Another tax year, another swath of pension tax changes.
This year, one of the most sig-nificant changes is the reduction of the annual contribution limits, leaving advisers to find alternative solutions for high earners wishing to shelter retirement savings from tax. To what extent are products such as maximum investment plans and VCTs being used to fill the gap?
The new rules allow pension savers to pay up to 100 per cent of earnings into a pension but cap contributions at £50,000.
Investors can also carry the allowance forward for three years, creating an allowance of £200,000 over four years.
The Government will still give basic-rate tax relief on all contributions (even those of non-taxpayers).
Higher-rate taxpayers will get relief at 40 per cent or 50 per cent at their marginal rate. There are also new limits on the lifetime allowance,
which has been reduced from £1.8m to £1.5m.
VCT fundraising in the 2009-2010 tax year was more than double the previous year, driven largely by the changes in the income tax rules.
Many are expecting another bumper year in 2011, this time driven by investors seeking to maximise the tax-efficiency of their retirement savings.
Equally, maximum investment plans have also been making a comeback for those who can invest over and above the pension and Isa allowances. For example, HSBC launched an open architecture Mip in January on the Ascentric platform with the express aim of mopping up high-net-worth retirement savings.
The tax benefits of both types of investment can be seductive. Investment into new VCTs attracts tax relief at 30 per cent as long as they are held for five years. Distributions are free from income tax and any gains are free from capital gains tax.
Contribution limits are also more generous than pensions – investors can put in up to £200,000 a year, with no income restriction.
Mips have higher maximum contribution levels (depending on the product), avoid higher-rate tax and have some investment flexibility.
However, there is certainly no sense among advisers that either VCTs or Mips are replacing pension savings. Evolve Financial Planning director
Jason Witcombe says: “Most of my clients are high earners and the majority will be affected by the loss of personal allowance at £100,000-plus.
However, we have to bear in mind that the pension allowance and carry forward is still pretty generous.
“We’ve been pretty forthright with clients, saying that they really must ’buy now while stocks last’ in terms of pension contributions. In particular, the chance for 50 per cent tax relief is a golden opportunity.”
Once they have filled their pension and Isa contributions, Witcombe then encourages his clients to use their capital gains tax allowance as a priority. He likes this route because it means that clients can go into the investments they want, rather than, for example, using VCTs, where they would have to be invested in very small companies. It is only at that point that he would consider VCTs or Mips.
Hargreaves Lansdown head of advice Danny Cox agrees that VCTs are in no way a replacement for either pensions or Isas but can be a
He says that because VCTs are higher risk and less liquid than other investment assets, he recommends a maximum allocation of 5 per cent to 10 per cent of an investment portfolio.
He adds: “The tax relief of 30 per cent on a maximum of £200,000 is part of the return and in many cases is the difference between the investment losing and making money. That said, these can compliment a portfolio and provide taxfree income.”
Cox is less positive on Mips. He says: “These are being talked of at the moment as a savings vehicle to complement a pension. I am not convinced of their validity. Basically, these are the old qualifying 10-year endowment plans with minimum life cover. Their advantage is they avoid higher-rate tax.
’We’ve been pretty forthright with clients, saying that they really must “buy now while stocks last” in terms of pension contributions. In particular, the chance for 50 per cent tax relief is a golden opportunity’
The downside is the cost of the life cover required to make them qualifying and the commission terms for the adviser generally make them very expensive negating much of the tax benefits.”
Witcombe believes they have a place for someone with investable assets in excess of pension and Isa allowances. He likes the fact that investors are not restricted in the way they invest the money but adds that people need to be confident that they can continue to pay the premiums for the full term. He says investment bonds are another similar alternative. Their suitability will depend on the relative tax position
on entry and exit.
There is a space in the market for alternative retirement savings vehicles – not least because the pension rules are subject to so much government whimsy. However, the allowances are still generous and Isa and CGT allowances are likely to be used before VCTs and Mips reap the benefit.