26th April 2016 at 2:55pm
A new study brings pensions out on top when it comes to saving for your old age.
A tax-efficient winner
A recent study by the Institute of Fiscal Studies (IFS) found pensions are still the most tax-efficient way to save, despite the big tax changes introduced this year.
The IFS compared the returns you’d receive saving into a pension with alternatives such as buying your own home, becoming a buy-to-let landlord and investing in a stocks & shares ISA.
Why pensions are the best option
They all have their merits but it was the tax advantages associated with pensions that tipped the balance in their favour.
Pensions also receive a huge boost thanks to the introduction of the auto enrolment legislation, which means employers have to match employee contributions. According to the IFS, workers get a 60% boost to their pension pots under the new set-up. “Since employers rarely make equivalent offers to match employees’ contributions to say, an ISA or a house, it makes savings in a pension much more attractive relative to other assets,” the report said.
And paying into a personal pension, you are effectively lowering your income tax bill the study concluded. What’s more, the returns on your investments are not taxed (though you will pay income tax on withdrawals).
With the added bonus that you can take 25% of your pension pot as a lump sum without having to pay a penny in tax, pensions looked an attractive option. In the words of the IFS “pension saving is in effect subsidised”.
Tax changes make no difference
Pensions still came out on top despite a number of changes to the ways savings are taxed from April 2016. There is the new Personal Savings Allowance (PSA), which will allow basic rate taxpayers to enjoy up to £1,000 of interest from their savings absolutely tax free. Higher-rate taxpayers are allowed £500, whilst additional rate taxpayers don’t have any PSA.
This will mean 16 million people stop paying any interest on their savings income, says the IFS, and 95% of people will no longer have their savings taxed.
However the report says the change will weaken the incentive for many people to save in a cash ISA.
“For most people, the ordinary bank account will in effect be tax free in much the same way as cash ISAs, and there will be little incentive to save in a cash ISA,” it said.
The PSA also means an end to tax deduction at source on savings accounts provided by banks and building societies, which will be of particular help to pensioners.
From April 2016, dividends up to the value of £5,000 a year will be tax free, although anyone receiving more than that will pay higher rates than at present.
The research also found that those people wanting to invest in property will make a far more tax-efficient move by investing in their own home, rather than by becoming buy-to-let landlords.
“Investment in owner-occupied housing is significantly more tax-advantaged than investment in property to let, even before recently announced changes to the treatment of mortgage interest for landlords,” says the report.
Saving for the future
For those of us who want to save long term, the message from the IFS is clear – think about having a pension.
Do bear in mind that laws and tax rules may change in the future and the information here is based on our understanding in April 2016.
Personal circumstances also have an impact on tax treatment. Investments can go down as well as up and you may get back less than you pay in. The information in this blog or any response to comments should not be regarded as financial advice.