In line with our risk management framework, today we published our Q4 2019 performance update.
Will the ISA topple the pension?
2015 will no doubt go down as the year of the pension ‘shakeup’. Chancellor George Osborne had already declared his plan for the revolution in 2014, but the impact of the freedoms has been marked. In the first three months after the obligation to annuitise was withdrawn in April, some £2.5 billion in payments were made to savers according to figures from insurers, while it is estimated that £27 million is being withdrawn from pension pots every day.
Suffice it to say, the savings landscape has palpably been altered forever.
Yet the revolution shows no signs of slowing down, as Osborne announced the publication of a green paper at the Summer Budget setting out sweeping reforms regarding the manner in which pension savings are taxed, and HM Treasury are conducting a consultation to explore the possibility of bringing them into line with the tax relief structure of ISAs. The consultation process is effectively looking at three potential options:
i) Creating a new ‘Pension ISA’ as an alternative to the existing pension
ii) Keeping the pension, but offering a flat rate of tax relief
iii) Maintaining the status quo
The first option would be the most radical change of all, and may have some people scratching their heads. However, the simplicity of ISAs has made them immensely popular, and there is growing debate – particularly among basic rate taxpayers - as to whether they should turn to an ISA instead of a pension even in the current climate.
The existing architecture for taxation on pensions is known as EET (Exempt, Exempt, Taxation), which means that tax relief is offered to both contributions and capital growth of the fund, with income only being taxed once it is withdrawn at retirement age. Like the existing ISA, a Pension ISA would remove upfront tax relief (savers make contributions from their taxed income, unlike a pension), but allow fund growth and withdrawals to be tax-free (TEE).
For the Exchequer this would be enormously enticing, as it would provide an advance on tax revenues usually deferred until withdrawal on pensions, and topping up the coffers would give his bid to reduce the fiscal deficit a significant boost.
However, the consultation should, first and foremost, be about the benefits to the saver. Certainly, the simplicity of a Pension ISA would be appealing, and avoiding the notorious insurer fees associated with drawdowns from pensions would add to the appeal. In addition, the ability to access these savings before the age of 55 is another benefit of the proposed overhaul.
Such accessibility could be seen as a blessing and a curse though. Indeed, with pensions currently ring-fenced as they are, succumbing to the temptation of frivolous spending of one’s life savings doesn’t come into the equation, and a retirement nest egg of some sort is essentially guaranteed. The other thing to note is that contributions into pensions still generally yield better lump sum values at retirement age than ISAs.
The case for flat-rate tax relief
The numbers advantage significantly diminishes for basic rate taxpayers though, and this is due to the nature of the current pension tax relief rules. Individuals currently receive upfront tax relief at their marginal rate on contributions, which clearly favours higher earners, who could then, in theory, manage their portfolio such that they are taxed at a lower rate by the time they enter retirement and begin drawing down from their pot.
With the imperative being on incentivising lower earners to save, the case for a flat rate of upfront relief, at a percentage somewhere between the basic rate and higher rate tax bands, has been mooted as a good solution. In simple terms, something like 30% would be a fairer middle ground between higher and lower earners, providing the latter with greater benefit when making contributions.
This would also preserve the existing pension model, and avoid the complexities that would arise by running this concurrently with the Pension ISA system. After all, the introduction of a Pension ISA wouldn’t mean the pension as we know it would suddenly disappear – it would obviously need to run its course for decades to come.
What about just staying as we are?
It should be borne into mind that although pensions are classed as EET, the taxation on withdrawals is, in reality, only a partial taxation given that 25% of each withdrawal is tax-free. In addition, some experts believe that the elimination of an upfront tax break with a Pension ISA would discourage people from saving, given that the long-term benefit of tax-free withdrawal is less tangible than a ‘win’ at the start. To reference that abominable old cliché: A bird in the hand is worth two in the bush.
Yet despite the strong counter-arguments to the Pension ISA, it would also take a brave individual to argue that the pension system in its current form is in fine fettle, and Osborne’s willing to question the gospel and implement changes should be welcomed. Of course, too many radical changes in a short space of time could undermine the credibility of the retirement savings landscape, and may result in savers becoming reluctant to ‘buy in’ to any new system if they suspect everything will just be changed again at the next Budget.
Whatever the result of the consultation, any change that not only encourages saving across the board, but also simplifies things is something we will ultimately champion. We’ll be watching with a keen interest to see which way the Chancellor decides to go.
- Innovative Finance ISA: The good and the 'bad'
- HMT confirms new third-way Innovative Finance ISA
- Innovative Finance ISA: The force to awaken P2P lending
Get email updates for future blogs:
Our website offers information about saving, investing, tax and other financial matters, but not personal advice. If you're not sure whether peer-to-peer lending is right for you, please seek independent financial advice, and if you decide to invest with Lending Works, please read our Key Lender Information PDF first.
Since opening our doors back in 2014, we’ve always prided ourselves on living and breathing two key principles at Lending Works: innovation, and putting the customer first in everything we do.
With the retail sector enduring its fair share of challenges, companies are looking at new ways to attract customers, and drive conversion. In an overcrowded, dog-eat-dog marketplace, with behemoths such as Amazon flexing their muscle, it’s easier said than done.
On 4 June 2019, the Financial Conduct Authority (FCA) released its new regulatory framework for peer-to-peer lending (P2P); a Policy Statement known as PS19/14. As you might imagine, it's a document which, following a three-month consultation, is a hefty read of no fewer than 102 pages.
In a difficult climate, customer acquisition and lead generation present stern challenges for UK retailers, and a great deal of marketing spend invariably gets directed towards getting feet through the door.
Over the last decade, there can be little dispute that the reputation of mainstream banks – and particularly the so-called ‘Big Four’ (HSBC, Barclays, Lloyds and RBS) – is at its lowest ebb.
The peer-to-peer (P2P) lending industry is now regulated by the Financial Conduct Authority (FCA). The regulatory framework has been designed to protect customers and promote effective competition.
Most people consider income tax to be a given, but in the UK it is barely two centuries old. In this article, we look at how this tax has developed over the years, and also why it is set to remain at the core of our tax system for many decades to come.
Open banking celebrated its second birthday last month, but has the ‘revolution for financial services’ that was promised actually come to pass? In this article, we look at the progress the initiative has made so far, and what the future holds in the face of high levels of scepticism.
On the face of it, a 'broken' energy market needed fixing, and the price caps introduced in early 2019 were heralded as the solution. But, one year later, have they actually helped consumers save?
Last week, the Office for National Statistics surprised economists by announcing that the Consumer Price Index (CPI) had sunk to 1.3 per cent for December – a full 20 basis points lower than City expectations, and also the November equivalent.
January tends to be a comedown following the Christmas festivities, and, from a personal finance perspective, a time for many Britons to lick their wounds. In particular, for those who’ve over-extended their credit card, it may feel like the walls have started to close in.