The new annual and lifetime allowances will seriously limit the importance of pensions for many high earners. Thousands that currently regard their pension as the main source of their future income and capital in retirement will have to look to alternative means of accumulating wealth.
It is not just those nearing the threshold that need to avoid exceeding the new lifetime allowance of £1m that kicks off in April. Lots of people in their forties and fifties, and even many in their thirties or earlier, could be in danger of building up excess retirement sums. A pension fund could quite reasonably double in value every 10 years, assuming about 7 per cent net annual growth.
And then there are all those higher paid people with incomes of at least £210,000 a year whose annual allowance will be brought down to a measly £10,000.
Of course, making extra pension inputs before April will be a must for most higher and additional rate taxpayers if they have the headroom. But, beyond that, advisers should be thinking about alternative strategies as a matter of urgency.
Isas and collective investments
Isas make a great deal of sense for almost everyone intent on building a significant amount of capital. The new dividend tax combined with a more or less static capital gains tax small gains exemption together add up to a powerful tax incentive. And with the annual limit now at £30,480 for a couple, the speed of accumulation is rapid. Employers can contribute to an employee’s Isa but apart from the possible introduction of some saving discipline, there is not a great deal of advantage from a tax perspective. Simply building up retirement savings in collective investments makes a huge amount of sense. And for higher and additional rate taxpayers it might be worth considering UK and offshore bonds if the charges are not ridiculous and they can reasonably expect to pay less tax when they need to cash them.
Buy-to-let, meanwhile, will still be a favoured path for many, even after the Chancellor’s hammer blows to this market last year. The 3 per cent extra stamp duty on second homes and buy-to-lets from April may boost the market in the short term and then depress it for a bit later in the year, but its basic driver shows few signs of going away. Quite simply, there are not enough new homes being built in UK, especially in the most prosperous areas. It will pay to be picky about location (as always with property) and the structure of stamp duty will continue to favour smaller properties even more.
The restrictions on tax relief on borrowing for buy-to-let will slow down individual portfolio growth by reducing borrowing capacity but 20 per cent relief is still better than zero relief, which is what most other investments get.
Clients that want to use residential property to build their retirement funds will need to understand what they are getting into. Letting property to other people is much more like a business than a passive investment. Even with (expensive) agents there is likely to be some participation needed by the landlord.
The attractive sounding gross yields are quite a lot higher than the net yields. The loss of the 10 per cent wear and tear allowance will make the post-tax position a good deal less alluring too. What is more, income can come and go with tenants and voids as well as regular bouts of expenditure.
VCTs and EISs
So will the diminishing attractions of pensions lead investors to the more exotic offerings from VCT and EIS providers? Chances are they will. But, as with buy-to-let, they will also have to understand what they are getting themselves into. Of the two, my guess is VCTs will turn out to be the more popular, if only because of the potential for drawing tax-free income and gains from an investment where the annual input is limited to a pretty generous £200,000 and there is no limit on output.
Most of the focus on VCTs is on their initial offering but they are potentially very versatile vehicles, especially after the first five years. With this in mind, providers and advisers should start looking at their long-term use and how they should be designed for the future.
Danby Bloch is chairman at Helm Godfrey