTs and the EIS are designed to encourage investments in small unquoted companies (including renewable energy projects, such as solar farms), so it's important to be aware that this means there is a substantial risk you may lose your investment.

Tax tip of the week

Rent-a-room relief allows you to earn up to £7,500 a year in rent, tax-free. However, the relief only applies when the letting income comes from your "only or main residence", warns Tax Tips & Advice. If you had to move away temporarily for work, and wanted to rent out a room in your house over this period, whether or not you could still benefit from the relief would depend on the facts, according to HMRC: "are you putting down roots, or just biding time until you return to your main home?"

However, a property need only be a main residence at any time during the "basis period" the tax year, or the duration of the period that the room is let. If your residence in the property overlaps with that of your tenant, you should benefit from the relief. Where you vacate the house to rent a room on a short-term basis (via Airbnb, say) the relief should also still apply.

Who will get your pension when you die?

More than 750,000 people may miss out on inheriting pension benefits because pension providers have not been notified of changes in people's circumstances, warns new research from insurer Royal London.

The problem reflects the way private pension providers ask savers to fill in an "expression of wishes" form when they first begin making contributions. This form sets out who should receive any pension benefits that can be passed on in the event of the saver's death. In many cases, the circumstances of savers may change radically in the decades after they begin a pension plan, but the "expression of wishes" forms don't get updated. This may mean the wrong person inherits the benefits a former spouse following a divorce, for example, rather than a new partner.

Expression of interest forms aren't legally binding. In practice, pension providers have discretion over who they pass benefits on to and may be able to consult savers' wills to get a full picture of their preferences. Nevertheless, the problem can be very difficult to resolve and may result in a painful and costly dispute, with no guarantee of the result the saver intended.

The exact rules on who is entitled to inherit pension benefits and what tax is due vary according to the nature of the scheme and the age of the saver who dies. However, savers should keep providers up-to-date on their wishes including all pensions taken out in the past, even if you have stopped paying into them.

David Prosser is a regular MoneyWeek columnist, writing on small business and entrepreneurship, as well as pensions and other forms of tax-efficient savings and investments. David has been a financial journalist for almost 30 years, specialising initially in personal finance, and then in broader business coverage. He has worked for national newspaper groups including The Financial Times, The Guardian and Observer, Express Newspapers and, most recently, The Independent, where he served for more than three years as business editor.