The headline grabber of yesterday’s Spring Budget announcement by the Chancellor, Jeremy Hunt, was the extension of free childcare provision for 1 and 2-year-olds. It had previously been limited to 30-hours per week for 3 and 4-years-olds and is part of the “getting people back to work” drive that is a central part of the current government’s stated policy.
While the new rules don’t come into effect until 2024 they will certainly be welcomed by the working parents of young children.
But there was another announcement that has grabbed less attention, though still plenty, and will make a potentially significant difference to personal finances later in lives. Pension investment rules have been updated to lift the annual tax-free pensions allowance by a generous 50%, while the lifetime contributions cap has been abolished entirely.
Higher earners will now be able to pay £60,000 into pension products annually, before income tax is applied. And from later this year, you will no longer limited to the previous lifetime tax free pension allowance of £1,073,100. Up to £60,000 a year, you will soon be able to build as big a pre-tax pension pot as you can.
Taking advantage of the additional pension allowance and removal of the lifetime cap will also help protect your loved ones from Inheritance Tax, which pensions are exempt from if passed on to a spouse or children.
You are, however, limited to withdrawing up to £268,275 of your pension’s assets in tax-free cash – not an issue for anyone not keen on seeing their pension pot eroded by inflation. And if you don’t have especially high expenses, it should plenty to see you through any market downturns without having to cash in depreciated investments before they have time to recover.
Another big pensions change announced by Jeremy Hunt yesterday is how much money you can draw down from that pension pot before it is treated as taxable annual income. That is rising from £4000 a year to £10,000 a year – a whopping 150% increase that will see many of those drawing down from their pensions make double figures in tax savings annually.
You will also now need to earn over £260,000 a year, previously £240,000, before your annual pensions allowance starts to be tapered.
How does the annual pension allowance work and what counts towards it?
The increase in the annual pension allowance that can benefit from tax breaks rising from £40,000 to £60,000 from April means the maximum relief by income tax band now stands at:
- 20% standard rate income tax payers can benefit from up to £8000 of tax relief on pension contributions.
- 40% higher rate income tax payers can save up to £16,000 in tax relief on pension contributions.
- 45% higher rate income tax payers can benefit from tax relief on pension contributions of up to £18,000.
That is money that would go to the tax man if you didn’t divert it into pension investment products or cash held within a pension wrapper like a SIPP before income tax is levied against your earnings.
It is important to note that contributions made to both workplace and private pension products count towards your annual £60,000 allowance. As do contributions made by your employer to a workplace pension.
4 tips to make the most of your pension investments
To make the most of the extra £20,000 you will now be able put towards your pension annually, and the removal of the upper limit that you can accumulate over your working life, stick to these 4 simple but golden rules.
- Minimise fees and other expenses
As with all investments, the level of fees charged by product and platform providers can make a significant impact on your long term returns. Losing 1% or so a year to fees and charges may not sound like a lot but it mounts up over 20, 30 or even 40 years. The impact is also more considerable than you might imagine when compound returns over decades are factored in.
Whether making a choice of provider for a private or workplace pension (within the framework of choices your employer offers), compare providers, plans and products based on fees, investment options, flexibility, and customer service.
A managed fund, for example, might charge up to 2.5% or more annually while a cheap tracker fund can cost as little as 0.1% in annual fees. That doesn’t mean you should avoid managed funds entirely but select more expensive investment products very carefully. The data shows a minority manage to outperform the market when fees are taken into account.
Low-cost pension providers, such as robo-advisors or stripped-back online investment platforms, may offer competitive fees and diversified portfolios. However, they may not provide personalised advice or as wide a range of investment options as traditional but pricier pension providers.
However, unless you are particularly wealthy and have more complicated finances as a result, you may not benefit greatly from more expensive pension providers and products. And may well see your long term returns eroded significantly over time by higher fees.
- Diversify your pension investments
To maximise the potential returns and minimize risk, it’s essential to diversify your pension investments across various asset classes, industries, and geographic regions. Aim for a mix of equities and bonds. And if you are a high earner or sophisticated investor, you might also consider alternative investments, such as real estate, commodities, or private equity.
Equities: Investing in stocks or shares of companies can offer higher returns in the long run but come with higher risks. Consider diversifying your equity investments by choosing different sectors, company sizes, and countries to spread the risk.
Bonds: These fixed-income securities provide regular interest payments and can help balance the risk associated with equities. Government and corporate bonds are popular choices for pension portfolios, but be mindful of interest rate risk and credit risk.
Alternative Investments: Real estate, commodities, and private equity can provide additional diversification and potential returns. Private equity investments in British start-ups and growth companies made through the EIS and SEIS schemes, or VCTs, can also further reduce your tax bill. However, they may have higher fees, lower liquidity, and unique risks compared to traditional investments.
- Adjust your risk profile over time
As you approach retirement, it’s important to gradually adjust your pension investment risk profile to protect your assets from market volatility. For example, if you had retired last year or plan to in the near future, you wouldn’t want to have to sell equities to raise cash to fund your retirement.
As retirement approaches, you would typically reduce your exposure to riskier assets, such as equities, and increase your allocation to more conservative investments, like bonds or cash equivalents. A common rule of thumb is to hold a percentage of bonds equal to your age, but this may vary depending on your personal risk tolerance and financial goals.
- Regularly reviewing and rebalance pension investment
Periodically reviewing your pension investments ensures that your portfolio remains aligned with your financial goals and risk tolerance. Market fluctuations may cause your asset allocation to drift away from your target, necessitating rebalancing. Rebalancing involves buying or selling assets to restore your portfolio’s original allocation. Aim to review your portfolio at least once a year or after significant market changes.
In summary, investing in a private pension in the UK involves selecting a suitable pension provider, plan and cost-effective products, diversifying your investments across various asset classes, adjusting your risk profile as you approach retirement, and regularly reviewing and rebalancing your portfolio.
Following these guidelines can help you build a robust pension pot and secure a more comfortable financial future in retirement. And you now also have an extra £20,000 a year to do it with!
