Pension Contributions - is it wise to pay as much as possible into pension?

LongTimeThinker

I have recently turned 30, last year I took the time to research pensions and soon discovered I have been a bit foolish not contributing earlier in my career.

That changed nearly a year ago and I have been contributing 10% of my salary, which my employer matches.

I am a 40% rate tax payer and my contributions come out of my gross salary automatically.

I am considering increasing my contributions to 20% but I am not sure if its wise or if I have missed something?

My wife and I also save £2k/month at the moment and luckily we aren't struggling. Both in secure jobs (as secure as they can be I guess!) and I can always drop my contributions if needed. I would like the option of retiring at 60 and I figure the more money I have in my pension the better off we will be.

Is there any reason why I shouldnt increase my contribution? I see it as being very tax efficient and a bit of a no brainer but I am no expert!

Thanks.

Linton

It makes sense to put sufficient into your pension to get the full employer contribution and to get below the 40% tax level. Beyond that other factors come into play. You dont want more in your pension than you need to provide long term income for your retirement. If you are planning to retire early it would be more flexible to build up a substantial S&S ISA portfolio to bridge the gap between your retirement and when your full pensions, including State Pension, are paid.

I dont like your thought of being able to drop contributions if need be as it suggests you could regard your investments as an extension to your current account. Better I think to build up a significant but capped cash emergency fund to provide 6 months cover for major problems such as loosing your job.

Seabee42

There are some longer term issues to consider like the fact the Life Time allowance may never go up (may even go down). What that means is with inflation of say 35 years to go an income of £62500 will be only worth £22,000 p.a. in todays terms.

On the other side if you are a higher rate tax payer it is likely that politicians will take that away the higher rate tax relief at some point so maybe there is an argument to take advantage while you can. Pension saving is like a safety net you will feel better if you have it but there are other ways to provide an income in retirement.

atush

I would pay in extra IF your current pension payments don't bring you under the HRTax band.

After that (once you have paid enough in to bring you down to Basic rate, I would concentrate on as said, the emergency pot of cash. Then S&S isas.

Make sure the OH is paying into a pension as well.

Triumph13

I agree with Linton's views on getting full employer contribution and 40% tax relief, but if your pension is defined contribution rather than defined benefit and you expect to access it via drawdown, then I'm not sure I'd agree about S&S ISA being a better vehicle for 'bridging the gap' for an early retirement - except in the case where you want to retire before you are legally allowed to start drawdown and take your lump sum - currently 55. If you have any hopes of doing that then definitely S&S ISA to bridge the gap to 55.
Generally the decision on whether to put more into your pension now is a complex one, driven largely by the question 'am I likely to need to get at the money before retirement?'
If you are happy that you won't need access to it then the tax benefits point very strongly indeed to the pension contributions.
Is your wife a 40% tax payer too? If you both have 40% relief unused then I would be looking to manage the contributions to equalise your pensions as much as possible to minimise the impact of any limits such as the LTA and maximise the income you can potentially take in retirement without one of you ending up paying HRT.

Linton

Triumph13 wrote: »

I agree with Linton's views on getting full employer contribution and 40% tax relief, but if your pension is defined contribution rather than defined benefit and you expect to access it via drawdown, then I'm not sure I'd agree about S&S ISA being a better vehicle for 'bridging the gap' for an early retirement - except in the case where you want to retire before you are legally allowed to start drawdown and take your lump sum - currently 55. If you have any hopes of doing that then definitely S&S ISA to bridge the gap to 55.
......

The trouble with drawdown is that you are significantly limited in what % of your money you can take out each year. Flexible drawdown isnt applicable as that requires £20K/year of pension income to be in payment.

So if you were planning to retire on a total £25K/year gross with £12K of state pension coming in after 10 years you would need a pension pot of just less than £450K initially to provide £25K income until SPA. The alternative using S&S ISAs is £250K to fund the 10 years prior to SPA and £200K in a pension 10 years later. Clearly the advantage of 10 years investment returns makes the latter very much more attractive.

Triumph13

Linton wrote: »

The trouble with drawdown is that you are significantly limited in what % of your money you can take out each year. Flexible drawdown isnt applicable as that requires £20K/year of pension income to be in payment.

So if you were planning to retire on a total £25K/year gross with £12K of state pension coming in after 10 years you would need a pension pot of just less than £450K initially to provide £25K income until SPA. The alternative using S&S ISAs is £250K to fund the 10 years prior to SPA and £200K in a pension 10 years later. Clearly the advantage of 10 years investment returns makes the latter very much more attractive.

That all depends whether anyone in power b###ers about with the tax free lump sum. If you need to replace £12k pa of state pension for 10 years then you would need £120k if you were otherwise untaxed or £96k if it was all going to be subject to basic rate tax. With 40% relief like the OP your £250k of ISAS would be £417k if they'd put it in a pension. 25% lump sum on that is £104k which you can use to bridge the gap and still have £313k to be drawing down from - plus your other £200k of pension. You therefore end up with an income of about £32k gross instead of your £25k

Triumph13

Or to put it another way, if:

1. You are 40% in, 20% out; and
2. You don't plan to retire before you're allowed to access the pension; and
3. They don't change the rules

Then for every £600 you end up with in a S&S ISA you could have had £750 in a pension PLUS £250 of lump sum.

The £750 in the pension gives the same post tax income as the £600 in the ISA would.

The £250 lump sum is therefore 'free money' you receive in exchange for accepting the rules on how you access the £750 left in the pension.

The big if is number 3 above. Exactly how sustainable is it politically to have a system where pensions are worth so much more to 40% tax payers than they are to 20% payers?

Linton

Triumph13 wrote: »

That all depends whether anyone in power b###ers about with the tax free lump sum. If you need to replace £12k pa of state pension for 10 years then you would need £120k if you were otherwise untaxed or £96k if it was all going to be subject to basic rate tax. With 40% relief like the OP your £250k of ISAS would be £417k if they'd put it in a pension. 25% lump sum on that is £104k which you can use to bridge the gap and still have £313k to be drawing down from - plus your other £200k of pension. You therefore end up with an income of about £32k gross instead of your £25k

I did say in an earlier post that the OP should get below the 40% band first with pension contributions. The problem with replacing 10 years of state pension with the 25% tax free lump sum is that you must have the full (in my example) £450K or there-abouts in your pension 10 years earlier for the 25% TFLS to be sufficient.

Triumph13

Linton wrote: »

I did say in an earlier post that the OP should get below the 40% band first with pension contributions. The problem with replacing 10 years of state pension with the 25% tax free lump sum is that you must have the full (in my example) £450K or there-abouts in your pension 10 years earlier for the 25% TFLS to be sufficient.

Agreed, but in this case as the OP is 30 and looking at upping his contributions from 20% to 30% in total (inc 10% Employer's) then as long as this is all at 40% there should be the scope for a pretty decent TFLS. For him still to be in 40% with 20% employee contributions he'd need to be on about £52k. 30% of that for 28 years with a 3% real return would give a fund of £680k and so a TFLS of £170k which more than covers the 10 years of state pension.

Am I spending too much time playing with pension spreadsheets?

LongTimeThinker

Wow. Thank you both for your comments, lots to take in, ill have a good read through them all.

Yes my wife is also a 40% tax payer, she is a couple of years younger and has everything all organised for her pension starting next month. Her contributions are the same as mine but unfortunately her employer contributions are not.