7% pa return over 30-40 years

yatinsardana

bowlhead99 wrote: »

A few potential flaws in your thinking (I don't have any specialist knowledge of the NHS scheme other than like nearly all final salary / defined benefit schemes it is reputed to be a good one)
What you contribute is saving you tax off the highest-taxed part of your current salary. For example in 2014/15 if you earn 45k you get (roughly) 10k personal allowance then 32k at 20% and the last 3k you pay 40% on. If you don't contribute that 3k and take the cash instead you are paying 40% tax and a chunk of national insurance (effectively, more than 40%) on it before you can put it in the ISA.

When you retire, lets say that optimistically you are on high rate tax as you suggest. I say optimistically because only 15% of the country pay high rate tax and the massive majority of those are in gainful employment. To be a higher rate taxpayer without a job, you need a large amount of investments or a very good pension. (clearly there are some people here who are doing it, but are not your typical pensioner - this is an investment board and not a normal crossection of the UK). But perhaps your final salary is good enough to get you there.

So, having avoided 40+% tax on your contributions today, what % tax do you really pay on the money when it reaches you in retirement as a 'high rate taxpayer'? Well, if current rules remain (as they have done for a very long time), 25% of the pot is entirely tax free. Then let's say what you have left: the 75% to deliver an annual taxable income, gets you a similar level to the 45k we were looking at before (i.e. just into high rate tax). You pay 40% on 3k of it, 0% on 10k of it, 20% on most of it. So you are paying on average, less than 20% on the annual pension income. And that annual pension income is only 75% of the value; the other 25% is tax free to clear your mortgage or give you several years' income at once, or whatever. So the blended average rate of what you get out is somewhere between zero and less-than-20%, while it was 40% saved when going in.

So, it's flawed reasoning to say I'm saving 40% now but pay 40% in retirement; the maths doesn't stand up. You are saving >40% now and will pay <20% in retirement. Of course if you are only saving 20% now to pay <20% in retirement it is less useful but hopefully you will cross into being a high rate salary band at some point, it sounds like you are planning that already.

You are right that the absolute amount of cash they put in now is not your concern. They will perhaps put more in if the overall pension pot is getting low and less in other years if the returns are extraordinarly above target. As you get a guaranteed payout you don't care how much they have to put in to get you there. However, there is a big mistake in assuming that because you can ignore that percentage it is not much of a benefit to you.

The bit that you are missing is that the 14% employer contribution does make a lot of difference. Your nominal contribution (5%, 10%, 15%, whatever) PLUS their 14% is what allows them to grow the pot enough to a big enough level. If you give them 11% and they give them 14% there is 25% at work.

That level of total reward gets you the kind of return enabling you to giving up a small fraction of a salary now for 40 years... a small fraction of a junior doctor salary and later the same small fraction of a mid-tier doctor salary and later the same small fraction of an executive senior consultant salary... and then receive back a very large fraction (40/60ths = 67%) of an executive senior consultant salary for the next 40 years without doing any more productive work for the second half of your life. It is a staggering return.

Part of that is the miracle of compound investment returns but part of it is that half the investment and the compounding on the investment - or just call it a guarantee of a huge return - comes from the employer's money. Which you are turning away if you ignore the scheme and simply try to self-invest.

Sure, you can give up that 14% that they are willing to spend on you to enhance your returns and simply invest 28% rather than 14% of your own money. Assuming you are young now, and expect your pay rises to beat inflation over the years (i.e. you are not just doing the same junior job with inflationary payrises at 2% here and there, but you are moving up the ranks to double or triple or quadruple your salary in real terms over the course of your career): have you looked into what fraction of your salary you would need to start putting away now to deliver 40 years of an inflation-linked earning stream at 2/3rds of your final salary? You might find it's 25-30%+.

Dunstonh is correct on this. But you don't need to be a financial advisor like he is, to see it.

The argument of pension vs ISA has been done before.

Whether to pay income tax now and grow it tax free in an ISA wrapper, then take out the final amount tax-free ; or to not pay income tax now, grow it tax free in a pension wrapper, then take out the final amount taxable - has been done before.

Consider £100 of gross salary.
- Take it and pay 20% tax, invest the £80. Have the £80 increase 60x over the next 60 years with a great investment performance. You're left with £4800.
- Alternatively don't pay the tax and invest the £100 in a pension. Have the £100 increase 60x over the next 60 years with a great investment performance. Take it out of the wrapper and you have £6000 less 20% tax = 4800.

So the net or gross investment argument gets you to the same place. It is a wash if your marginal rate is literally the same number on the way in or the way out. But as shown before, the rate at each end of the time period is not going to be a flat 20%. The rate at the end, for most, will be considerably less than the average rate when you were employed, because you have an annual allowance at 0% and a low rate band before getting to the high band. Even if you don't consider the tax free lump sum.

If you do consider that tax free lump sum, you're getting access to a quarter of the cost and investment returns that didn't pay tax on the way in or the way out. That is why people like the pension wrapper, the tax savings usually make up for the loss of flexibility of having it tied up until you reach pension age.

And if you don't think the tax savings are enough on their own to make up for the loss of flexibility, what about the 14% of FREE MONEY from the employer. That is what is buying you high returns. Sure, their contribution rate is irrelevant to you because you just get a fixed (high) return. But one way to think about that 14% is to say 5% of it is adding to your pot to hopefully deliver a high return, another 5% is added in lower risk assets to buy you a guarantee of that high return come rain or shine, and then as a cynic, the last 4% is lost in the general inefficiency of any civil service / government organisation.

Whether the 14% this year really gets you the same return enhancement as putting aside another 14% of your own money, is not quite clear. But given you are young and have other priorities it is likely very much better for you to just enrol and give them the minimum you have to, to stay in the game and get the guaranteed free money and a safe retirment, than to not enrol and instead put aside 20-30% of your gross salary for personal investments and hope they all work out well. Especially while it is a relatively low salary for the first X years of your career.

Crystal clear!

Do you know? Genuinely thank you so much for clarifying so many things here and taking out the time to explain them in detail. I've been scratching my head over the last week trying to make up my mind over pensions vs isas and you've just clarified so many things including some basic fundamental mistakes in calculations!

Thanks to all on the forum for their input and thoughts. Great place for discussions!

planteria

i think you've had some great replies yatinsardana, and it's good to see how well you have absorbed them & responded.

all i would reiterate is that, along with staying in the NHS pension scheme, with the interest that you have taken, start to invest in an ISA or Pension too, even if a small amount per month.

atush

jem16 wrote: »

Perhaps you could explain your reasons here as it might help to understand what you are trying to achieve in turning down one of the best pension schemes around?

I agree, there is nothing to say apart form you could be insane to not join the NHS scheme.

Having said that, nothing to stop you investing in either a PP or S&Sisas and hining your investment skills at the same time?

wotsthat

This forum costs the taxpayer a fortune!

planteria

wotsthat wrote: »

This forum costs the taxpayer a fortune!

im thinking about trying to get a job with NHS after reading this thread :laugh:

atush

Well. thing is our advice here probably does. but we try to give the best advice to the individual, even if it isn't in 'our' ie the taxpayers best interest lol

People here dont really begrudge public sector workers their pensions, unless they come spouting about how they are being ripped off so much they want to strike

yatinsardana

planteria wrote: »

i think you've had some great replies yatinsardana, and it's good to see how well you have absorbed them & responded.

all i would reiterate is that, along with staying in the NHS pension scheme, with the interest that you have taken, start to invest in an ISA or Pension too, even if a small amount per month.

Solid advice! I definitely plan to do that. Just because I'll be joining the pension scheme will definitely not mean I won't be investing regularly on the side. Apart from being very keen on being responsible with my money, I genuinely enjoy investing and it's good fun so I definitely plan to continue.

Think ISA will be the way forward outside the pension scheme for me as it gives easy access and the growth is all tax free.

yatinsardana

atush wrote: »

Well. thing is our advice here probably does. but we try to give the best advice to the individual, even if it isn't in 'our' ie the taxpayers best interest lol

People here dont really begrudge public sector workers their pensions, unless they come spouting about how they are being ripped off so much they want to strike

I genuinely thank you all not only for advising me on this topic but in general for giving such good advice on this forum. It's nice of you guys to take the time out and help people gain knowledge about things they don't know about and you guys know plenty about.

yatinsardana

planteria wrote: »

im thinking about trying to get a job with NHS after reading this thread :laugh:

Haha by all means, if you're ready to take a pay freeze for the last 4 years and have the uncertainty over the future of NHS, along with budget constraints more than ever before meaning you are more or less doing the job of 2-3 doctors yourself and being paid the same - what you used to be paid 4 years ago.

In fact I just got an email where it was highlighted that despite European working regulations, junior doctors are still working 90 hours a week and paid a basic salary of 22,500

Although on the brighter side I do think there is generally a security about your job and that's good. Although the staff at mid-staffs will disagree about that with me today especially after today's news about it being dissolved.

CLAPTON

yatinsardana wrote: »

In fact I just got an email where it was highlighted that despite European working regulations, junior doctors are still working 90 hours a week and paid a basic salary of 22,500

.

you're spoiling it now using that clever word 'basic' : they actually receive a lot more