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Do you want a £40,000 annual ISA allowance?
A joint pensions and ISA allowance has been proposed by one pension expert, but is it workable?
by Michelle McGagh on Nov 27, 2012 at 09:50
The merit of pensions versus ISAs has long been debated, but a proposal from a think tank could put the argument to bed.
In a report from the Centre for Policy Studies (CPS), a think tank, entitled ‘Costly and ineffective: why pension tax reliefs should be reformed’, pensions expert Michael Johnson has set out a number of proposals to reform pensions tax relief which he believes will save the government money and be more beneficial to savers.
Pensions currently offer a big tax break. Every time you make a contribution you receive tax relief on it – 20% if you are a basic rate taxpayer and 40% if you are a higher rate taxpayer – which is paid back to you in the form of a contribution top up.
This relief has come under scrutiny because it mostly benefits the wealthy who get relief at 40%. Rumours are swirling that it will get the axe in the Autumn Statement on 5 December.
Another element of pensions that chancellor George Osborne could target is the annual allowance for pension contributions. Every year you can contribute a maximum of £50,000 to a pension up to a limit of £1.5 million over your lifetime – although most people don’t get anywhere near their annual or lifetime allowances.
Marrying pensions and ISAs
Johnson thinks the government should make radical changes to both pension tax relief and the allowances on offer and incorporate the much-loved ISA, which currently has an allowance of £11,280.
Both pensions and ISAs have their benefits; pensions give you a tax break in the form of tax relief, but you get taxed when you take the income; ISAs on the other hand provide a tax break on the way out as you don’t pay tax when you take your money out, although you do have to pay income tax on the money before it is saved.
Johnson recommended the introduction of a combined allowance of between £30,000 and £40,000 a year for pensions and ISAs. Each year you could decide whether to use the allowance to contribute to pensions or an ISA and receive the relevant tax break.
The pension and ISA pots would remain ring-fenced from each other but we could witness a situation where pensions are side-lined in favour of ISAs, which are more popular as they allow people to access their money when they like.
Johnson also recommended scrapping higher rate tax relief and replacing all income tax relief with a 25% or 30% single rate which would encourage those paying the basic rate of income tax to save more.
A poor retirement
Tom McPhail, head of pensions research at Hargreaves Lansdown, said Johnson’s proposals were not ‘anchored in reality’ and would see people entering retirement with little to live on.
‘You have to strike a balance between ISAs and pensions. We get a lot of investors saying that the fact that the money gets locked away in a pension is a good thing. There is a real risk that if you give people the option not to lock the money away then people will get to retirement without anything to live on,’ he said.
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