Your Pension and Investments after the Budget24th March 2016
Chancellor George Osborne presented the annual Budget statement last week. Besides numerous announcements on economic policy, public finances and taxes, this year’s Budget contains several very important changes which will affect the ways we save for retirement and how our investments are taxed. This article summarises the main opportunities as well as things to watch out for. The full speech, which includes details on new tax thresholds and allowances, is available here.
ISA Allowance Jumps to £20,000
It is no secret that the Chancellor likes ISAs and wants to encourage taxpayers to save for retirement using this tax wrapper. The annual ISA allowance has significantly increased in the last years and also the flexibility of ISA accounts has been improved. This Budget brings another huge increase in the annual ISA allowance – from the current £15,240 to £20,000 (that will be equal to half the current annual pension contribution allowance). It will only come into effect in 2017 though; for the 2016-17 tax year the ISA allowance stays at £15,240.
The way ISAs work is very simple (simplicity is a key selling point besides tax savings). You put after-tax money in (there is no tax relief unlike pensions), but from that point neither the income nor the capital gains are subject to any further tax, as long as you keep the funds within an ISA account (you can transfer money in between ISA accounts though, with some restrictions). This can lead to substantial tax savings if you allow your investments to compound tax-free over many years.
New Lifetime ISA for Young Savers
Besides standard ISAs, the Budget speech has introduced a completely new kind of ISA, called Lifetime ISA. Its main idea is to encourage younger people to save for retirement. The scheme will start from 6 April 2017 and allow anyone under 40 to deposit up to £4,000 per year in a Lifetime ISA account. The best part: the Government will add 25% to your deposit (in other words, you get extra £1 for every £4 you save).
There is a catch. You must use the money for the right purposes, which are either to provide income in retirement or to buy a home. If you choose to withdraw money from your Lifetime ISA before the age of 60 and use it for a purpose other than buying a home, you will lose the bonus (plus any interest on it) and also have to pay 5% charge.
If you are familiar with the recently launched Help to Buy ISA and feel like this is quite similar, you are right. It appears the Lifetime ISA will replace the Help to Buy ISA in the future. Those saving in a Help to Buy ISA will be able to transfer the funds to a Lifetime ISA account after 6 April 2017 and keep any bonuses.
Huge Drop in Capital Gains Tax
If you save outside a pension plan or ISA, every time you sell your investments you are liable to Capital Gains Tax on any capital gains exceeding the annual CGT allowance (currently £11,100 and rising with inflation every year). This year’s Budget has brought a surprisingly high cut in the CGT rates, effective from 6 April 2016:
- Basic rate drops from 18% to 10%.
- Higher rate drops from 28% to 20%.
Unfortunately for Buy-to-Let investors, these changes won’t apply to property, which will continue to be taxed at the existing CGT rates. This is another step to diminish the attractiveness of Buy-to-Let as a way to save for retirement.
Pension Tax Relief and Lifetime Allowance
In the months and weeks before the Budget speech, it was feared that the Chancellor might restrict or entirely abolish the pension tax relief. According to George Osborne’s own words from last summer, the very mechanism how pensions are taxed in the UK could change going forward, possibly approaching the ISA model – after-tax money in (which means no tax relief on pension contributions) and tax-free money out.
Those were the speculations prior to the Budget, but importantly the fears have not materialised and for now pension tax relief remains in place without any changes announced in this Budget. The Chancellor has admitted that extensive consultations have taken place but “it was clear there is no consensus” on the issue.
For now it means the annual pension contribution allowance stays at £40,000 for 2016-17 (for those earning up to £150,000) and the contributions still attract a tax relief equal to your marginal tax rate, which makes pensions particularly effective for higher rate taxpayers. One change which has been known for a while but comes into effect on 6 April is the Lifetime Allowance dropping from £1.25m to £1m.
Summary and Things to Do
- Although the pension tax relief is safe for now, the risk of substantial changes to the existing pensions model remains. To those well below their Lifetime Allowance, we recommend to continue with contributions while the opportunity is there.
- ISAs have become very significant and can’t be overlooked. Remember that the annual ISA allowance is lost when not used by the tax year end. You have until 5 April to use the £15,240 allowance for 2015-16.
- Keep in mind that ISAs should not be treated as a substitute to pensions. Both schemes have advantages as well as restrictions. For most people it is best to combine them.
- If you are planning to sell some of your investments in the near future and likely to exceed the CGT allowance, consider waiting until 6 April, when CGT rates become lower (and you will also have the new year’s allowance to use).