At MoneyWeek we have long favoured saving into individual savings accounts (Isas) over saving into pensions. There are all sorts of reasons for this. But the main one has long been the simplicity of Isas. You put the money in after you have paid tax on it. Then once it is in its wrapper, it is safe. You don’t have to fill in any forms or reclaim anything from the taxman. And you can withdraw the capital gains and the income from an Isa any time you like without paying further taxes.
Pensions just aren’t as good. Again, there are all sorts of reasons why we say this. But there is one main one: uncertainty. Take the tax relief. It sounds attractive. But pension saving doesn’t let you avoid paying tax. It just allows you to defer it. When you take income or capital as income from your pension later – as drawdown or annuity payments – you will be taxed at income-tax rates. They might be lower than the current rates. They might also be higher. Who knows?
Then there is the tax-free bit. Right now you can take 25% of your fund tax-free on retirement. That’s nice. But will it still be true in five years? Ten? Again we just don’t know. However, what we do know is that, while everyone thinks Isas are a good thing, almost everyone has a gripe of some kind with the way in which pensions are structured. That, along with their endless complications (which mean you can make major changes to them without most people noticing), means that they are usually a political target.
This week is no exception. Say hello to a new report from the Pensions Policy Institute that points out that pension tax relief currently costs the taxpayer a total of £35bn a year, but is nonetheless a “poorly understood” incentive. It suggests the possible removal of tiered relief (where you effectively get back all the tax you have paid on money you put in a pension, regardless of your marginal rate of tax) in favour of a single rate of tax relief. So you’d get, perhaps, 30% back, regardless of whether you pay tax at 20% or 45%.
That’s good for low earners – who would find their pensions more heavily subsidised than ever – and bad for high earners. It also suggests capping the lump sum you can take on retirement at £36,000, to prevent the well-off and those on final-salary pension schemes taking large, tax-free amounts on retirement.
These things might happen. They might not. But the point is that when you put your money into a pension fund you effectively agree to leave it hostage to the whims and political priorities of government. That’s not a particularly good idea. Isas might not be 100% safe, of course. But given that the tax on the money in them is already paid and that 23 million people in Britain have one and understand how it works (and so will protest at change), I suspect they are an awful lot safer than pensions.