For those who are self-employed, or who do not qualify for a traditional pension, or who are just disillusioned with the whole pension scenario, there are a number of options that may be worth pursuing, depending on your individual circumstances and retirement goals.
Before we explore the tax-friendly alternatives to a pension, it is important to note that when making plans for retirement, it is advisable to seek independent, specialist retirement planning advice from a qualified professional who will take time to guide you through the options available, and ensure that any alternative pension ideas you choose align with your goals, attitude to risk, and personal circumstances.
Why save for retirement?
If you have a picture in your mind as to how you would like to spend your retirement, there is every chance that your aspirations won’t be met by the State Pension alone. You may not even be in line for a State Pension or the full amount available, depending on your employment history.
Creating a retirement nest egg is therefore essential if you are to fulfil your dreams for a life beyond work that allows you to enjoy what means most to you.
To pension, or not to pension?
Whilst it is never too late to start paying into a private pension scheme, or increase contributions to an existing private or workplace pension, some people are starting to see less value in the traditional pension.
This may be due to the possibility of them not rising in value in line with earnings, or simply because the tax benefits associated with pensions are being eroded, especially for higher earners. Some retirement savers have also already ‘maxed out’ their pension allowances, and are therefore looking for alternative pension ideas.
In addition to this, more people tend to be seeking greater control over how their money is invested, rather than leaving it in the hands of their pension provider.
For these reasons, it is not uncommon for people planning towards their retirement to start exploring alternative pension investments.
What are some examples of tax-friendly alternatives to a pension?
Pension alternatives will depend on your attitude to risk, at what age you wish to retire and how much time you have until then, and how much disposable income you have to invest.
Here are some of the most common examples of alternative pension ideas:
1. Venture Capital Trusts (VCTs)
VCTs are investments in small, usually unquoted and often young companies. The investments can offer upfront tax relief and tax-free growth. Dividends are tax-free, although they can vary and are not guaranteed.
There is also a generous annual allowance and no lifetime limit, and you may also receive up to 30% income tax relief.
It is important to note however that there are fairly high risks involved in VCTs as pension alternatives, especially given the nature of the investment in small, young companies. Something else to consider is that once you reach retirement, whereas a pension would provide you a regular income, it is not as straightforward to cash in a VCT as it is to draw down a pension.
Finally, whilst pensions generally fall outside of your estate for the purposes of Inheritance Tax, VCTs form part of it and their value could be taxable.
For this reason, it is vital to seek professional financial planning advice before making any decisions.
2. Individual Savings Accounts (ISAs)
An ISA is one of the most common tax-friendly alternatives to a pension.
ISAs are tax-free savings accounts that are not subject to tax on capital growth and any income generated. Some retirement savers use ISAs in addition to their private pension to help build a bigger pension pot and spread their risk, or because they have reached their tax-free annual allowance for their pensions.
ISAs are flexible and allow instant access to your money. There are different interest rate tiers depending on the chosen product, and it is also possible to create an ISA account that invests in stocks and shares.
The key thing to be aware of with ISAs is that they carry a fairly limited maximum annual allowance. Any unused allowance at the end of the year resets and cannot be carried over to the next year.
On a more positive note, ISAs are transferable to a spouse on the death of the account holder.
3. Lifetime ISAs (LISAs)
Lifetime ISAs are designed to help people between 18 and 39 save for their first home or retirement. You can contribute up to £4,000 per year, and the government adds a 25% bonus (up to £1,000 per year). The money grows tax-free, and you can withdraw it tax-free for your first home or after age 60.
However, if you withdraw the money for any other reason before the age of 60, you may face a penalty of 25%, effectively losing the government bonus and some of your own money.
Do be aware that the amount you pay into your LISA is linked to your overall annual ISA allowance.
4. Alternative Investment Market (AIM) ISAs
If you have an eye on Inheritance Tax planning whilst considering your pension alternatives, you may wish to consider transferring existing ISAs or investing future annual contributions into an Alternative Investment Market (AIM) portfolio ISA.
These are special types of ISAs that invest in companies listed on the Alternative Investment Market (AIM), which can help mitigate your IHT liability. The key advantage here is that you can still access the money in these ISAs if you need it, but any remaining funds that aren’t withdrawn may be passed on tax-free after two years, thanks to Business Relief rules.
However, AIM investments can be riskier than regular ISAs and might not be suitable for everyone. As we always say, it is vital to seek professional advice to see if this option fits your financial goals and individual circumstances.
5. Self-Invested Personal Pensions (SIPPs)
SIPPs offer tax relief on contributions, meaning the government adds to your pension pot based on your income tax rate. For example, a basic rate taxpayer gets 20% tax relief, so a £100 contribution only costs £80. Higher and additional rate taxpayers can claim extra relief through their tax returns.
You can invest in a wide range of assets, including shares, bonds, and commercial property. Any growth in your investments is free from capital gains tax (CGT), and income generated within the SIPP is also exempt from tax.
Upon reaching retirement age, you can withdraw up to 25% of your pension pot tax-free, with the rest being taxed at your Income Tax rate.
6. Enterprise Investment Schemes (EIS)
EIS can offer significant tax advantages, including up to 30% income tax relief on investments up to £1 million per tax year (or £2 million if at least £1 million is invested in knowledge-intensive companies).
There’s also no Capital Gains Tax (CGT) on gains from EIS shares if held for three years and provided Income Tax relief has been given and not withdrawn. You can also defer CGT on other assets by investing in EIS.
What’s more, after holding the investment for two years, EIS shares may qualify for 100% inheritance tax relief under Business Relief rules.
Do bear in mind, however, that EIS investments are made in smaller, high-growth companies. This means they come with higher risk, although the tax benefits can be potentially attractive.
7. Seed Enterprise Investment Schemes (SEIS)
SEIS can offer even more generous tax relief than EIS, with 50% income tax relief on investments up to £100,000 per tax year. Like EIS, there’s no CGT on gains from SEIS shares if held for three years and provided Income Tax relief has been given and not withdrawn. Again, you can usually reclaim CGT paid on other assets.
SEIS investments can also qualify for 100% inheritance tax relief after two years under Business Relief.
Again, SEIS investments are in very early-stage companies, so while the potential rewards can be high, so is the risk.
Looking for tax-friendly alternatives to a pension? Talk to the retirement planning specialists at Partridge Muir & Warren.
At Partridge Muir & Warren, we have been advising clients on their retirement and pension options for over 50 years. Our advice is independent, fully tailored and focused on the best interests and personal aspirations of our clients.
If you would like to discuss your retirement options, including pension alternatives, you are welcome to get in touch with our friendly retirement planning team to arrange a no-obligation complimentary consultation.