However, it is not only NHS staff who are adversely impacted by this tax, as this can impact all high earners who save into pensions.
We have previously looked at the tapered annual allowance and explained how this change, made in the 2016/17 tax year, reduces the tax relief you receive on your pension contributions. Before looking at the alternatives to pension saving, here’s a brief summary of the issues.
High earners facing additional tax charges thanks to the tapered annual allowance
The annual allowance is the amount that people can pay into their pension each year in order to benefit from tax relief. The current standard allowance is £40,000 and includes both your own and any employer contributions.
The ‘taper’ reduces the annual allowance from £40,000 to as little as £10,000 for those whose total ‘adjusted income’, including pension contributions made on your behalf by your employer, is more than £150,000.
This can be a problem if, for example, your earnings don’t follow a predictable pattern. If you don’t know what your earnings will be in any one year you can’t know what your annual allowance will be!
Alternatives to making pension contributions if you’re facing taper issues
When considering long-term savings, pensions are often the most tax-efficient and preferable choice. But for those who need to save more than £10,000 a year in order to achieve their retirement goals, other savings options need to be considered. Some other popular options include:
One recent addition to the suite of retirement savings products is the Lifetime ISA (LISA).
You can open a LISA if you’re aged between 18 and 39 and you can invest up to a maximum of £4,000 into a LISA each tax year, up to your 50th birthday.
Note that the £4,000 forms part of your overall ISA limit, currently £20,000 a year. Your £20,000 limit includes all ISAs and so if you contribute the £4,000 limit into the LISA, your remaining allowance for Cash, Stocks and Shares, or Innovative Finance ISAs is £16,000.Both Cash and Stocks and Shares LISAs are available, depending on whether you want a cash or stock market-based investment.
One main benefit of the Lifetime ISA is that for every £4 you save, the government will add £1 (up to a maximum of £1,000 every tax year). This bonus is paid monthly, so you’ll also benefit from compound growth.
As with other ISAs, your money grows tax-free. You can make withdrawals from your LISA after the age of 60, and these withdrawals are tax-free.
If you access your cash before the age of 60, you’ll pay a 25% penalty on any withdrawal unless you’re using the money to buy your first home.
Every individual has an ISA allowance, so a married couple could, for example, currently contribute a total of £8,000 to Lifetime ISAs each tax year, and you would both benefit from the government bonus.
Remember also that the ISA allowance resets every tax year, and so you can continue to invest up to the limit every 12 months.
If you have maximised your ISA allowances, then you can save for your retirement in a wide choice of other investments and you don’t have to be restricted by the £20,000 limit. Many of these work in similar ways to ISAs, although they typically don’t offer the same tax benefits.
These may include:
- Unit trusts
- Investment trusts
One option is to invest a lump sum into one of these investments and then to ‘drip feed’ this into your ISA in order to maximise your allowance every year.
For certain clients, and only in the right circumstances, Venture Capital Trusts (VCTs) may also be an option, although these are high-risk investments.
Each of the above requires careful consideration, tax planning and may not be suitable for every investor. Detail about the benefits and potential pitfalls of each are beyond the scope of this article.
Using your spouse’s pension allowance
If you are comfortable with taking a ‘team’ approach to your retirement planning, then married couples wanting to maximise their tax-efficient savings can consider utilising both spouse’s pension allowance.
So, if a spouse is earning £25,000 a year but only paying £5,000 into their pension, it may be possible to contribute another £20,000 gross to their pension. This way, your household pension savings are being bolstered. If your spouse is not working, you can still pay up to £3,600 a year into their pension, and this will only cost £2,880 thanks to the tax relief.
If you’d benefit from expert advice regarding your retirement planning, or you’d like to discuss any of the points made in this article, please get in touch.
This article is distributed for information purposes and should not be considered investment advice or an offer of any security for sale. This article contains the opinions of the author but not necessarily Ermin Fosse and does not represent a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but is not guaranteed. It is not a promotion of Ermin Fosse’s services.
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