Tax relief: who gets the benefit?

EdInvestor

There's an article out today, quoting the authoritative Money Management magazine, which says that even at stakeholder levels, over 25 years charges will wipe out 25% of a pension fund.The most expensive plans will extract no less than 43% :eek:

.... even with the new, higher, stakeholder charges of 1.5% a year for 10 years and 1% thereafter, over 25 years charges are likely to wipe out 25% of your pension fund. For the highest-charging plan, the pension company is taking no less than 43% of your retirement fund.

So who's getting the benefit of the 22% tax relief subsidy paid into standard rate taxpayers' personal pensions?

Is it the customer or is it the insurance company ( or - more usually - the IFA/salesman who sold the product, as much of the money will go to pay his commission/salary)?

If the customer is not getting any benefit from the tax relief, should s/he just forget about saving in pensions?

Is it right that we, as taxpayers, are subsiding insurance companies and salesmen/IFAs in this way? Or is there a better way to use our taxes to help us save for retirement?

dunstonh

Communism failed in Russia. If you still feel that these things should be provided free of charge, then move to China.

Our weekly shopping basket would be 25% cheaper on that basis, as would most things we buy. Why should financial services be any different?

Is it the customer or is it the insurance company ( or - more usually - the IFA/salesman who sold the product, as much of the money will go to pay his commission/salary)?

For the record, if a £50pm net (£64.10 gross) pension is sold, I get £2.88 of each contribution paid to me. Thats 4.49% of the contribution. Thats not much of a margin for profitability.

EdInvestor

Our weekly shopping basket would be 25% cheaper on that basis, as would most things we buy. Why should financial services be any different?

I have to agree 100% that tax relief on shopping is a terrific idea, which I'm sure will be supported by 100% of Moneysavers, not to mention the population as a whole.:D

Robert_Sterling_3

dunstonh wrote:

For the record, if a £50pm net (£64.10 gross) pension is sold, I get £2.88 of each contribution paid to me. Thats 4.49% of the contribution. Thats not much of a margin for profitability.

Does that mean that if the pension contributions are paid for 40 years then you get £1382.40 in total?

dunstonh

Robert_Sterling wrote:

Does that mean that if the pension contributions are paid for 40 years then you get £1382.40 in total?

Correct. Not a lot really is it. For the time spent setting it up, covering the lifetime liability and FSA fees, it would take 20 years to get a reasonable amount. Then if you include annual reviews in that, you would never break even. You can't even consider doing monthly/quarterly reports with that level of income. It almost costs the same in administration to handle the £2.88 as it comes in every month. Bit like the revenue sending you a bill for 2p but using a 29p stamp.

jamborino

I don't think the original poster was necessarily being critical of IFAs and their charges per se, but rather making the point that if the benefit of tax relief on stakeholder pensions contributions is effectively eroded by the charges then why not just save your money in the highest interest-bearing account available until retirement?

For those like me that aren't experts in this area it seems a valid enough point to make, but it wasn't addressed in any of the replies.

dunstonh

Ed is always critical of IFAs and charges.

The post didn't get addressed because it's concept is ridiculous. To assume that a product should be provided without a profit margin by anyone in the distribution chain is daft. In fact, that is the only answer that can be given.

His 25% figure is also misleading. The charges are not 25%. The affect of charges over the term account for around 25% of the final value. That means that if the charges were not taken and then had growth at the same rate, that the total amount accounts for around 25% of the final value.

For example:
Total contribution paid 11,129.00
Charges 6,200
Effect of charges 13,900
Final fund value 43,700

So, the charges are actually 14% of the final value.


If you removed the profit margins from Tescos and their suppliers, you would save more money in 10 years than most people pay in charges on financial services over their lifetime.

then why not just save your money in the highest interest-bearing account available until retirement?

Interest bearing accounts are not free. There is a profit margin on these as well. The difference between pensions and savings accounts is that the charges on pensions are disclosed. They are not on savings accounts. Its a common mistake made. Indeed, the margins on savings accounts are almost certainly higher than those on stakeholder pensions.

EdInvestor

There are really two issues here:

1.How big a benefit is tax relief?

and

2.How much of this benefit is eaten up by charges which can be avoided if you invest direct?


The main problem area is personal pensions and basic rate taxpayers. The actual benefit of the tax "relief" for these people is quite small - if you invested the money in exactly the same direct way with very low charges in an ISA and a SIPP pension, the actual benefit to the pension investor in retirement income over the ISA investor would be a little over 6%, and for that he loses control of around two thirds of his capital.

So the pension tax relief is really very unattractive to the basic rate taxpayer in the best of circumstances.

When you add on the fact that 25% of an average pension fund invested at a 1% annual charge is going to be wiped out over 25 years, then it makes the whole idea even more unattractive. This is a very high cost way to invest.

"Tax relief" should really be referred to as "tax deferral" IMHO, as it is in America.Many people don't seem to realise that although you get tax relief when you pay in, you have to pay tax on the pension income received (other than the 25% tax free cash lump sump you can take - which is where the 6% margin over the ISA comes from).

It's really a very ineffective way to save.

[The position is clearly better if employers are contributing free money to a pension and negotiating lower charges by "buying in bulk" for employees, and for higher rate taxpayers.]

dunstonh

if you invested the money in exactly the same direct way with very low charges in an ISA and a SIPP pension, the actual benefit to the pension investor in retirement income over the ISA investor would be a little over 6%, and for that he loses control of around two thirds of his capital.

That would involve in people taking more control of their investments and having a lot more knowledge. The vast majority of people are not in that position and require investment funds. Also, the lack of diversification that would follow that would give portfolios that are of a higher risk nature than the average person would want.

Where services are provided, you have to pay for them. I have a painter in at the moment decorating a few rooms. I could do it myself cheaper but I don't want to do it. I could grow carrots in the Garden but i don't want to.

Nick_C_4

I have to agree 100% that tax relief on shopping is a terrific idea, which I'm sure will be supported by 100% of Moneysavers, not to mention the population as a whole

Well, you're wrong, because I wouldn't. Given that most people spend most of the money they earn, that would be equivalent to, say, halving income tax. Then the government would have far less money to spend. You may get some people in favour, but if it's such a popular idea, why hasn't any political party tried to push it? Because the NHS, the education system, the roads, etc etc would all collapse.

EdInvestor

Dunstonh

I wasn't suggesting that people should invest in SIPPs. I was suggesting that basic rate taxpayers should not invest in personal pensions of any sort where there was no free money from employers involved. Rather they should use ISAs.

When you compare ISAs and personal pensions on a like for like minimal charges basis, the advantage conferred by the pension and its so called "tax relief" over the ISA to the basic rate taxpayer is a mere 6% rise in income when retired.This is very piddling considering you give up access to your capital forever.:(

And this is the best case scenario - this is a comparison where the pension has not had 25% of its value removed in charges.

The argument will become academic next year anyway, when the current "use it or lose it" annual tax relief rules will be replaced by the lifetime limit.This will mean you can save in ISAs during your working life and then switch the money into a pension near the time you are due to retire and get all the tax relief. If you want to that is - many people will prefer to keep control of the capital and avoid paying tax on their income, I suspect.