3.2.2 Tax-efficient savings

In the following video, David Harrison of True Potential LLP argues the case for using Individual Savings Accounts (ISAs) to build up a fund for retirement income. David explores why this may be a better route to building up pension savings than using conventional pension schemes. David also highlights the way that successive governments in the UK have changed the tax rules applying to pensions – a comment which is particularly apposite given the significant changes to tax relief on pension contributions and to the taxation of pension benefits that have taken place recently.

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MARTIN UPTON

Do you think ISAs are a better way of saving for the future than using pension products?

DAVID HARRISON

Yes I do. I mean it's very simple. If you are - I'll give you our example as a company ... when we became an ISA manager it took us about six weeks to set that up with HMRC. So we were able to handle people's money within six weeks. Bearing in mind we have got highly qualified people. We are well capitalised blah, blah, blah, all of that.

So several months later to become a pensions provider it took us nearly ten months and millions of pounds to be able to handle the complexity of a pension and you might think well it's easy, we just ... right ... if it's an ISA your employer or you have taken money for tax out of that money and you then invest it. So the complication, if you like, is already in the market. The complication of how much tax, should it get taxed actually blah blah - it's gone. The employer or you have sorted that out. What's left goes into an ISA and that ISA grows tax free and crucially if you're in retirement or whatever and of course you've got access to it.

The thing that puts people off a pension is lack of access to their own money for maybe twenty or thirty years. Can you imagine, you know, when I was a youngster you went to business school you'd get case studies of Shell or BP with their twenty or thirty year strategic business plans. My goodness did they see $40 a barrel of oil? No. You know do they know what the price of oil is next week? No. Thirty years time? Not a hope. Right? So asking people in their twenties or thirties to put away money out of harm's way until they're fifty-five, that's not attractive at all.

That's the biggest thing that we've identified. I know that. I'm an adviser. I know that. People tell me that. I know that, I'm a human being. You know somebody says 'put money over there and you can't get it back until you're whatever age', it puts you off.

So ISAs, you can put it away and you can get access to it. So they're very simple to administer. With a pension, if you're a pension provider, these are things that people don't know. We have to take into account your tax status which means you give me some money and then six weeks later, six weeks later the Inland Revenue have given me your contribution from tax and I have to buy those same units, right - try and get the things to dance together and invest it. But when you come to retire and I give you some money from the pension I also have to deduct tax. I have to know your National Insurance number. It's incredibly complicated for such a simple system because also it's called a pension - well it's not. It's a savings plan up to the point that you draw it down and up to the point where you ask me for my money back. So up to that point it's a misnomer, this sort of oxymoron pension, which an ISA just cuts through that.

The other thing is governments fiddle about with things, not just in this country. You see people's pensions getting nationalised in different countries. All of a sudden you don't have a pension - the government needs your money. Anything that smacks of that just gets into your psyche. An ISA you think it's in the building society bank or a stocks and shares ISA you can get your hands on it. There are different kinds of ISAs these days but they've one thing in common - they're very, very simple.

Second thing in common, the chancellor hasn't fiddled about with it. He hasn't changed them. He hasn't begun to tax them through the back door or whatever and that's the thing. Often people say to me 'yes but you move people's pension into an ISA what happens if the - well what happens if?' The thing is in pensions the chancellor, and chancellors before him, have cheated, have moved things around.

When I was a kid I know I got my first job I remember the personnel guy telling me you know 'the national insurance that's your - David, that's your pension. When you retire'. Well I have retired in those terms. I've got like everybody else a hundred and fifty five - I don't even know if I've got that from the State because I was contracted out for a while. I need to check that you know.

It's - ISAs are simple. Pensions are complicated. I would recommend anybody forget about tax relief. It comes and goes. Put your money in an ISA. I don't - I haven't put money into a pension for example since 1996 when somebody else was putting money into my pension for me and it's not a good deal. I think most financial advisers would say that unless they're pension specialists, which they may be biased.

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Having reviewed the main types of financial investments – and prior to examining conventional pension schemes in the next few sections – we should look at how tax-efficient investments can be used to build up a savings pot to draw on in later life.

Rather than making contributions to occupational or personal pension schemes many people prefer to make their own investments. There is much scope to invest in tax-efficient schemes – particularly now that the annual limit on investing in ISAs has been raised so much in recent years. In 2018/19 the limit for such investments is £20,000 per person. The income and capital gain on these investments are not subject to taxation and this helps the aggregate saved amount build up over the years.

When investing for the long term there is also scope to choose Stocks & Shares ISAs, rather than Cash ISAs, given the likelihood – based on historical evidence – that these will perform better over the longer term.

An attraction of going alone in building up savings for the future is that ISA products can be simpler and easier to understand than pension products.

Those aged under 18 years can start early by investing in Junior ISAs. In 2018/19 the annual allowance is £4,260 per child.

As you saw earlier this week, from 2017/18, lifetime ISAs have been available for those under the age of 40, with an annual investment limit of £4,000, designed to help with property purchase or income in retirement.

Other tax-efficient ways to save for the future include onshore and offshore bonds. These are investments that have the form of insurance policies and attract a favourable tax treatment for the investor.

With onshore bonds the tax planning benefit is that income and capital gains can be rolled into the investment over time and it is only subject to life fund tax (where the funds are taxed as though the investor had paid the basic rate of income tax on the gains made by the fund). Withdrawal of up to 5 per cent of the fund can also be made each year without immediate liability to tax. This annual limit can be carried forward if not used, though the aggregate carried forward cannot exceed 10 per cent. The major benefit arises from cashing in the bond, or accessing funds above the annual tax-deferral allowance of 5 per cent of the investment, when you are no longer a taxpayer or have moved overseas and have become a non-UK resident for tax purposes. So onshore bonds allow the returns on the bonds to be rolled up to a point in time when drawing on the investment can be done with a limited or nil liability to tax.

With offshore bonds, which are held in overseas countries, there is the additional benefit of all the income and capital gains being allowed to roll up on a gross basis with no liability to life fund tax. This allows the funds invested in offshore bonds to roll up more quickly than those in onshore bonds. There may, though, be a liability to a typically small withholding tax levied by the overseas country’s government which cannot be recovered even by non-taxpayers.

The bonds are more complex than ISA products and consequently advice should be sought before investing in them. Investments in certain of these bonds may also present ethical issues for investors. Additionally, offshore bonds are not normally covered by the UK’s consumer protection rules. They can, though, form an effective way to save in a tax-efficient way for the future.