Are you over 50 and wondering about your finances when you stop work? Standard Life’s Julie Hutchison reveals how moving an ISA into a pension could deliver a significant boost to your retirement income.
The new pensions landscape, which falls into place from 6 April, creates some interesting knock-on effects when it comes to making the most of your savings. One of these is particularly relevant if you’re within touching distance of the age of 55, which is when the new flexible access for pensions becomes available to you.
The question you might want to ask yourself is: should you move any ISAs into your pension?
When pensions were more restrictive in the past, the answer to this could well have been negative. But since modern pensions now give you access to what you want, when you want, from age 55, you could view them as a stocks & shares ISA with a short period of delayed access which disappears at age 55 – at least, when you look at it from the perspective of someone who is around 50 years of age (so you don’t have long to wait). Pensions also have the added attraction of giving your savings a significant boost because of the way tax relief works.
The numbers add up
Let’s assume Anna is 52 years old, has a salary of £92,000 and stocks & shares ISAs worth £50,000. She also has a pension valued at £200,000, as well as cash savings for emergency use.
If Anna closes her ISAs and pays the £50,000 into her pension, her contribution would turn into £62,500 because of the tax relief top-up in tax year 2014/15. That’s £12,500 the tax man has added to her savings, just because they now sit inside her pension instead of her ISA.
It’s also possible that Anna could select the same investment funds inside her pension as she used to have inside her ISA. So the ‘lift and shift’ exercise really is about changing the ‘tax wrapper’ which sits around the investments, and of course, the tax relief top-up on the way in.
And because Anna is a higher rate taxpayer, there’s a further uplift to her finances if she files a tax return and claims higher rate tax relief. If she does so, she’ll receive a refund of income tax of £12,500 – paid into her bank account from HMRC – because more of her income will be taxed at 20% instead of 40%.
So far, so good. But there’s a restriction on the annual amount which can be paid into a pension, and this is £40,000. Anna has exceeded this, so needs to use the carry forward rules linked to unused annual allowance from the past 3 years. Luckily, she has some carry forward available, since she did not make full use of her pension allowances in recent years.
It’s also worth remembering that money held inside a modern pension is normally outside your estate for inheritance tax purposes. It’s different for an ISA – that is usually inside the IHT net, if your total assets (including property) are worth £325,000 or more, unless an exemption applies.
A final consequence of an ISA-to-pension transfer is the tax treatment of withdrawals. You don’t pay tax when you take money out of an ISA. With a pension, 25% of what you take out is tax free, and the rest is taxable, depending on what rate of income tax you pay. But if Anna is going to be a basic rate taxpayer when she retires, then the sums stack up in her favour, in terms of the overall benefit of re-homing her ISA money. Indeed, the sums could work out well for her even if Anna remains a higher rate tax payer in retirement.
Don’t trip up on your annual allowance
Calculating what unused annual allowance you have is not straightforward because different pensions have varying contribution periods, and are not the same as the tax year. Also, if you get it wrong, you face a tax charge. You should speak to a regulated financial adviser for the expert help you need to keep your pension plans on track.
This blog and any responses to comments are not financial advice. A pension and a stocks and shares ISA are investments. Their value can go up and down and may be worth less than you paid in. Laws and tax rules may change in the future. This information is based on our understanding at 5th March 2015.