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pension advice needed - we dont have a clue!!

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  • clear_blu
    clear_blu Posts: 140 Forumite
    dunstonh wrote:
    There is no compounding of tax relief over the years. If you pick the same funds and get the same charges then at the end of the day a the pension fund will only be higher by the 22% tax relief regardless of the length of time.

    I am not sure that I understand what you are saying........
    If you invest say £100 a month in a pension the amount actually invested is £128. Now if we assume for the sake of arguement that charges and underlying investments are the same and give a return of say 6% growth at the end of the year then the returns would be as follows:-

    Pension premium £100 monthly=£1530 in a year+6%=£1628
    Add another years premium=£1628+£1536=3164+6%=£3354
    and so on after just three years this pot would be worth £5183

    Using the same method the ISA would be worth just £4049

    Surely it can be seen that an investment in a pension would give at least 28% more.

    I do agree that an ISA leaves much more freedom but that can be a problem as the cash is always available and a great number of people would find it difficult to resist dipping in from time to time.

    One more thing to consider......Gordon Brown considered restricting ISA savings to £1000..........Knowing the way he thinks it wont be long before he has another crack at them.
    I have retired from a career in Financial Services........Thank God. Any advice given may be as a result of senile dementia so dont take it too seriously.......;)
  • dunstonh
    dunstonh Posts: 119,679 Forumite
    Part of the Furniture 10,000 Posts Name Dropper Combo Breaker
    You pension pot after three years is only higher by the exact amount of the tax relief. So, after 30 years or so when you get to retirement, you can decide whether to move it all (or some) in at that point or leave it in a tax free arrangement.
    One more thing to consider......Gordon Brown considered restricting ISA savings to £1000..........Knowing the way he thinks it wont be long before he has another crack at them.

    We arent talking about cash ISAs here though. It has to be equity ISAs to be realistic. Other considerations are the potential remove to pension commencement lump sum and the lack of flexibility to move out of a pension once in one.
    I am an Independent Financial Adviser (IFA). The comments I make are just my opinion and are for discussion purposes only. They are not financial advice and you should not treat them as such. If you feel an area discussed may be relevant to you, then please seek advice from an Independent Financial Adviser local to you.
  • EdInvestor
    EdInvestor Posts: 15,749 Forumite
    Surely it can be seen that an investment in a pension would give at least 28% more.


    Yes but the ISA income is tax free while the pension income is taxed @22% - so the advantage is only 5%, ie the tax free cash - it's not enough when you lose control of the capital and have severe restrictions on taking the income.
    Trying to keep it simple...;)
  • jamesd
    jamesd Posts: 26,103 Forumite
    Part of the Furniture 10,000 Posts Name Dropper
    clear_blu wrote:
    and so on after just three years this pot would be worth £5183

    Using the same method the ISA would be worth just £4049

    Now you retire. You take the ISA money, it's tax free and you have 4049.

    You take the pension money. You pay basic rate tax on it and end up with 0.78 x 5183 = 4043 (really would be the same as ISA).

    The pension can really do better than that. You can take 25% tax free, so do that and you get:

    5183 x 0.75 x 0.78 + 5183 x 0.25 = 4328

    7% more than the ISA. though note that EdInvestor wrote 5% more, don't know why there's a difference.

    That 25% tax free helps but then you get to deal with the restrictions on how you can use pension money, particularly the requirement to buy an annuity. There's talk of reducing or eliminating this 25% tax free option, at which point a big gain from the pension option vanishes for basic rate tax payers.

    The pension is also better up to the point where you start paying basic rate tax, since you got tax relief at basic rate or higher rate but are paying no or lower tax when you take the money out. So arranging a pension to provide this much is quite a good idea if you can stand the restrictions. The ISA can't benefit from this since you paid for it out of after tax money when you contributed.
    clear_blu wrote:
    Surely it can be seen that an investment in a pension would give at least 28% more.

    Not that much more, but there are some benefits at lower pension amounts.

    So, quick guidelines for basic rate tax payers:

    1. Pension for each person individually up to inflation-adjusted point where basic rate tax on the pension starts.

    2. ISA after that.

    Doesn't apply when:

    3. Paying higher rate tax, which gets more tax benefit on contributions and this might be enough to compensate for the inflexibility, if you're going to be a basic rate tax payer in retirement.

    4. your employer will let you pay pension contributions with salary sacrifice. The employer and employee national insurance contributions saved get you extra free money equal to up to their value. Free money is good and may compensate for the reduced flexibility of the pension.

    5. you still haven't used all the money your employer will match in pension contributions. Usually best to take all of this free money from the employer.

    And hopefully I managed to dodge any simple mistakes that EdInvestor or dunstonh will have to correct... :)
  • dwsjarcmcd
    dwsjarcmcd Posts: 1,857 Forumite
    Part of the Furniture 1,000 Posts Combo Breaker
    I just wanted to comment on the 'risk' refered to by the OP in their original post. People regularly state this but don't realise that if they are paying regular premiums (as opposed to lump sums, which is a different arguement) that falls in the price of their investments can be a good thing in the early years because as the investor pays the same monthly figure, they buy more 'units', which means that if the price of the units eventually increases, you have more units increasing in value.

    The opposit can be said if the units increase in value, you are buying less of them, so the gain may not be as much as you would think.

    The trick is knowing when to consolidate the units into safe (cash) funds as you come to the end of the term
  • EdInvestor
    EdInvestor Posts: 15,749 Forumite
    jamesd wrote:
    7% more than the ISA. !!/quote]

    I think that's right.
    1. Pension for each person individually up to inflation-adjusted point where basic rate tax on the pension starts.

    For most people the personal allowance will be covered by the basic state pension and the age allowance by the S2P topup.
    4. your employer will let you pay pension contributions with salary sacrifice. The employer and employee national insurance contributions saved get you extra free money equal to up to their value.

    Be careful here: the reduction in NI will cut your second state pension so you may simply be replacing money you would have got anyway.Also salary sacrifice reduces your pay for mortgage multiple purposes.

    Check your state pensions entitlement here:

    https://www.thepensionservice.gov.uk
    Trying to keep it simple...;)
  • jamesd
    jamesd Posts: 26,103 Forumite
    Part of the Furniture 10,000 Posts Name Dropper
    EdInvestor, do you really think it's likely that the S2P increase will be sufficient to exceed the value of investing the full saved employer and employee NI contributions when using salary sacrifice? Seems unlikely to me.

    Salary sacrifice might reduce mortgage multiples, depends on the specific questions asked and how keen you are on giving them inaccurate numbers (the after sacrifice value) to calculate the multiple from. Personally, if I was using salary sacrifice and wasn't asked specificaly for gross PAYE salary I'd give the more accurate pre-sacrifice salary and provide additional information later for both pre- and post-sacrifice to ensure that the mortgage company received a completely clear picture of the situation. Not giving complete details would be a bad idea - if the mortgage company didn't understand what was happening they might think it was a fraudulent application rather than just providing data in the form required to obtain the normal and correct calculation result. Still, salary sacrifice that you can opt in and out of whenever you like is handy for this situation.
  • EdInvestor
    EdInvestor Posts: 15,749 Forumite
    jamesd wrote:
    EdInvestor, do you really think it's likely that the S2P increase will be sufficient to exceed the value of investing the full saved employer and employee NI contributions when using salary sacrifice? Seems unlikely to me.


    As you know S2P is being reorganised over the long term to benefit the lower paid and the OP's hubby only gets 14,400 pa, so I reckon he will probably qualify.I doubt he could afford to sacrifice any salary anyway, do you think?

    The basic point is they should first check their postion with the state pensions as they may already be quite well placed, and would be better off putting extra savings in their ISAs where they are accessible at least for the next few years as children may require extra spending.

    BTW congrats to the OP for doing so well with the finances so far :)
    Trying to keep it simple...;)
  • jamesd
    jamesd Posts: 26,103 Forumite
    Part of the Furniture 10,000 Posts Name Dropper
    He's already using salary if he's paying pension contributions and the OP is contemplating 100 of after-tax income a month, so it's not more sacrifice, just more money for the same sacrifice. Though the benefit decreases that salary sacrifice can cause may be significant. Salary sacrifice does require the employer playing along though and if there's no employer pension scheme the employer may not want the hassle anyway.

    Without salary sacrifice I agree with you and think that ISA saving is a better choice. The "nothing risky" guidance from aliyah rules out equities and that's unfortunate since that's the way to maximise the chance of having a decent pension. Maybe a 50-50 split between equities and cash might be interesting and provide for longer term growth and money potential for the kids in the shorter term or a safe part of the pension funds.

    The talk about S2P changes is somewhat worrying and I suppose might persuade anyone on above average earnings to opt out if some of the more "interesting" options like flat rate regardless of contributions happen. And presumably it'll be done retroactively for contributions already made, magnifying the uncertainty effect for those trying to plan for 20-40 years of what fiddling around governments might do.
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