My Cash ISA Pension Account Proposal: Simple, Transparent, Cheap, Fair & Flexible

Written by Karen Bryan

coinflowerI’d love to see a radical overhaul and simplification of UK personal pensions, which are currently far too complex and weighted toward the interests of the financial services industry and higher rate taxpayers.

I’ll be able to access my stakeholder pension next year. I couldn’t believe that I won’t have the option of a taking a 25% tax free lump sum from my stakeholder pension and leaving the rest invested. With a stakeholder pension, I am forced to buy an annuity if I want to take the 25% lump sum. To follow my desired course of action, I’d have to transfer my stakeholder pension pot into a Self Invested Personal Pension (SIPP). If I want to protect the value of my pension pot by putting the remaining 75% into a savings account rather than stockmarket-based investments, I’d have to pay annual charges for having SIPP pension pot in a savings account. This ridiculous situation of paying fees to have a savings account prompted me to start formulating a better personal pension set-up which would benefit the average person.

Here is my proposal for a Cash ISA Pension Account (CIPA).

A CIPA would combine the benefits of a personal pension, by giving holders the benefit of 20% tax relief on their contributions and the benefits of a Cash ISA, with any interest and income from the CIPA being tax free. I’d cap the tax relief at 20%, I don’t see why higher rate taxpayers should get more benefit from personal pensions.

A CIPA would be a tax free wrapper, you would be able to put the money built up in a CIPA into any available savings account.  You’d need to do your own research to select the savings account(s) into which you were going to put your CIPA cash, just as you do currently with a Cash ISA.  For security, you’d need to limit the amount on deposit with any financial institution to £85,000, the maximum covered by the Financial Services Compensation Scheme (FSCS).

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An account like this should incur no, or miniscule, charges, enabling  CIPA holders to get the maximum benefit from their savings. At present, between 14-40% of the value of personal pension pots is eaten up by annual charges payable to personal pension providers.

CIPA holders would be able to access up to 25% of the total fund value at any time throughout the time which they hold the account. To ensure that most of the CIPA value was used toward a pension, the remaining 75% could only be accessed when you reached the age of 55. There would be no complusion to take the 25% lump sum, if you decided that you’d rather use it towards income in retiral.

Now, although a savings account has historically offered a lower return than a stockmarket investment, not having to pay any, or much lower, annual charges on a CIPA, is going to significantly increase the net return on a CIPA.

CIPA holders would know the precise value of their pension pot when planning retirement, unlike a stockmarket-based pension pot.

From the age of 55, CIPA holders would be able to either purchase an annuity, to give them a guaranteed tax free income for the rest of their lives, or start to withdraw tax free income (up to defined limits similar to income drawdown) from their CIPAs. Taking tax free income from the CIPA pot might be a better course of action, as an annuity provider can take as much as 18% profit when you purchase an annuity.

There could be a similar Stocks and Shares ISA Pension Account (SSIPA) for people who wished to invest in the stockmarket. Investment in equities would incur some charges.

I propose a CIPA/SSIPA annual contribution limit of £15,120.  That would mean a net contribution of £12,096 topped up with tax relief of £3,024. I arrived at the figure of £15,120  by adding together the current £11,520 Stocks and Shares ISA limit (unfairly double the Cash ISA limit) and the £3,600 (gross) Stakeholder Pension contribution limit for people who aren’t employed. This limit would rise annually by the rate of inflation.

At present, you can claim tax relief on 100% of earnings up to an annual limit of £50,000. Adding that £50,000 to the Stocks and Shares ISA limit of £11,520, gives a total of £61,520. Therefore my proposed annual limit of £15,120 is less than a quarter of that amount. But let’s be realistic here and admit that only the pretty wealthy could afford to set aside tens of thousands of pounds a year into their pensions and ISAs.

I calculated that using the National Employment Savings Trust (NEST) model of a total 8% of salary per annum contribution (4% by employee, 3% by employer and 1% in tax relief) of the mean UK salary of £26,871,  for 40 years with an average annual interest rate of 4%, would give you a pension pot of £214,527. That sum would at the age of 66 allow you to take a lump sum of £53,742 (assuming you hadn’t taken out any cash earlier) and to buy an index linked single life annuity, paying you an annual pension of £5,604.

I estimate that my proposal would have, at worst, a neutral effect on UK public finances. The Government would save money with less generous tax relief on pensions and fewer claims for State Pension top-up benefits, but would lose income tax paid on pension income above the personal tax threshold.

I believe that simplicity, transparency, no or low cost, fairness and flexiblity of a CIPA would attract far more people to save for the reasons below:

  1. Access to 25% of value of the CIPA would draw in people who don’t want to tie up their cash until they are 55.
  2. 20% tax relief to boost the value of a CIPA; when you put £80 into the account it would become £100.
  3. Tax free pension income available from the age of 55.
  4. No loss of a massive portion of your personal pension pot to annual charges.
  5. Easier to plan retirement when you know the size of your pension pot.