Choosing which employer pension scheme to contribute to

werutd

I recently changed jobs and the pension benefit is significantly reduced at the new place compared to what I had previously.

My new employer will match a 1% contribution paid by salary sacrifice (increasing by 1% each year, but only to a max of 3%). I can sacrifice more than this, but it won't be matched, and they don't pass on any of their employers NI saving. The scheme is run by Aegon and gives a 0.5% discount on "standard" AMC. For the default investment choice this works out to 0.75%.

I still contribute to my previous employers scheme, run by Aviva. It has a 0.4% AMC charge basis (more is charged for certain funds from the open market). It also has a pot running at only 0.3% charge basis for money transferred in from the previous pension provider used by that employer (and they also allowed me to transfer a different previous pension into this pot with the same lower charges).

The fund choice appears to be marginally better at Aviva, but there isn't much in it. I favour passive/index funds with the lowest charges I can get.

Obviously I don't get any benefit of salary sacrifice if contributing to the Aviva scheme, however as a higher rate tax payer this benefit is only 1% in my case? (I know I also have to remember to claim back the additional income tax from HMRC when contributing to the old scheme).

My new employer has a vague statement about not being able to change salary sacrifice level for certain periods of time once set, so I need to make an informed decision when setting this up.

I want to contribute up to 15% in total and initially thought I would do this all with salary sacrifice. However having realised there is not that much gain and that the higher charges will likely erode any this relatively quickly anyway (assuming same fund performance), I'm thinking it would be best to contribute 1% by salary sacrifice to get the employer matching contribution and put everything else into the Aviva scheme.

Sorry for the long post, have I missed anything in my thought train here? Anything else to consider?

dunstonh

The scheme is run by Aegon and gives a 0.5% discount on "standard" AMC. For the default investment choice this works out to 0.75%.

That doesnt match what you would expect. The base charge for Aegon shouldnt really be anything higher than 1%. They may have some more expensive funds and its possible the default fund is more expensive than 1% but i would expect a 0.5% discount on an Aegon plan to be 0.5% p.a. for internal funds.

I'm thinking it would be best to just sacrifice the 1% to get the employer matching contribution and put everything else into the Aviva scheme.

Aviva will never match that. Your assumption on how charges work is incorrect. There is no way 0.35% p.a. difference in charges could ever catch up with a matched employer contribution. e.g. £100 into the employer scheme costs you £80. Employer matches it to bring it to £200. The other scheme would just be £100. The cost difference on £100 is 35p a year. It would take around 280 years for that 35p difference to erode that extra £100 given by the employer.

werutd

dunstonh wrote: »

Aviva will never match that. Your assumption on how charges work is incorrect. There is no way 0.35% p.a. difference in charges could ever catch up with a matched employer contribution.

That wasn't what I was comparing. I'm talking about any contributions I make over and above the 1% which I will definitely make using salary sacrifice and the employer matching.

I may still need help with the sums though.

Option A is paying into Aviva out of my net income, claiming back the higher rate portion of the tax, and the ongoing charge being 0.4%

Option B is sacrificing gross income into Aegon, nothing matched by the employer, but its the NI saving I need to take into account and the ongoing charge of 0.75%

(I will double check the standard fund charge...)

Your_Hero

werutd wrote: »

That wasn't what I was comparing. I'm talking about any contributions I make over and above the 1% which I will definitely make using salary sacrifice and the employer matching.

I must say as your choice of words were a bit misleading since you said you will "sacrifice the 1% contribution", implying you will opt out and not take the 1% employer matched contributions just so you can say 0.35% AMC. But I'm glad this is not what you meant.

I may still need help with the sums though.

Option A is paying into Aviva out of my net income, claiming back the higher rate portion of the tax, and the ongoing charge being 0.4%

Option B is sacrificing gross income into Aegon, nothing matched by the employer, but its the NI saving I need to take into account and the ongoing charge of 0.75%

(I will double check the standard fund charge...)

Not everything boils down to charges. You can find some funds that are cheap as chips at 0.1% if you wanted, but whether or not they are good or right for you is another matter.

You save 2% NI as a HRT by salary sac. Also with the employer's scheme you will receive full tax relief at source.

werutd

I've edited the original post slightly to hopefully make clearer. I need to go and do the sums on the 2% NI and decide based on this.

I know not everything boils down to charges, but without financial advice or a lot of research on the funds available, that's what I have to go on and I want to factor it into the decision.

Interestingly my Aegon transaction history shows the fund name as "Balanced 1.25% (A)" but clicking on the PDF link opens a factsheet that states "disclosable yearly charge/expenses: 1.00%". I need to check the statement they sent as I'm sure it mentioned 0.75% as the actual charge.

FatherAbraham

werutd wrote: »

I want to contribute up to 15% in total and initially thought I would do this all with salary sacrifice. However having realised there is not that much gain and that the higher charges will likely erode any this relatively quickly anyway (assuming same fund performance), I'm thinking it would be best to contribute 1% by salary sacrifice to get the employer matching contribution and put everything else into the Aviva scheme.

Sorry for the long post, have I missed anything in my thought train here? Anything else to consider?

I would prolly use salex (salary exchange, = salary sacrifice) into the FL scheme for the whole 15%, to get the (small, but welcome) 2% NI saving, and because it simplifies cashflow with respect to HMRC, giving full relief at contrib time rather than up to a year later.

Later, when I left that employment, I'd transfer the more expensive scheme to the cheaper one.

With a 2% NI uplift on your salex contribs, it will take some years before the charges differential eats away the head start on on the occupational scheme.

Furthermore, by limiting the employer scheme to 1%, you run a small but real risk of forgetting to upgrade to 2% in a year's time -- remember that there's a limited window for salex modifications (because salex requires a contractual modification, and is therefore cumbersome). Missing a year of extra 1% employer contribs would really hurt.

Actually, this is what I am doing, although my !!!!!!! employer caps salex at 20%, so the rest has to go without the NI uplift.

Warmest regards,
FA

bowlhead99

werutd wrote: »

I've edited the original post slightly to hopefully make clearer. I need to go and do the sums on the 2% NI and decide based on this.

To be honest, the sums aren't very complex but need a logical think through...

Sacrifice method - say you sacrifice £100. You get £100 in the pension pot and zero net pay relating to that £100 in your bank account.

Net pay method - say you don't sacrifice the £100 and you get it paid into your bank after deductions. You lose £40 tax and £2 NI leaving £58 in your bank account. You contribute £80 of cash into the pension and the provider grosses it up to £100. Then you claim £20 off HMRC because you paid £40 tax on the £100 which you've entirely put into a pension so you need £40 back in total and the provider only gave you £20 of it. So your bank account has +58-80+20, leaving an 'overdraft' of £2. Meanwhile the pension has the exact same amount, £100, in it, that it would have by the sacrifice method.

So you have the same pension assets but the difference is that the making of manual contributions has cost you the £2 NI which you could have avoided paying, but didn't, so now you have a £2 overdraft.

In the sacrifice method, you don't have the £2 overdraft, so you effectively have £2 more of cash sitting around after paying all your taxes, for every £100 that got into your pension pot.

It is a bit difficult to visualize having zero of the £100 ever touching your bank account but the bank account of £0 being a 'bigger' number than the £2 overdraft you get when following the 'full NI, manual contribution' method. So rather than comparing £0 cash with £2 overdraft, let's just see it as having £2 spare in your pocket or in your bank, compared to doing a manual method. What should you do with that £2? I guess an easy thing to do would be to get it into a pension .

What you would do with that 'spare' £2 is to give £2.67 to a pension company who would gross it up at 100/80, to give you £3.33 in the pension pot after they'd obtained 20% tax relief for you. You would make an HMRC claim for the other 20% of the £3.33, resulting in £0.67 coming back into your bank. So your bank account goes: Spare £2, less £2.67 contributions, add £0.67 from HMRC, is zero. Now there's no spare money left in your bank.

Double-checking that maths: The figure of £2 spare money in your bank that you previously had, from using the 'sacrifice' method, can simply be seen be seen as the after-40%-tax net amount from a potential £3.33 pension contribution. £2 is 60% of £3.33. So, simply make the appropriate size of contribution and the £2 is fully invested, adding £3.33 to the pension assets.

So by following the sacrifice method we can see that you can end up with £100 in the pension pot from your company and £3.33 from the contributions of your £2 NI savings grossed up for HMRC relief/rebate, resulting in £103.33 in pension assets.

While by contrast, following the 'manual contribution, full NI' method would have got you just £100 in the pension.

By my reckoning that £100 gross pay sacrificed can be 'worth' £103.33 of pension, while that £100 taken through a payslip and an NI system and then re-contributed back in, is only worth £100. So clearly it is a better approach to be starting off with almost 3.5% more pension assets, given that the difference in management fees is only 0.35% a year. It would take some considerable time for fees alone to erode that gap and after a decade you may well have changed jobs and pension funds four or five times anyway.

Just going back to that £103.33 figure: it might seem counter-intuitive to be able to get £103.33 in a pension when you only started with £100, and the truth is that you can't. The extra £3.33 is really coming from some other gross pay that you earned that month, not the £100 we were watching that that went directly into the pension. But it is totally valid to use them like this, because basically in the 'manual, full NI' method, you are giving up £2 of NI that you could have otherwise gone and spent on a half pint of beer or whatever. By not blowing your money on unnecessary NI, you are clearly better off, so can still buy the beer. But as a smart investor you will be putting it in a pension to buy multiple beers in retirement.

Couple of other obvious points to make:

* If one pension scheme appears to be 0.4% even for ex-employees while the new fund is 0.75%, looks like the headline savings are 0.35% p.a. by using the old provider. But the funds might produce very different results depending on what they actually do, that dwarf the 0.35% 'saving'. If using the cheap default fund with the old provider is putting you only 60% in equities while the default fund at the new place is putting you 80% in equities, the equities-heavy fund may well give you more returns over the long long term despite its higher fees and its managers being no more competent than the managers at the old provider. So the more expensive fund could be more suitable for your goals. You won't know until you look into the details a bit more and get the factsheets.

* Second thing to acknowledge is that there is also some value in not having to do a time-delayed HMRC claim to get the £20 tax money back, which might not be until January or February after the April taxyear ends, if you're lazy about it. However this might be limited to a one-off effect because once you establish that you're making (say) £1200 p.a. pension contributions from net pay, HMRC can adjust your tax code every year to account for that, so you are not literally waiting all year to get your money back after contributing it each month. Or at least, you are suffering some time lag but it's not building up and up and compounding each year into a materially worse problem.

But arguably you could imply you've a 'missed return' on the £20 per £100 that you are sitting around and waiting for via a rebate, when it could have been working for you immediately via sacrifice. If pension assets could have been growing 6-8% a year, and your average wait time is 6 or 7 months - i.e. some contributions being lost for a year, some for only a month or two - then the £20 you're waiting for would have earned 80p while instead you had to wait around for the HMRC cheque.

This is a much smaller effect than the benefit of NI avoidance - we're talking 80p vs £3.33. But altohether it means the 'cost' to your gross pension pot of NOT using sacrifice is north of £4 per £100 invested. I think a slightly cheaper default fund choice from your legacy provider would struggle to make a serious dent in that upside *even if* its cheap fund was saving half a percent per year of fees and delivering returns every bit as good as the expensive fund which let you use salary sacrifice.

HTH, ideas rather than advice of course.

werutd

Thanks for that! I'm still a bit unsure of their charging model, but here is the detail from the statement:



Unfortunately it seems to be impossible to work out the actual charge I will end up paying for any of the funds listed on their website.

dunstonh

active member discounts are being abolished from 2016 and some providers are already acting on that to abolish them early.

werutd

Just thinking outloud, if I favour ISAs over pension for retirement investing but I still want to avoid paying higher rate tax on the investments, doesn't the net pay method work quite well as I can claim back the relief for the additional 20% and put it into an ISA instead of a pension?

So then at least some of the money has a bit more flexibility. Or have I in fact not avoided the higher rate tax at all, as its accounted for somehow by HMRC?

bowlhead99

werutd wrote: »

Just thinking outloud, if I favour ISAs over pension for retirement investing but I still want to avoid paying higher rate tax on the investments, doesn't the net pay method work quite well as I can claim back the relief for the additional 20% and put it into an ISA instead of a pension?

So then at least some of the money has a bit more flexibility. Or have I in fact not avoided the higher rate tax at all, as its accounted for somehow by HMRC?

If you are doing the net contribution method, you have a few options with each and every £100 you earn.

You can protect £96.67 from tax by getting it into a pension, then taking the other £3.33, letting it get taxed at 40% leaving £2, and using the £2 to pay your NI bill. Nothing left over for an ISA.

Or, let's say you took your £58 net pay, dumped it into a pension pot where it was auto-grossed up to £72.50, then when you get your HMRC rebate (72.50 *20% = 14.50) you could put that £14.50 into an S&S ISA.

Effectively we'd be saying with this second approach that you had protected £72.50 from tax by getting it into a pension (a smaller number than before), then taken £3.33 taxed at 40% leaving £2 for the NI bill as before, then taken £24.17 taxed at 40% leaving £14.50 for the ISA.

So you are still saving some tax, but you're compromising how much total tax benefit you can get, in order to pay yourself more now. You're paying about £11 tax whereas in the first example you were only paying £1.67. You could put even more into an ISA and pay even more tax, if you like - all the way up to paying £40 tax and having a big ISA but no pension at all.

Tax is not something we like to pay, but paying a bit to keep something outside the pension lockup might be a good compromise if you need the flexibility of accessing some of the money before the pension age. It still doesn't stop you changing your mind and taking the tax break later, within reason, if you don't actually expect to need the money early.

After all, say you chose not to put £10k in a pension and let it get taxed at 40% instead, giving you a £6k ISA. After a decade of 7% growth it doubles to at £12k. If you're still a 40% taxpayer at that point ten years down the line, you can simply dump £20k in a pension taking a net pay hit of £12k and still paying your bills by releasing the £12k from the ISA. You have £20k in the pension just like if you had put the £10k in now and let it double over the decade. So, as long as you keep an eye on the rules about whether 40% tax relief is still expected to be available, and what the annual contribution limits are, you have more flexibility by not locking into a pension today. The same investments exist in S&S ISAs as they do in pensions.

Presuming you expect to continue to make decent pension contributions, you will hopefully have enough total pension income in retirement (state plus employer/private) to take you above the nil rate band as a retiree. So, a good chunk of the incremental money you are thinking of putting into a pension now for 40% relief is not so much getting 'relief' as 'deferral' - it won't fully escape tax in retirement.

Hopefully, a quarter of it will escape tax altogether ('tax free pension commencement lump sum') but the balance of everything else you've built up in the wrapper will likely be charged at at marginal rate. If you have a monster pension pot that rate might be the 40% you are 'saving' today. Or if you're just on basic rate, that could be 15%, 20%, 25%, 33%, at the whim of the government of the day.

So, pensions can be very valuable and should definitely be used by high rate taxpayers as there are clear tax efficiencies. But an element of the efficiency is deferral rather than an avoidance, and it comes at a price of inflexibility / lack of access. Therefore, as you suggest, there is certainly some merit in having a proportion of your spare money go into S&S ISAs rather than having every spare pound go into a pension. You will miss out on the absolute maximum tax saving this year but it may be a compromise that suits you.