Pension advice pls - company contributes

jem16

jamesd wrote: »

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.

I think we need the OP to clarify it it's a salary sacrifice scheme. Many occupational pensions take pension contributions directly from salary and they are not salary sacrifice schemes.

jamesd

"because my pension contributions are taken out of my salary at source I benefit from tax and national insurance reductions" seems to be confirming that it is salary sacrifice because that's how the NI contributions get saved.

If it wasn't NI there would still be a tax gain for the pension, just less. If higher rate now and basic rate in retirement a higher gain.

As well as the general low chance of investments doing worse than a cash ISA the effect of the tax and NI relief is to increase the pot size so that the more routine drops in investment markets wouldn't take the pot value below the value of the money in the ISA even at the start. The few times a decade 20% drops on a 25% higher pension pot value only take the value down to 100%, same as the amount paid in. The once or twice a decade 40% drops would still take it below the starting value for a few years, though.

Of course the ultra-cautious in the short term - unwilling to accept ups and downs - who will accept being much less well off in retirement can also use cash savings in a pension pot. It'll hurt their retirement income badly but the capability is there. Still, it's a bad idea, the short term caution is hurting the long term financial health.

jem16

jamesd wrote: »

"because my pension contributions are taken out of my salary at source I benefit from tax and national insurance reductions" seems to be confirming that it is salary sacrifice because that's how the NI contributions get saved.

Yes I saw that which was why I asked to OP to confirm if it was a salary sacrifice arrangement in Post 7. The OP may simply be assuming he is saving NI rather than knowing it is.

The OP has been back but has not yet confirmed this which does make me doubt that he knows for sure.

I'm not disputing the tax gains but again as I asked in Post 7 we need to clarify if there's a higher rate tax saving or not. Basic rate gain would be marginal.

Your_Hero

jem16 wrote: »

Yes I saw that which was why I asked to OP to confirm if it was a salary sacrifice arrangement in Post 7. The OP may simply be assuming he is saving NI rather than knowing it is.

The OP has been back but has not yet confirmed this which does make me doubt that he knows for sure.

I'm not disputing the tax gains but again as I asked in Post 7 we need to clarify if there's a higher rate tax saving or not. Basic rate gain would be marginal.

I see your point but I wouldn't say the basic rate gain is marginal. It certainly isn't as good as high rate gains of course.

I take your point about the pension being taxed on its way out too (income phase), but it's the accumulation phase that's where the real gain comes in. Even with the basic tax relief it allows gross roll up. In a very crude way, it's almost like someone loaning you £20 for each of your £80 you invest, with no interest payable. You will end up better off even if you eventually have to pay 20% income tax at the end (especially as you get 25% tax free). Assuming basic rate payer still of course.

jem16

Your_Hero wrote: »

I take your point about the pension being taxed on its way out too (income phase), but it's the accumulation phase that's where the real gain comes in. Even with the basic tax relief it allows gross roll up. In a very crude way, it's almost like someone loaning you £20 for each of your £80 you invest, with no interest payable. You will end up better off even if you eventually have to pay 20% income tax at the end (especially as you get 25% tax free). Assuming basic rate payer still of course.

I don't agree with you here. The only difference is the 25% tax free cash.

Let's look at an actual example - assuming only basic rate tax relief with no NI saving.

£200pm into a pension for 40 years. Assuming 5% growth you would end up with £297,713.

£160pm into a S&S ISA for 40 years. Same 5% growth would give you £238,170.

If there was no tax-free lump sum all of the £297,713 would be taxable - I'll assume at 20% just to see if it makes any difference as you suggested having a "gross roll up" did.

20% tax on £297,713 is £59,542.60. Take that from £297,713 and you have £238,170.40. I suspect the 40p gain is just down to the previous figures rounding up.

Of course if you then take the 25% tax free cash it lowers the tax bill and you would have £253,056.05 - approximately £14,886 better off - ie around 6.25%.

So yes a marginal gain and certainly worthwhile especially with the new rules coming into force in April 2015 but it's not the tax relief that's making the gain, it's the 25% tax free cash.

Your_Hero

Thanks for that Jem16.

You are right in that example that a basic rate payer would be no different vs an ISA because it is a very extreme scenario here and you've assumed the 20% tax applies to the whole pension.

But this would not happen in practice. Not the whole pension pot will be taxed at 20%, unless a (foolish) full withdrawal was conducted (which would not be just 20%, but also 40% and 45% tax) because you have the personal allowance of £10,000.

So the gross pension pot of £297,713, of which 25% is tax free immediately, and the rest could be drawn out as income and partly tax free (amounts under the PA) to benefit from an overall greater amount than had it been in the ISA, even if some of your pension income gets taxed at 20% (whatever you draw over the PA)

jem16

Your_Hero wrote: »

Thanks for that Jem16.

You are right in that example that a basic rate payer would be no different vs an ISA because it is a very extreme scenario here and you've assumed the 20% tax applies to the whole pension.

No I didn't assume that at all. I merely used the whole lot at 20% to show you that "gross roll up" of tax relief made no difference.

As you can see I clearly said what would happen after the 25% tax free lump sum.

jem16 wrote: »

Of course if you then take the 25% tax free cash it lowers the tax bill and you would have £253,056.05 - approximately £14,886 better off - ie around 6.25%.

So yes a marginal gain and certainly worthwhile especially with the new rules coming into force in April 2015 but it's not the tax relief that's making the gain, it's the 25% tax free cash.

Your_Hero wrote: »

But this would not happen in practice. Not the whole pension pot will be taxed at 20%, unless a (foolish) full withdrawal was conducted (which would not be just 20%, but also 40% and 45% tax) because you have the personal allowance of £10,000.

So the gross pension pot of £297,713, of which 25% is tax free immediately, and the rest could be drawn out as income and partly tax free (amounts under the PA) to benefit from an overall greater amount than had it been in the ISA, even if some of your pension income gets taxed at 20% (whatever you draw over the PA)

I wasn't even considering withdrawing the whole pot as it would indeed be very foolish with 40% and 45% tax being an issue.

However I have also taken into account that the OP already has a pension and is thinking about how to increase it. The PA allowance will, more than likely, be used up through the state pension and whatever the current pension contributions give. So it's more than likely that the OP will have to pay 20% tax on this extra pension income and the only gain will be the 25% tax-free cash.

zagfles

jem16 wrote: »

No I didn't assume that at all. I merely used the whole lot at 20% to show you that "gross roll up" of tax relief made no difference.

It's lucky there are amateurs on this forum to correct the mistakes of the professionals

jamesd

Trouble is, the gross roll up does make a difference. With a flat rate state pension that's likely to be about £8,000 and a personal allowance of £10,500 that's £2,500 where the gain from the gross roll up is not taxed. Plus the portion that's in the tax free lump sum. For the remainder, not in lump sum or personal allowance, the gross roll up part doesn't really make a difference unless the tax rates are different between paying in and taking out.

While I chose to use just the tax free lump sum in my calculation earlier, the personal allowance is another part of what makes pensions more beneficial than the ISA alternative. It's of particular significance to those with smaller pension pots, making pension use more attractive to those who are likely to have lower incomes in retirement, mainly low earners when contributing.

Using older rules and allowances I calculated the effect of all of this and gave the results in a post in the ISA vs Pensions former sticky topic. The higher personal allowance now will increase the advantage of the pension compared to the calculations there.

jem16

jamesd wrote: »

Trouble is, the gross roll up does make a difference. With a flat rate state pension that's likely to be about £8,000 and a personal allowance of £10,500 that's £2,500 where the gain from the gross roll up is not taxed.

As I said, the OP is looking to make EXTRA contributions so there is unlikely to be anything left over as I would expect his main pension contributions to easily use up that £2,500.

Plus the portion that's in the tax free lump sum.

Of course - already noted that will count for a 6.25% gain. A figure that I have seen you using yourself.

For the remainder, not in lump sum or personal allowance, the gross roll up part doesn't really make a difference unless the tax rates are different between paying in and taking out.

I'm glad we're all agreed with that now. Gross roll up does not gain anything at all. Any gain comes from other factors which I have already noted.

I think it boils down to this;

1. Employer contributions - use the pension.

2. Salary sacrifice - use the pension especially for basic rate taxpayers as there's more NI to save.

3. Higher rate taxpayer and likely to be basic rate in retirement - use the pension.

For a basic rate taxpayer who has already used up all of his/her employer's contributions and is not using a salary sacrifice scheme it's not so clear cut as there's likely to be no gain other than the 6.25% that the tax-free cash gives then it's not so clear cut. Choices then could be ;

1. If a Defined Benefit scheme and wishing to retire earlier than the DB scheme allows - use a pension as you have the whole PA to use up so a 20% gain at least.

2. If a DC main scheme then perhaps use a S&S ISA if you envisage being a higher rate taxpayer later. Then put it in the pension.