Hit the pensions lifetime allowance? Make sure you use your Isa
Many savers are running into the pensions lifetime allowance. But don't forget that you can also use your Isa to save for your retirement – it has no such limit.
It’s a nice problem to have, but growing numbers of savers are running into the pensions lifetime allowance – a lifetime limit on the size your pension pot can grow to before being taxed (rather than a limit on contributions). And given that the tax charges to pay on pension funds above the threshold – currently just over £1m, and frozen until 2025 – are rather punitive, the case for looking beyond pensions for long-term savings is stronger than ever. Individual savings accounts (Isas), in particular, charge no tax, however large your nest egg grows.
In fact, the number of Isa millionaires continues to increase. Data published last month by Investing Reviews, based on freedom of information requests, suggests around 2,000 Britons have now built up savings within their Isas of at least £1m. The average Isa in this group is worth £1.4m; around 60 savers have Isa holdings worth more than £3m, and one has more than £6m.
Become an Isa millionaire
To reach those totals, savers will have had to take full advantage of their annual Isa allowance – now £20,000 – and to have enjoyed a fair wind from investment returns. If you were starting from scratch today, it would take around 22 years of investing £20,000 a year to hit the £1m mark, assuming annual returns of 7% a year. The richest Isa savers today must have earned returns of more like 20%–25% since the launch of Isas in 1999, given that Isa allowances were smaller in the early years.
Nevertheless, the scale of Isa savings that many people have managed to amass is impressive – and underlines why Isas have become a mainstay of retirement planning for so many. On tax breaks, there is not a lot to choose between Isas and (defined contribution) pensions: the latter offer tax relief on contributions, but there is tax to pay when you cash them in; the former offer no upfront relief, but with no tax to pay on the way out. Pensions do offer the chance to cash in 25% of your fund tax-free at retirement, but that advantage now has to be weighed against the risk of breaching the lifetime allowance.
Pensions versus Isas
As for contribution limits, the Isa allowance is half as generous as the £40,000 annual allowance on pension contributions available to savers who earn at least that much each year. But wealthier savers – the ones who are most likely to face a lifetime allowance issue – often have lower pension annual allowances in any case, because once your annual income hits £200,000, your contribution limit starts to fall.
If you can join a pension scheme at work, it almost always makes sense to do so, otherwise, you’re missing out on a pension top up from your employer – effectively free cash. But pensions should not be viewed as the be-all and end-all of long-term savings. The data on millionaires shows that Isas can also be a very effective way to build wealth.
Remember, too, that Isas are much more flexible than pensions. You can cash them in whenever you like, rather than having to wait until age 55, as is the case with pensions (bearing in mind that this age limit on pensions is only likely to go higher, while the tax benefits are constantly under threat).