Pension advice pls - company contributes

waterwatereverywhere

Hi,

About a year ago I started paying into a pension scheme provided by my employer.

I can choose how much I pay in and am considering whether to increase my contributions and would welcome some advice.

I've always been nervous of paying into a pension because of the risk factors of losing some of the capital and also because you used to be unable to withdraw any money from the pension, but I understand that recent rule changes now mean you can withdraw a lump sum tax free early - have I got this right? Are there any restrictions?

As long as I can withdraw a lump sum early then it would seem to be a very tax efficient way of saving, because the pension is automatically deducted from my salary giving me Tax and National Insurance savings.

I'm thinking of increasing my contributions from 3% to around 9% at the moment and the company pays around 6% on top of this.

Any advice gratefully received. Many thx in advance.

waterwatereverywhere

P.S. I've just googled and found the extract below which explains the new rules I am thinking about, however I was under the mistaken belief they were already in force. Pls does anyone know?

Unless there is definitely an ability to withdraw a cash sum tax free and early then the option to increase my contributions becomes less attractive to me, as I could just put extra savings into an ISA instead.

FROM HARGREAVES LANSDOWN's WEBPAGE:
"New rules proposed for April 2015
Further pension rule changes proposed for April 2015, could remove restrictions on the amount you can draw from your pension entirely.

This is a hugely significant change.

The government is currently consulting on the proposals, and expects the new rules to be in force from April 2015. We don't know what form the changes will take, but if you register for our updates and we'll keep you informed"

xylophone

https://www.gov.uk/government/uploads/system/uploads/attachment_data/file/301563/Pensions_fact_sheet_v8.pdf

jem16

waterwatereverywhere wrote: »

I'm thinking of increasing my contributions from 3% to around 9% at the moment and the company pays around 6% on top of this.

Will the company match any extra payment that you make or is the 6% their maximum?

waterwatereverywhere wrote: »

P.S. I've just googled and found the extract below which explains the new rules I am thinking about, however I was under the mistaken belief they were already in force. Pls does anyone know?

They are not in force as yet. The plans are for them to be in force from April 2015 provided the plans are passed.

Unless there is definitely an ability to withdraw a cash sum tax free and early then the option to increase my contributions becomes less attractive to me, as I could just put extra savings into an ISA instead.

I'm not sure what you mean by early or indeed tax-free. The rule change will not allow you to access the pension before age 55 just as it is now. Also, just as it is now, you will only be allowed 25% tax-free. The rest will be taxable as normal income.

Your_Hero

There has always been an option to draw money out tax free and early. It is currently age 55 minimum, 25% tax free and rest is taxable as income. This has NOT changed.

The only change is to income drawdown where you can draw out the full pension pot whereas previously you needed a minimum guaranteed income of £20k, reduced to £12k currently and then down to 0 next April. As I said earlier this will be taxed as income still.

The tax relief you receive on pensions is more compelling than an ISA. What would you do in your old age without any income (excluding state pension)?

waterwatereverywhere

Hello,

Many thanks for the helpful replies.

In answer to one of the questions, yes the company will increase its contributions but not until I've been with the scheme for several more years - can't remember how many exactly, but not for some time. Then it increases by a few percent.

I understand now that the proposed new regulations I had heard about in the press are not yet in force.

I just can't work out whether it is a better/safe option to increase my pension contributions right now.

By way of background, my mortgage is paid off and I have no dependents to worry about, plus some ISA savings built up over the years.

The main attraction seems to be that because my pension contributions are taken out of my salary at source I benefit from tax and national insurance reductions which mean the net cost to me is less than it would otherwise be.

So my thoughts were that it would be a tax efficient way to save, if I could treat it like a savings account and withdraw the money at or around age 55 if I should need it then.

So are you saying that at 55 I could withdraw only 25% tax free and any other withdrawals would be taxable?

If I don't actually need to withdraw the monies at age 55 then I would be happy to leave them in the fund and just take the income as a normal pension (so regular monthly income) and presume these income payments would be taxable as income too?

My main concern is that I think the pension fund can go up and down so that I might lose capital and I am super-cautious which is why I tend to prefer the safety of ISAs over the risk involved with pension investments - but does the tax saving outweigh this, if I have the ability to withdraw from the pension if it looks like the value is going down?

Sorry to ask so many questions but I don't know much about this area and would like to make the right decision.

jem16

waterwatereverywhere wrote: »

The main attraction seems to be that because my pension contributions are taken out of my salary at source I benefit from tax and national insurance reductions which mean the net cost to me is less than it would otherwise be.

The tax is obviously a bonus but remember you will probably pay tax when you take the pension. Unless you are a higher rate taxpayer which is an obvious benefit.

As to NI, unless it's a salary sacrifice scheme you won't save anything on the NI. Is it salary sacrifice?

So are you saying that at 55 I could withdraw only 25% tax free and any other withdrawals would be taxable?

Yes that's always been the case and the new rules don't change that.

If I don't actually need to withdraw the monies at age 55 then I would be happy to leave them in the fund and just take the income as a normal pension (so regular monthly income) and presume these income payments would be taxable as income too?

All pension income is taxable including the state pension. Only your 25% lump sum is tax-free.

My main concern is that I think the pension fund can go up and down so that I might lose capital and I am super-cautious which is why I tend to prefer the safety of ISAs over the risk involved with pension investments - but does the tax saving outweigh this, if I have the ability to withdraw from the pension if it looks like the value is going down?

I'm assuming you are now talking Cash ISAs as opposed to S&S ISAs? For long term planning such as retirement, cash ISAs are really unsuitable as you're simply replacing investment risk with inflation and shortfall risk. As I'm sure you know cash ISA rates are not keeping up with inflation at the moment so you are losing money in real terms.

As to the pension, once it's in there it cannot be withdrawn till age 55 at the earliest.

Your_Hero

It would be foolish to use cash ISAs to replace a pension. You are basically guaranteed to lose its value in real terms (after inflation) over the long term.

Cash is really only for short term purposes.

jamesd

Lets say that for each month's contribution there was only a one in ten chance that you would be less well off investing the money than if you put it into a savings account instead. What about if that chance was only less than one in twenty or one in fifty?

Here's what really happened in the years between 1899 and 2010, the chance of investing beating cash for each number of years:*

2 years: 67%
3: 69%
4: 72%
5: 74%
10: 90%
18: 99%

Retirement investing is usually long term so overall if you'd invested in the past you'd generally have had less than a one in a hundred chance of each month's money doing less well than in a savings account. Each month gets a different chance so overall your chance of not beating cash savings is lower than this. Small but not quite zero.

The reason for this is that over time the long term gains become so large that they mean that even the worst dips are no longer enough to take things below what savings would have done instead.

In the past one of the risks was a big dip just before buying an annuity. That could lock in the bad result for the rest of your life, though it would still almost certainly have been better than cash savings. There hasn't been a requirement to buy an annuity since 2006 so that risk is no longer around. Now all you need to do is draw enough to live on while you wait for the markets to recover. You still should allow a generous safety margin just in case you experience a really long recovery time, though.

By using cash savings you're taking a bet that things will turn out a lot worse than they have in the past. So you should invest, but I'll consider ISA of pension in another post.

* Source: Equity Gilt Study 2012

jamesd

So, ISA or pension? Or a bit of each? Lets pretend that you're a basic rate tax payer for this, if you're not just say so but the result for that is even more in favour of pensions than for basic rate. For convenience I'll pretend that you're just about to reach 55 so I'll ignore all of the investment gain potential and just consider the tax advantage of a pension over an ISA.

You're using salary sacrifice. What this means is that you don't pay the 12% employee NI on your pension contributions and you also get 20% basic rate tax relief. You pay in £100 gross and your net cost for that in the pension pot is £68.

Now you reach 55 and want to start to take the money. First thing you do is take out the 25% tax free lump sum leaving £75 in the pension. Lets say you take all of the £75 in the pension pot and pay basic rate tax on it. You end up with £60 after tax.

You've paid in at a net cost to you of £68 but have received £25 + £60 = £85. 85 / 68 = 1.25, a 25% gain.

That pension tax relief has made you a gain of 25% on your money that you wouldn't have got if you'd used the ISA instead.

It's hard to beat pensions, particularly for basic rate with salary sacrifice.

Where ISAs have an advantage is ease of access, particularly before age 55. You need ISA or other investments outside a pension if you want to provide for things like long term inability to work or retirement that happens before age 55. As you approach 55 the amount you need for those things decreases and it becomes sensible to start to move more of the money into a pension instead.

The catch in the past has been the limit on how much money can be taken out. That could mean that it was better to use some ISA investing to allow drawing capital at a faster rate than the pension would allow. But the pension restrictions have already been relaxed, increasing the amount that can be taken out by 25% (the change from 120% to 150% of GAD). And there's that plan to allow unlimited drawing, which may well eliminate the rest of this reason.

Pensions are an extremely useful tool and for most parts of retirement planning they should be the main tool. The planned changes are likely to eliminate most of the few remaining cases where they might not be best, other than the retire or other need before age 55 case.

jamesd

I mentioned long term inability to work. For cases where that's due to illness there's a product called permanent health insurance. That will pay out a set amount for every year from the time you become unable to work, or sometimes after a year or some other shorter delay. Those payments stop only when you become able to work again or when you reach retirement age.

It comes in two main types, own job or any job. Own job is the better of the two, it'll pay out if you can't do your own job. Any job will not pay out unless you can't reasonably do any job. The own job type is more expensive because it's more likely to pay out. This isn't as inexpensive as some types of insurance but it's the one that can greatly protect you from the bad situation of being unable to work.

This product is particularly useful for people who are a long way from age 55 and who couldn't just meet their needs out of their investments, say by retiring early. Firms that have a salary sacrifice setup are also quite likely to offer this as an optional benefit that you can purchase.

It's well worth considering. It's the most valuable to me of all of the types of insurance I have except buildings insurance. I have quite a high investment risk tolerance but that's because it helps me to meet my financial security objectives. This is one of the other forms of protection that I have.

There is another type of insurance that sounds similar, accident, sickness and unemployment. That is quite different because it will only pay out for a short time, perhaps a year. PHI is for the long term.