Pensions are bad from a tax point of view.

ProDave

That is a startling conclusion I have drawn.

I have one small DC pension (my others are DB) I paid into this during a 5 year period of employment and paid in a total of £7K. At the time I was a 40% tax payer, so on the way in, that contribution would have saved me £2800 in tax.

Fast forward to now. That pension is in drawdiwn now. It actually more than quadrupled in value in the time it was left invested so reached £30K I have already taken the 25% tax free leaving £22.5K and would like to draw some more. But anything I draw now will be taxed as income. I am now only a basic rate tax payer.

So if I draw that £22.5K and pay 20% tax on it, it will cost me £4500 in tax to get what is left of my money. I could not even draw it in one lump and remain a basic rate tax payer, so to even achieve that it would need to be drawn over 2 or 3 years.

This leaves me to the startling conclusion, had I know at the time, I would have been much better NOT investing it in a pension, but rather paying the tax so it was "all nine" and investing it instead in something like an ISA. Assuming I could have got the same growrh, the net result would have been more of my money free to spend as I like with no tax liability. And I would not have had to wait until I was 55 to get access to it.

goRt

So you saved 2.8k in tax, multiply that by the 4* increase is 11.2k and now contrast that to the 4.5k tax bill you control.

This has been the tax rule since forever, so fully known to you.

cloud_dog

So, what you are really saying is, can I give back the additional free £12000 the government helped me acquire in order to reduce my tax liability?

This is like a Trump tweet, a smidgeon of truth to support a position.

NoMore

http://monevator.com/sipps-vs-isas-best-pension-vehicle/

kidmugsy

ProDave wrote: »

That is a startling conclusion I have drawn.

I have one small DC pension (my others are DB) I paid into this during a 5 year period of employment and paid in a total of £7K. At the time I was a 40% tax payer, so on the way in, that contribution would have saved me £2800 in tax.

Fast forward to now. That pension is in drawdiwn now. It actually more than quadrupled in value in the time it was left invested so reached £30K I have already taken the 25% tax free leaving £22.5K and would like to draw some more. But anything I draw now will be taxed as income. I am now only a basic rate tax payer.

So if I draw that £22.5K and pay 20% tax on it, it will cost me £4500 in tax to get what is left of my money. I could not even draw it in one lump and remain a basic rate tax payer, so to even achieve that it would need to be drawn over 2 or 3 years.

This leaves me to the startling conclusion, had I know at the time, I would have been much better NOT investing it in a pension, but rather paying the tax so it was "all nine" and investing it instead in something like an ISA. Assuming I could have got the same growrh, the net result would have been more of my money free to spend as I like with no tax liability. And I would not have had to wait until I was 55 to get access to it.

I shall be sure to bookmark this as one of the dafter posts I've read here. And, by golly, there have been lots of daft ones.

Marcon

Pity your reasoning is entirely wrong.

Brynsam

Hindsight is a wonderful thing.

Where did you invest the £2,800 you saved in tax? Presumably in an ISA where it more than quadrupled in value, so you now have over £11,000 tax free to take into account when concluding pensions aren't tax efficient.

kuratowski

The fault here is comparing absolute amounts of tax (£2800 vs £4500) paid on different bases. To compare correctly you need to look at relative amounts (% of your money paid to the taxman). In that way, it is immediately obvious that paying tax at 40% immediately is worse than paying 20% on 75% of a future pot plus nothing on the other 25% of the pot.

In numbers, you avoided paying £2800 tax which would've been 40% of your contributions (£7000). At retirement, you pay £4500 which is 15% (=(1-0.25)*20%) of your pot (£30000). So if you didn't pay into a pension, you only kept 60% of your money. But by using a pension, you keep 85% of your money.

bostonerimus

The tax efficiency of retirement savings is complicated as it depends on relative tax levels while contributing and withdrawing and political considerations outside of our control. Therefor. I think it's sensible to use both ISAs and pensions to maximize flexibility.

cloud_dog

kuratowski wrote: »

The fault here is comparing absolute amounts of tax (£2800 vs £4500) paid on different bases. To compare correctly you need to look at relative amounts (% of your money paid to the taxman). In that way, it is immediately obvious that paying tax at 40% immediately is worse than paying 20% on 75% of a future pot plus nothing on the other 25% of the pot.

In numbers, you avoided paying £2800 tax which would've been 40% of your contributions (£7000). At retirement, you pay £4500 which is 15% (=(1-0.25)*20%) of your pot (£30000). So if you didn't pay into a pension, you only kept 60% of your money. But by using a pension, you keep 85% of your money.

Lets not confuse a good sound bite with facts

dunstonh

This leaves me to the startling conclusion, had I know at the time, I would have been much better NOT investing it in a pension, but rather paying the tax so it was "all nine" and investing it instead in something like an ISA.

Wrong.

In very simple terms focusing on the differences, you got 40% tax relief going in and are paying tax at 20% on 75% of the draw.

To allow like for like comparison, I have assumed the full tax relief is invested in the pension (which some people do) rather than spent in the years in question as the ISA has no such relief.

£100 into the pension cost you £60. So, that would mean £60 in the ISA.
Both get the same returns and the same charges. So, no difference there.

Let's say your contributions continue and the funds grow and you are now at retirement.
Pension is worth £100,000
ISA is worth £60,000

Let's say you draw 5% annually and your state pension uses up all your personal allowance making you a basic rate taxpayer.
Pension: 5% annually is £5,000. 25% of that is tax-free which leaves £3750 subject to 20% giving you £3000 after tax plus £1250 tax-free = £4250
ISA@ 5% annually is £3,000. it is all tax-free.

Would you rather £4250 AFTER £750 of tax
or £3,000 with no tax to pay?