Salary Sacrifice, 42% saving, 25% tax free cash, 86% of contributions back

Leo83_2

Hi guys,

I have been working out some figures recently, and to me anyway, saving into a pension scheme is a win win, no brainer plan for the future. With higher rate tax relief, you end up getting a massive portion of your contributions back when you take out the 25% tax free cash at the end.

Employee earning £50k per annum and is contributing 10% of his salary through a salary sacrifice scheme into his pension pot. His employer matches this 10%. With a 42% saving, for his £5k contribution the real net cost to him or drop in take home pay is £2,900. (58% of £5k)

So for every £10k going into his pension pot he is only contributing £2.9k. Just to keep the maths easy and forgetting pension growth, multiply this by 10yrs to give him £100k in his pot (In terms of contributions)

He gets to withdraw £25k of every £100k in his pot come retirement which in essence means he is only paying £4k out of every £75k that will be used to buy an annuity/drawdown.

Pension saving in effect is just that, take the 25% tax free cash and you are going to get back 25/29 (86%) of all the contributions you have ever put in. The rest + growth is used to generate an income.

The figures will vary of course, this is just a matched scheme, if your employer is paying in more than matched then the figures are going to be even better.

What have I missed, why are there even doubts about saving into a pension scheme? Surely, its a no brainer?

Leo

bigadaj

Because many people aren't higher rate taxpayers. If you are standard rate and you're employer doesn't match then it is by no means clear as you lose access and charges may relatively high, so in these cases for many people savings in isas make sense, after which paying a mortgage down is often attractive to people who have a low risk view.

hugheskevi

What have I missed, why are there even doubts about saving into a pension scheme? Surely, its a no brainer?

You haven't missed much, certainly in the circumstance you describe a pension is highly attractive.

Pensions work best when one or more of the following applies (and if none apply, a S+S ISA may well be more appropriate):

• Higher or additional rate income tax payer
• Employer contributions are available
• You are in receipt of means-tested benefits (which now includes child-benefit)
• You have salary sacrifice available

However, many would argue that the following make pension saving unattractive:

• Policy change risk - pension rules change every few years, which is a big deterrent to long term saving. For example, the lump sum may be removed before you reach retirement, the age at which you can access the pension could be increased, National Insurance could be merged with income tax and you end up paying 32% on your pension income. Once the money is in the pension, you are a sitting duck, eg, to things such as Lib Dem proposals to tax wealth - with unwrapped or ISA investments you can take appropriate avoiding action, but not with a pension.
• Charges will eat up all the growth
• The performance will be very poor (which can be linked to charges)
• When you come to annuitise the rate will be so poor it won't have been worth saving
• Unless you have built up a big pension pot, means-testing might mean you are no better off from saving than if you hadn't saved at all
• It is all fiendishly complicated, but one way or another the consumer will lose - history shows pensions have a very poor track record of consumer protection (used in its broadest sense) and not all of these things are in the dim and distant past but are still happening today - Maxwell, Equitable Life, people losing most of their pension when their employer ceased trading, the change to earliest age of access from 50 to 55, the change from RPI to CPI revaluation/indexation, the changes to rules around income drawdown which reduced the amount of income that could be taken by about 40%, etc.

There are straight-forward counter-arguments to all the above, but there are half-truths amongst most of that list so you can see why someone without a detailed knowledge of pensions could be put off.

Zero_Sum

and if you're in a defined benefit scheme, it makes no difference what you're employer puts in.

oh and I don't think contributing to a pension scheme is actually classed as a 'salary sacrifice scheme'

mysk_girl

Pension schemes can be salary sacrifice. Mine is. It depends how they employer has set it up.

gadgetmind

Zero_Sum wrote: »

oh and I don't think contributing to a pension scheme is actually classed as a 'salary sacrifice scheme'

I pay into my pension via sal sac, so not only do I save tax but also NI, and then my employer boosts my contribution by 10% as a thanks for saving them employer's NI!

Zero_Sum

gadgetmind wrote: »

I pay into my pension via sal sac, so not only do I save tax but also NI, and then my employer boosts my contribution by 10% as a thanks for saving them employer's NI!

but that happens anyway in a non sal sac scheme

mysk_girl

The NI doesn't. You get tax relief, but both employer and employee still have to pay NI. Salary sacrifice saves both money.

xylophone

but that happens anyway in a non sal sac scheme

The employer might be sharing his NI savings with the employees by paying a supplementary amount into their pensions.

gadgetmind

xylophone wrote: »

The employer might be sharing his NI savings with the employees by paying a supplementary amount into their pensions.

Yup, that's the boost.

If I decide to take £100 via my pay packet, I lose at least 42% so get a heady £58 to take home. As there are various other claw backs it can be less than this.

If instead I sacrifice it into my pension, £110 goes straight in there. (For technical reasons, it's about 80bps more but you get the idea.)

Zero_Sum

mysk_girl wrote: »

The NI doesn't. You get tax relief, but both employer and employee still have to pay NI. Salary sacrifice saves both money.

employers rate is normally 13.8%, because I'm in the pension scheme my emplorers NIC is reduced to 10.4%

and also I get a 1.4% discount on my NIC's