Pension questions and thoughts (aka...help!)

mush1234

Hi there, hoping for a little advice (be warned, I'm pretty clueless!)

Im a partner in a ltd company, I have a 50% share. I'm 36, I own a £280 house (£40k left to pay), I have about 60-80k in personal savings, and I have no other dept anywhere or to anyone.

I could also - at a push and assuming nothing goes wrong...save an additional £20-30k a year.

Currently though I have no pension, I have been somewhat slack about this but also iv kinda avoided it all together as I'm always hearing negative about them. But that said, iv also thrown all spare cash into the mortgage.

A friend of mine suggests not getting a pension at all, his suggestion is to simply put the money into high interest savings accounts and ISAs?

What are your thoughts regarding this approach?!

Another question... I recently looked at a pensions calculator, which told me I would need a pension valued at £200k to receive 12k a year. Could I save £200k and at the suggested age of 65 pay that into a pension plan and receive a working pension until death?

Love to hear some opinions!

jamesd

High interest savings accounts don't pay as much as investment growth does over the long term. This makes them a bad choice for retirement planning which usually has a long timeframe.

ISAs can be as bad as savings accounts (using a cash ISA) or as good as any other investment (using a stocks and shares ISA). Though without the tax relief of a pension that can be useful.

Your friend is suggesting an approach which typically results in a poorer retirement than standard retirement planning. It has the advantage that it has minimal investment risk and the disadvantages of high inflation risk and low investment returns, typically zero or negative after inflation, while stock markets might reasonably be expected to deliver say 7% after inflation even for moderately cautious investors.

Overpaying on mortgages is another way to make yourself poorer over the long term. Same basic reason: you only save the mortgage interest but saving that costs you the higher investment growth, so you end up worse off.

Nothing particularly wrong with cash savings or overpaying on mortgages and both are good choices for those who are extremely cautious. They can also be appropriate as part of a mixture of investments.

calypso_rhapsody

Oh dear Mush - my initial thought is that you should visit an IFA and take some overall advice as you clearly need some. If your partner also needs advice you may be able to get it invoiced to the company as 'advice on directors remuneration structures' and get corporate tax relief on the fees.

In all likelihood the advice will be to set up a pension scheme with contributions via the company - if you sacrifice salary the contributions come from the company and no NI is payable so the company can at a minimum contribute to your pension the NI it would have paid.

Pensions v ISAs is regularly debated on this forum - and i've only really started looking at the pensions board recently. In summary you get tax relief on the way in to pensions (esp valuable if you are, as i suspect, a 40% tax payer) but apart from a 25% lump sum which is tax free you are taxed on the money as it comes out. And you can't access the money until you are 55 - this could increase.

ISAs offer no tax relief on investment but gains and income are tax free as the investment grows and there is no tax when you draw on it. No age limit = so more flexible.

In general other investments are not tax sheltered ... but there are some more esoteric ones that are (EIS, VCTs etc).

I'd suggest that a mix of pension and ISA may be right for you - but of i were you i'd make sure that the pension is enough to provide for your minimum desired level of pension income/ You could take account of the state pension but it's 30 years or more away for you so i'd discount it in my planning ....

PS do look at taking dividends rather than salary from your business (apart from the small salary needed to maintain your state pension contributions ...) - at the moment this is marginally better (admit i have not checked the sums since the autumn statement)

dunstonh

I'm always hearing negative about them.

Like what?

remember that the most common complaint with the type of pension you would use is that they dont get enough income in retirement. However, that is nearly always because people dont pay enough into them and have a misconception on the amount they will pay back. i.e. someone paying £50pm thinking they are going to get £1000pm back is always going to be disappointed when they get back £150pm. Problem isnt the pension. Problem is their lack of contribution and a lack of realism.

Half the stuff you hear about pensions is either wrong (frequent media error is to confuse future money terms with todays money terms) or not applicable to the type of pension that you would have or applies to pensions from 30 years ago and not those today.

A friend of mine suggests not getting a pension at all, his suggestion is to simply put the money into high interest savings accounts and ISAs?

What are your thoughts regarding this approach?!

Awful option. At your age, it is virtually guaranteed that option would give you the least in retirement of all the options available. You will be getting no real growth and would actually be losing money in real terms. You willl have to pay tax (on non-ISA) and NI on money taken out of the company to put into the savings.

Friends making recommendations like that are dangerous to your finances.

Another question... I recently looked at a pensions calculator, which told me I would need a pension valued at £200k to receive 12k a year. Could I save £200k and at the suggested age of 65 pay that into a pension plan and receive a working pension until death?

No.
1 - it wouldnt be tax efficient (you would have paid NI on getting the money out where with pension you wouldnt)
2 - you would fall foul of lifetime allowance rules (£50k a year can go into pension)
3 - there is no logical reason that would benefit you

Pensions are not a perfect product/tax wrapper. However, no product ever is. A helicopter is great for taking you to an oil rig but useless for the school run.

As a director, a pension allows you to get money out of the company without paying NI on it. Plus, the contributions are a business expense so you dont pay corporation tax. i.e. company heading for a £100k profit, you put £20k in a pension and the corporation tax will be based on 80k, not 100k.

The 200k on that calc is the gross figure. So, a pension would need you to pay £160k to get that level of income whereas savings would need you to save £200k

If your partner also needs advice you may be able to get it invoiced to the company as 'advice on directors remuneration structures' and get corporate tax relief on the fees.

Yes, the IFA can actually bill the company rather than within the pension and the bill is a deductible business expense.

jamesd

Here's an illustration of the power of pension tax relief that may help to explain why neglecting them is a bad idea. While you're not 55 I'll use that age for convenience because that's when you can take money out of a pension.

Pay £66,666 gross into a pension with higher rate tax relief. Net cost to you is £40,000, the amount needed to clear the mortgage.
Do it with salary sacrifice and have the saved NI paid into the pension. That's 2% personal NI and 13.8% employer NI, a total of 15.8% of £66,666 = £10,533.
Total in the pension pot is now £66,666 + £10,533 = £77,199. So far you've made a 93% gain on your money just from tax and NI savings with no investment risk at all.

Now for a 55 year old you can take 25% out as a lump sum tax free. That's £19,299.75 taken out and £57,899.25 left in.

At this point your net cost is £40,000 - £19,299.75 = £20,700.25 with £57,899.25 in the pension pot. £57,899.25 / £20,700.25 = 2.8. So a 180% return on investment with zero risk.

You could use the £20,700.25 to repay some of the £40,000 that you would have paid off the mortgage. The remaining £57,899.25 can generate from 4% to 6% income a year from investments depending on how cautious you want to be. £2,316 to £3,474 a year. For life. Or put differently that's 11.29% to 16.78% equivalent interest for life on the £20,700.25 net cost. After 8.3 to 5.6 years, ignoring mortgage interest, you'd have finished clearing the mortgage and the rest is pure profit. Tax also ignored but you get the idea.

Compare this to a S&S ISA. Same £40,000 net. You end up with £40,000 net in the investment as well because there aren't any breaks. The money has to actually be paid to you to get into the ISA so you can't doge the NI. Same 4-6% income is £1,600 to £2,400 a year. Unlike the pension this has no income tax to deduct. But it's not quite comparable to the pension - you haven't paid £20,700.25 off the mortgage either. So moving on to dealing with that...

Instead of £40,000 you start with £40,000 - £20,700.25 = £19,299.75 in the ISA. At 4% to 6% income that's £772 to £1,158 a year tax free income.

Assuming a higher rate tax payer that compares to £1,389.60 to £2,084.40 after tax from the pension. 1.8 times as much from the pension even after higher rate tax. And you probably won't be paying higher rate tax all your life.

The ISA has £19,299.75 subject to inheritance tax to inherit. The pension has £57,899.25 and it's exempt from inheritance tax if paid to a spouse or dependent on your death. Otherwise there's be inheritance tax to pay just like the ISA - but on a much bigger starting amount.

Now you're not 55 yet so can't actually take the income and lump sum immediately, you'd have to actually invest the money. But it should have illustrated the value of the tax and NI relief available for pensions: you end up with more income and more inheritable lump sum for your money.

jamesd

Now there are disadvantages to pensions. You can't take the money out until you're 55, which also protects it from bankruptcy or benefits means tests. The income level you can actually take out is limited by the GAD limit and that's currently lower than desirable. And it's a bit more hassle to use pensions, though not much more. One big difference is that you can take out all of the money from an ISA so you can usefully use some ISA component to allow you to draw money at a faster rate than the pension allows. This is particularly useful if you want to retire earlier than 55 because you can drain it at a high rate until the pension kicks in.

mush1234

Cheers guys for the quite frankly fantastic advice!

There's one small issue (maybe) - while I'm a director with a 50% share my partner (also with a 50% share) is considerably less well off than me.

Now it's my understanding that because we run a ltd company all wages/dividends etc have to be paid in equal measure. I assume this would be the same case as pensions???

I only see this as an issue because while I would be happy to pay in 30-50k this year into a pension, I doubt my partner could afford too. Would my payments have to drop to his?

Does that make sense?

dunstonh

Now it's my understanding that because we run a ltd company all wages/dividends etc have to be paid in equal measure. I assume this would be the same case as pensions???

No. A general rule is the level of contribution should be in line with what you would pay someone else for doing the same role. If the profits can sustain it and you are a key worker then you can go to the £50k p.a. If a spouse/partner is also a director but plays little or no part in the company then a large contribution is hard to justify.

The amount one director gets does not affect the other.

atush

You need, as said above., to set up a company pension that pays both of you some of yoru salary into a pension. It will get tax releif at your highest rate (so I assume 40%) You can even have your company pay into the pension as well, which will be tax deductable.

Add to that investment growth and income over time and you can build yourself a nice retirment fund.

But do save in ISAs, both cahs and S&S, outside the pension as well.

jamesd

Have a read of the salary sacrifice sticky thread. You can pay each of you the same amount and one can choose to have the money paid into a pension by the company while the other can choose to have it by normal payroll. Not sure whether this is more or less efficient than dividends.

calypso_rhapsody

Mush - re your question about paying the two directors equally. It is possible that this is part of your agreement with the other shareholder - either explicitly (eg in a shareholders agreement maybe) or implicitly. This is, in my experience of small businesses, not uncommon - indeed i have some dealings with a company owned by three director/shareholders and equality of treatment is a holy grail for them.

Though Dustonh does make a valid point about contribution ... in that case all three work equally hard and are equally important to the business's success. Paying a relative who does little way over the odds could cause problems with HMRC.

But you can have equality without necessarily taking your remuneration in the same form. The test that i would suggest you could use is the cost to the company. You might choose to have a larger pension contribution than your partner but provided the company is bearing the same cost for each of you then that is still equality. If you do have a written agreement then you may need to agree a variation in writing.

If you decide to pay part of the remuneration as dividend (assuming hte company has distributable reserves) then they should be equal as you are equal shareholders but you can waive dividends if necessary to balance things up. Don't forget that dividends are not 'earnings' for the purposes of calculating your max pension contributions. But they do save a lot of NI!