Pensions are the default option for saving towards retirement and there are very good reasons why.
Thanks to the government’s generosity, they can be a very astute way to make the most of your money. If you are a higher rate taxpayer, it will only cost you 60p for every pound you put into your pension. That is before your pension fund manager and the power of compound interest get to work.
But they may not be the only way you need to prepare for your future financial security.
Why pensions have their limits
Pensions are excellent long-term savings vehicles, but there are two potential problems if they are your only investment.
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The first is that there are limits to the government’s largesse when it comes to pensions. The maximum you can contribute each year is currently £40,000, or your entire income, whichever is the smaller. Also bear in mind, you will usually pay tax if your pension pots exceed the Lifetime Allowance, the maximum currently £1,073,100.
While this seems a high figure, 40 years of contributions and some successful investment for growth from pension fund managers can easily reach it.
You could find yourself in the position of being unable to contribute as much as you want into your pension, without running into tax penalties.
The second problem is that any contribution you make to your pension pot will be locked away until you reach 55. This could cause problems if you want to access your money in an emergency. What’s more, the proposed steady rise in state pension age is likely to mean a similar rise in the early retirement date for your private pension.
With some think tanks proposing changing the state pension age to 70 by 2028 and to 75 by 2035, your private pension could be locked away for rather longer than you might wish.
Should you be investing outside your pension?
With their tax advantages, pensions should be the foundation for most people’s retirement planning. But, if you are in danger of going over the lifetime allowance or want to be able to access funds well before state retirement age, you might want to look at long term investments that can run alongside your pension.
Making regular payments into an ISA might be the solution for many people. Sadly, you will not be able to enjoy the same tax efficiency as with pension savings. Contributions to your ISA will have to be made from your income that has already had tax deducted.
However, on the positive side, the taxman will be more generous once that money is inside your ISA. It may offer the potential to be able to grow faster than investments outside an ISA because it can do so tax free. Even more valuable, when you come to take your money out, you will have no tax to pay on any growth it has enjoyed.
So unlike a pension, which could easily mean paying income tax on the payment you receive, income from an ISA investment is tax free, at least under current legislation.
What’s more, with an ISA and unlike a pension, there is no restriction on when you can take your cash. Build up a lump sum and take it out at any age that suits you, start investing again – there are none of the restrictions that are unavoidable with pension saving.
What should you do?
Whether or not you should be making ISA or other investments alongside your pension will depend on your personal circumstances and your plans. If you are likely to go over the annual and lifetime limits on your pension, or if you have plans such as property purchase that need access to your wealth before you reach retirement age, you may want to consider it.
Making the decisions that are right for you will be a great deal easier if you have an expert to help you take a clear look at your finances.
At Continuum we have the expertise in pensions and investments you need. Simply call us to get it working for you.
The information contained in this article is based on the opinion of Continuum and does not constitute financial advice or a recommendation to suitable retirement or investment strategy, you should seek independent financial advice before embarking on any course of action.
The value of investments can fall as well as rise and you may get back less than you invested
The Financial Conduct Authority does not regulate taxation advice.
A pension is a long term investment. The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available. Pension income could also be affected by interest rates at the time benefits are taken.
The tax treatment of pensions in general and tax implications of pension withdrawals will be based on individual circumstances, tax legislation and regulation, which are subject to change in the future.
Accessing pension benefits early may impact on levels of retirement income and your entitlement to certain means tested benefits.
Accessing pension benefits is not suitable for everyone. You should seek advice to understand your options at retirement.