First things first. Happy birthday to the state pension. One hundred years ago this month, the first pensioners went to the Post Office to collect a state pension of five shillings (25p) a week while a married man received seven shillings and six pence (38p).
Introduced by David Lloyd George in the Old Age Pensions Act of 1908, Britain’s first pension payment was given to those who were 70 on January 1, 1809. In an era when life expectancy was just 52 compared to today’s figure of 77, half a million people over the age of 70 got a pension. Now it’s more than 12 million with more than 700,000 people reaching state pension age in 2009 alone.
In real terms, taking into account a century’s inflation, five shillings was less than £20 in today’s money but those collecting the payment were happy enough with many said have to cried “God bless that Lord George”.
This year pensioners are set for a £4 billion boost with the biggest rise in the basic state pension since 2001. It will increase by five per cent ensuring that someone on a full pension will see their income rise from £90.70 to £95.25.
No doubt, since July 2007 most of us have experienced a fall in the value of any investment that is linked to the stock market, whether it is a pension, endowment, shares or ISA. For many of us, the advice is to stay put and weather the storm. The “paper losses” may be recovered sooner staying in equities and waiting for the upswing rather than jumping ship into cash for which returns will reduce further following the cut in the base rate to 1.5 per cent.
For many of us it may be beneficial to continue making contributions to savings policies to take advantage of the generous tax benefits, if nothing else. Take pensions as an example and for a moment just focus on the tax benefits.
If you were to make a single premium into a pension of £16,000, Her Majesty Revenue & Customs would increase this immediately to £20,000 by the addition of basic rate tax relief, an increase of 20 per cent. Not bad?
If you are a higher rate taxpayer (earnings in excess of £41,435), you receive an additional £4,000 tax relief making the net cost £12,000, a return of 40 per cent with no investment.
It doesn’t stop there, if the premium is made through a salary/bonus sacrifice arrangement with an agreement to rebate the employer’s national insurance, this increases the return by a further 12.8 per cent. We are now up to 52.8 per cent return on the original premium and the fund hasn’t been invested yet!
To effect your tax liability in 2008-09, the premium has to be paid into your pension prior to April 5, 2009. HMRC now ask you to assess your level of income for the year before it has actually ended.
Previously you had until the January following the end of the tax year to assess your income, tax position and address it through pension contributions. The higher rate tax relief is reclaimed through self assessment, the higher rate liability through self assessment.
You may simply want to remain in cash and “bank” the tax relief. The keen investors may see the current position of the stock market as a buying opportunity and not only benefit from the 40 per cent or 52.8 per cent growth in their premium through tax relief but to purchase units that may be showing a reduction in their respective value of 12 months ago. Any growth in a pension fund is free from capital gains tax.
One of the alternative options is to retain the funds in a building society for which the proceeds have probably derived from taxable income. So, to match the above position, ie to achieve £20,000 in a building society, you have to physically deposit £20,000. To realise the same sum as a basic rate taxpayer, you would have to earn £25,000, a higher rate tax payer £33,333.
Neither does the balance receive no tax relief. Instead you receive a measly amount of interest, which is taxable at 20 per cent for basic rate taxpayers. The recent cut in bank base rate is bad news for savers. Thirty per cent of deposit accounts available in the UK today are paying less than one per cent interest.
This is not to say it is an either/or scenario, pension contribution or building society. Retirement planning comes from many different sources and it is finding the happy balance between the various sources. One thing is for sure, we are all going to be searching for better returns on our savings and the tax incentives offered by pensions may be an attractive alternative.
For those who do their self-assessment returns on line, warnings by myself and others about “phishing” emails have filtered through to the HMRC website. The phoney site looks identical to the HMRC website (hmrc.gov.uk) using the same style, graphics and fonts and are being used to gather the names addresses and credit card details of web users.
Once the information has been obtained it redirects you to the official site. Introduction to the site is by the receipt of an email claiming that HMRC has conducted a review of your tax affairs and has found that you are due a rebate of £70 according to TaxCalc.com which produces tax software. Beware.
Trevor Law is a director with Montpelier Group (Europe) Ltd, the privately-owned independent financial advisers located at Barston near Solihull.
E mail: TILaw@montpeliergroup.com