The safest place for your retirement savings

Worried office workerA year or so back, Parliament's Public Accounts Committee published a damning report into the way that HM Revenue & Customs (HMRC) taxes older people -- especially pensioners.

Its conclusion: older taxpayers were poorly served by HMRC, and were getting a raw deal in their dealings with it. In short, they were more likely to comply with their tax obligations than other taxpayers, but were less likely to understand them.

The result? Many pensioners paid more tax than they needed to.

Too complex

There were, said the committee, several distinct factors at work.

For a start, because HMRC's systems don't cope well with older people's multiple sources of income, an estimated 1.5 million older people had overpaid tax by around £250 million, because of discrepancies between HMRC's records and the records of employers and pension providers.

In addition, some 2.4 million older people had also overpaid around £200 million in tax, because they did not have their savings income paid gross of tax, and hadn't claimed back the tax deducted at source.

And, despite the fact that older people generally have more complicated tax affairs, older people were less likely to contact HMRC for help.

Finally, it appeared that too few older people were claiming the age‑related tax allowances for which they were eligible. This wasn't too surprising, said the committee, because the rules on eligibility were difficult to understand, and older people did not find the claim form easy to complete.

No change soon

The committee made a number of recommendations, ranging from the introduction of simpler systems for older people, the provision of more help for older people in terms of tax advice and a drastic simplification of the age-related allowance system.

All good sensible stuff, especially the simplification of the age-related allowance system.

But don't hold your breath -- even though HMRC is introducing new systems. For even when those new systems are fully functioning, the National Audit Office has predicted that there will still be 20 million unmatched tax codes that it could take years to resolve.

Don't tell the taxman

But you don't have to wait for the slow-moving wheels of government to work their way towards a solution. Take matters into your own hands.

How? By sheltering as much of your retirement income as possible within an ISA.

For because ISA income is tax-free, there's no need to declare it on your tax return. That's right: there's no need to tell HMRC at all -- thereby neatly side-stepping a slew of tax problems of the sort identified by the Public Accounts Committee.

Share certificates? Stick them in an ISA. Brokerage account? Switch it to an ISA. Bank or building society savings? Make sure that the accounts are ISAs. And so on.

In short, do everything you can to simplify your taxable affairs by turning the income in question into income that is well and truly outside the taxman's clutches.

An ISA as a pension

Sound logic, to be sure. But there's an argument for going even further.

Here at The Motley Fool, a stalwart band of regular readers has always argued that ISAs -- and they're thinking stocks-and-shares ISAs -- are superior to pension income secured through annuities.

The reasoning? In contrast to the ever-changing pension regime, you keep control, your retirement income isn't subject to government whim -- look at Gordon Brown's infamous dividend grab -- and the charges are generally lower.

What's more, you determine when you can retire, not the government. And, unlike an annuity, your assets don't die with you; there's something to pass on to your heirs.

Now, back when the annual ISA allowance was a derisory £3,000 or so, the option of diverting significant amounts of retirement savings into ISAs rather than pensions wasn't really a practical proposition.

But with the lifting of the limit to more realistic proportions, and the decision to automatically index it to inflation, the picture has changed.

Next year's ISA allowance, for instance, is a hefty £11,280. Over time, you can build up a pretty decent retirement income with that sort of money.

Tax relief

Now, it's important not to lose sight of the impact of tax relief -- both on your decisions, and on the government's policy-making process.

For basic rate tax-payers, the ISA vs pension annuity is largely tax-neutral. With traditional pensions, you get tax relief on the way in, but your retirement income is taxed. With ISAs, there's no tax relief on the way in, but no tax on the way out, either.

Which neatly means that there's no incentive for the government to discourage the use of ISAs for pension saving. Quite the reverse, in fact, as from a cash flow perspective, it doesn't have to grant tax relief today, merely forego tax tomorrow.

You're a basic-rate taxpayer today, but likely to be higher-rate taxpayer in retirement? Then the ISA route is even more tempting.

You're a higher-rate taxpayer today, but likely to be a basic-rate taxpayer in retirement? You're losing higher-rate tax relief on the way in, but gaining an asset that you can leave to your heirs -- and potentially do so within the inheritance tax allowance, meaning that there's no further tax to pay.

In short, a lot to think about. But what's your view? Answers in the box below, please!

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