In our weekly series, readers can email in with any questions about retirement and pension savings to be answered by our expert, Rachel Vahey, head of public policy at investment platform AJ Bell. There is nothing she does not know about pensions. If you have a question for her, email us at money@theipaper.com
Question: I don’t have a private pension, only a state pension, but I am worried that it won’t be enough to sustain me in retirement.
I am 64 years old, have £40,000 in my cash ISA, and only pay the class 2 rate of national insurance. Can I put my ISA into a pension or shall I leave it where it is? What are my options?
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Answer: It’s perfectly normal to feel a bit uneasy as retirement approaches, especially if you don’t have a private pension to fall back on. But the good news is there are still steps you can take to make the most of your savings.
You will be relying on your state pension in retirement, so it’s vital to know when you’ll start receiving it and how much you’ll get. At present, the state pension age is 66, but this will rise to 67 by March 2028. So, as you’re currently 64, you have about three years to go before you can claim it.
To receive the full state pension, you’ll need to have 35 NI qualifying years. A qualifying year is one in which you were working and making NI contributions, getting NI credits (for example, if you were unemployed, ill or a parent or carer), or if you made voluntary NI contributions. You can get a forecast of your state pension by visiting the Government’s website.
And, if you’ve missed qualifying years in the last six, you have the option to pay voluntary contributions now – making up a missing year usually costs just over £900 but can add over £300 annually to your retirement income, which is scheduled to increase each year in line with the triple lock guarantee.
You’ve managed to save £40,000 in your cash ISA. The question now is whether to move this money into a pension or leave it as it is. To help you decide, it’s important to weigh up the tax benefits and practicalities of both options.
If you move some or all of your ISA savings into a pension, you should get tax relief on the contributions. For a basic-rate taxpayer, this means a 25 per cent boost to your pension pot. Higher-rate taxpayers can claim back even more through their tax return or by directly applying to HMRC.
However, when you withdraw money from your pension, only the first 25 per cent is tax-free; the rest will be taxed as income.
If you are the same-rate taxpayer in retirement as you are now, then the tax advantages you get on contributing to a pension will be reduced by the fact that you pay tax when you take out the income, but you will still benefit from a 25 per cent tax-free amount.
Even if your retirement income is modest, the single state pension is soon expected to exceed the frozen personal tax-free allowance. This means that if you receive the full state pension, any extra income you take from a pension could be taxed.
Any withdrawals from your ISA are completely tax-free. However, you won’t benefit from the upfront tax relief you’d get by paying into a pension.
Finally, although inheritance tax (IHT) may not be an issue, it’s worth noting that although pension funds are currently excluded from IHT, from April 2027 they will be included in the estate – the same as ISA funds – when working out what, if any, IHT is due.
However, even if you decide to move your ISA, this may only be possible in stages. There are two main rules which limit the amount of money you can contribute to a pension and receive tax relief. The first is that you can contribute up to 100 per cent of your UK earnings (including tax relief) each tax year, or £2,880 (£3,600 with tax relief) if you don’t have earnings.
The second rule is the annual allowance, which is usually £60,000 (although it may be lower for very high earners or those who have flexibly accessed their defined contribution pension pots). The £60,000 limit includes the individual’s contribution, any tax relief on that, and any employer’s contribution.
If you want to move your entire ISA pot into your pension in one go, you’d need to be earning at least £40,000 in that tax year. If your earnings are lower, you’ll need to move the money across in stages, keeping within the annual limits.
Before you decide what to do with your ISA savings, compare and consider the charges of the ISA and the pension; the pension charges may be higher. And if you move your cash ISA into a pension, think about how to invest your money. As your time horizon is short, it’s likely you will want to go for lower-risk investments.
If you need more help, it’s worth speaking to a financial adviser or to MoneyHelper (the Government’s free guidance service).