Four million over-50s missing out on tax boost by using Isas
Four million older workers are missing out on a 40pc boost to their savings by investing in an Isa rather than a pension, new research has shown.
Isas are more flexible than pensions because there are no limits or restrictions on what savers can withdraw. In comparison, pensions can only be spent without incurring a tax penalty after the age of 55.
However, pension contributions attract tax relief making them much more lucrative. Insurer NFU Mutual said there were four million savers aged between 55 and 64 that were using an Isa over a pension, even though they were not hampered by the pensions age limits. The savers were therefore missing out on tax relief for little benefit.
The firm said Isa's ease of access was a big advantage but more so for younger savers, who would be setting cash aside which they would need to withdraw freely. However, the perk was irrelevant for those older than 55 who can draw as much cash as they like, when they like, out of their retirement savings, under the pension freedom rules.
Anyone who pays into a workplace or personal pension receives tax relief, meaning that their contributions are effectively topped up by the government. Relief is granted at the saver’s “marginal” or highest rate, so people who earn more than £50,271 receive more from the Treasury.
A higher-rate tax payer investing £6,000 into a pension would receive £4,000 in tax relief, taking the total to £10,000.
Higher-earning workers tend to see their income fall in later life. This means they receive tax relief at 40pc but may only end up paying 20pc income tax in retirement. Therefore, the initial £6,000 investment would translate into £8,500 when accounting for tax relief and then a tax deduction, assuming no returns are made.
By comparison, someone who had invested the £6,000 into an Isa would not pay any tax on withdrawal but would miss out on the tax relief. Therefore an Isa saver would be 41pc worse off.
Sean McCann, of NFU Mutual, said: “For those looking to invest for five years or more, the tax relief available can give a significant boost to returns, particularly if you’re going to be in a lower tax band when you take the money out.”
However, those who plan to withdraw money while continuing paying into the pension should beware of a punitive tax rule. Withdrawing income from some types of pension can trigger the “money purchase annual allowance”, which reduces the amount a saver can pay in and earn tax relief every tax year by 90pc, from £40,000 to £4,000.
More than 1,000 people fell into the tax trap every working day in 2020, according to analysis of HM Revenue & Customs figures by Just Group, a retirement planner. More than 600,000 people accessed their pension pot for the first time in 2020, as many had to tap into their wealth to make ends meet during the pandemic.
