Adding up the benefits of moving cash to your pension pot

3rd July 2017

If you’re a higher rate tax payer in the run up to retirement, it’s worth thinking about where is the best place for your savings.

There are a number of issues to consider, and it is well worth consulting your financial adviser to discuss the options open to you – a little lateral thinking might help open up new opportunities!

Here is a Q&A to help you start thinking about what steps to take next.

Is the time right to move your ISA into your pension?

Many higher rate taxpayers could see their savings boosted by up to 41% by simply moving their ISA to their pension in the run up to retirement.

It’s a fact that, like for like, a pension wrapper will provide a bigger spendable pot than an ISA for most savers. This is down to the combination of tax relief on contributions and the ability to take a quarter of the fund tax free.

Is there any issue with easy access to my cash?

One of the main attractions of an ISA is that savings can accumulate tax free without there being any barriers to access should cash be needed ‘in case of emergency’. But for the over 55s, a pension can do the same and more.

What other issues should I consider?

There are issues to consider such as sufficient earnings, annual allowance and Lifetime Allowance headroom. Carry forward and spreading contributions across tax years can help. The result could be an increased fund with more tax efficient wealth transfer options. Independent advice is essential.

Does it all add up?

Do the maths and it paints a compelling picture for moving ISA funds at aged 55, when flexible access to your pension is available. Anyone benefiting from higher rate tax relief by using their funds to pay a pension contribution will always get more back, even after paying tax on the income they take from their pension.

Can you give me an example?

A gross pension contribution of £16,667 would actually cost a higher rate taxpayer £10,000. This can be funded from an ISA. Even if it’s accessed immediately with income tax at 40% on all the pension income, the return is £11,667 (£7,500 income after tax plus £4,167 tax free cash). That’s a 16.67% boost to your savings by simply moving it into your pension.

Would I still be paying a higher rate of tax in my retirement?

Quite possibly not. Most people will not be looking to access their pension while they are still working and earning. And according to the Centre for Policy Studies, less than 1 in 7 higher rate taxpayers will continue paying higher rate tax in retirement.

How would that affect the figures in the above example?

If you were a basic rate tax payer when you took pension income, not including any investment returns, what you would get back is £14,167. This provides an extra £4,167 than you would have had in your ISA – an increase of 41.7%. And remember, these figures are based on headline rates of tax. In reality the true effective rates of income tax in retirement are likely to be much lower.

Are there any situations I would lose out on moving my ISA to my pension?

You would not benefit if you only get basic rate relief on your contributions and paying tax at higher rate or above when you access your pension fund. This could apply if you used the new freedom to withdraw all your pot in one go. With advice you can manage your withdrawals over several tax years.

Are there any other benefits? For some it may be just as important to consider what can be passed on to family members on death, and assets left in pensions are usually free of inheritance tax.

Do the new ISA inheritability rules weigh in its favour?

They do provide a surviving spouse or civil partner with an increased ISA allowance equal to the value deceased’s ISA at the time of their death. BUT it doesn’t keep the ISA out of the survivor’s Inheritance Tax net. The fund could still suffer a 40% IHT charge on the second death if total assets exceed the IHT nil rate band.

What about the pension in this case?

Pensions are typically free of IHT. And it’s now possible to nominate anyone to receive your pension pot and for them to carry on taking an income from it. This applies even if they are below the normal pension age of 55, allowing children or grandchildren to have immediate access. It also means the funds don’t make their way into the beneficiary’s estate for IHT.

There may, however, be an income tax charge for a beneficiary drawing funds from a pension.

So, what does it all mean?

Most people will pay income tax at lower rates in retirement than during their working lives. For these people, saving in a pension over an ISA will always produce more spendable income, like for like. This also applies to those whose tax rate doesn’t change in retirement. Factor in the new pension death benefit rules and the case for pension becomes even stronger. But with pension tax relief under constant scrutiny, the time to act might be now.