Many people do not use pensions as their first choice for savings, despite research from Hargreaves Lansdown which suggests they offer better value than ISAs. EveryInvestor discusses some of the reasons behind many people's reluctance to pay into a personal pension, despite the advantages they can offer.
Hargreaves Lansdown's research found that the benefits to a basic rate taxpayer in a personal pension plan are eight per cent greater than in an ISA and it argues that this makes pensions better value. However, EveryInvestor points out that most of the £18.8 billion lump sum personal contributions to pension plans in 2006 was paid by higher rate taxpayers, while standard rate taxpayers usually opt for other savings methods.
"Rich people with plenty of capital can afford to give up access and flexibility on some of their money,’ says the company's CEO, Chris Gilchrist, "so it is quite rational for them to invest lump sums in pension plans. But exactly the same logic explains why most standard rate taxpayers don’t put lump sums into pensions and in general are right not to do so."
Mr Gilchrist, says this is because people dislike restrictions on access, loss of inheritability, and payment of tax on their income. He adds that the investment management company's assumption that tax rules will stay the same is unrealistic with such a long-term investment.
From April 2008, tax relief will drop along with the basic rate of income tax, and this will lower the enhancement to a £1,000 lump sum contribution by £32, from £282 to £250. Mr Gilchrist explains that there have been major changes in the tax rules on pensions over the last ten years and that it is more likely that they will change again than that the simple tax treatment of the ISA will alter. Furthermore, savers can easily counter any negative change in ISA rules by withdrawing their capital.
"People should contribute to occupational schemes to the extent that they benefit from employer contributions," says Mr Gilchrist, "but standard rate taxpayers should make personal savings into an ISA until they have used up their annual savings allowance before considering further personal pension contributions, unless they are very close to retirement."
"Advisers often wheel out the argument that pension savings are good because you don’t have access to your cash and can’t spend it. This is the same paternalism that creates rigid rules governing the conversion of pension fund capital into income through annuities. If people can be trusted to make investment choices with SIPPs, they can surely be trusted to decide whether to use their capital for retirement income or for other purposes," he concludes.
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