basic question about pension

happypie

i just want to confirm my understanding about this.
lets say i am in 40% tax bracket, now if I put 100 pounds in pension (lets ignore employer contribution for time being), in a way i have put only 60 pounds from my pocket and government has put 40 pounds. so is it right to say that i invested 60 pounds and made a return of  66% on day 1?


now lets say at the time of retirement, assuming pension (investment) didn't grow at all/grew only to cover fund charges. and i have got 100 pounds in my pension pot. assuming i have other income which puts me in 45% tax bracket at that time, now i can take 25 pounds (25%) as tax free, on remaining 75 pounds i would pay 45% tax (33.75 pounds) so i effectively would get 25+41.25 = 66.25 pounds in my account?

so i am making about 10% on my original 60 pounds - if my investment did 0 return.
is my understanding right about this?

Dazed_and_C0nfused

Maybe you could tell us what type of pension contribution you are talking about?

The tax relief works slightly differently with different methods.

happypie

Dazed_and_C0nfused said:

Maybe you could tell us what type of pension contribution you are talking about?

The tax relief works slightly differently with different methods.

ok, i didn't know that.
with salary sacrifice, employer will first put money in pension and then calculate tax. so my example is based on that.

with SIPP, is it different? if i put 60 pounds (tax deducted money) myself. pension provider will claim 20 pounds (i think?) and then when I do SA i will get 20 pounds from government? is this right understanding.

Dazed_and_C0nfused

There is no pension tax relief with salary sacrifice.  Because you aren't contributing  to the pension, your employer is.
 
The benefit comes from having less taxable salary to pay tax and National Insurance on.

If you contribute £60 to a SIPP the pension company will add £15 basic rate tax relief (courtesy of HMRC).  Giving you a pension fund of £75.

There is no extra fixed 20% tax relief.  The gross contribution of £75 increases the amount of basic rate tax you can pay which in turn can reduce the amount of higher rate tax payable.  So in a very basic situation you may save an extra £15 in tax (£75 x 20%).  So overall your £75 pension fund may only cost you £45.  It would cost even less if you it impacts your adjusted net income to the extent it reduces any High Income Child Benefit Charge or means you become entitled to some Personal Allowance you wouldn't otherwise be due (adjusted net incone > £100k but < £125k).

bowlhead99

happypie said:

i just want to confirm my understanding about this.
lets say i am in 40% tax bracket, now if I put 100 pounds in pension (lets ignore employer contribution for time being), in a way i have put only 60 pounds from my pocket and government has put 40 pounds. so is it right to say that i invested 60 pounds and made a return of  66% on day 1?


now lets say at the time of retirement, assuming pension (investment) didn't grow at all/grew only to cover fund charges. and i have got 100 pounds in my pension pot. assuming i have other income which puts me in 45% tax bracket at that time, now i can take 25 pounds (25%) as tax free, on remaining 75 pounds i would pay 45% tax (33.75 pounds) so i effectively would get 25+41.25 = 66.25 pounds in my account?

so i am making about 10% on my original 60 pounds - if my investment did 0 return.
is my understanding right about this?

If you are a higher rate taxpayer and the money going into the pension is all money that would have been taxed at 40%, then effectively £100 of pension assets will have cost £60 net. Or only £58 if you can do it through a salary sacrifice scheme and save the 2% NI you would have been paying on the income if it had been paid over to you as salary instead of contributed by the employer to a pension.

now lets say at the time of retirement, assuming pension (investment) didn't grow at all/grew only to cover fund charges. and i have got 100 pounds in my pension pot. assuming i have other income which puts me in 45% tax bracket at that time, now i can take 25 pounds (25%) as tax free, on remaining 75 pounds i would pay 45% tax (33.75 pounds) so i effectively would get 25+41.25 = 66.25 pounds in my account?

Your example is 'assume I am retired and have enough other income to put me in the 45% tax bracket' - i.e. you are assuming in retirement you are going to be on a higher annual income than you are while working, in fact your income is going to be over £150k a year to get you into that top tax bracket? I don't know whether to read that as you being either very pessimistic that you will be on such a high rate of tax, or very optimistic that as a retiree you are going to have so much unearned income that you will be on enough money every year to be in the 45% tax bracket for all your pension drawings rather than 40% or 20% or 0%. 

But yes if you are paying 45% tax on all your pension income while only being in the 40% tax relief bracket now, you'll not make much money on the tax relief side, because the benefit only really comes on the quarter of it that can be taken as a tax-free lump sum.

However most people getting the 40% tax relief now will find that in retirement they get some of their income at 0% (personal allowance), some at 20% (basic rate) and if they are bringing in over £50k in retirement, some at 40%.  Very few will be making so much money from other sources that the entirety of their annual pension income is taxed at 45% after taking the tax free lump sum.

Still, you don't know what successive governments will do to the tax rates.  I suppose they could make it a flat rate 45% for all, and scrap the 0%, 20% and 40% tax rates for all but the very poorest, but seems somewhat unlikely.

kinger101

Realistically, it's unlikely anyone would fall in a higher tax bracket during their retirement.  In the event you'd did, you'd likely have bigger issues with the LTA.  If you think you're in danger of that, then the pension isn't the right vehicle for savings.

Otherwise your calculations are essentially correct for that slice of income above the threshold (it won't all be taxed at the marginal rate).  
HR in, BR out = 85 p / 60 p = 41.67% gain
HR in, HR out = 70 p / 60 p  = 16.67 % gain
HR in, AR out = 66.25 p / 60 = 10.42 % gain

Incidentally, these are all better than the 6.25 % BR in (no SS), BR out.
***ETA: You'll also need to factor-in losing PA once income exceeds £125K

Albermarle

with SIPP, is it different? 

With any type of DC pension ( does not have to be a SIPP) if you contribute personally , rather than via a workplace scheme. they always claim the basic rate relief from HMRC and add it to your pension. They assume that you have the correct amount of pensionable earnings that entitles you to the tax relief. 

happypie

bowlhead99 said:

now lets say at the time of retirement, assuming pension (investment) didn't grow at all/grew only to cover fund charges. and i have got 100 pounds in my pension pot. assuming i have other income which puts me in 45% tax bracket at that time, now i can take 25 pounds (25%) as tax free, on remaining 75 pounds i would pay 45% tax (33.75 pounds) so i effectively would get 25+41.25 = 66.25 pounds in my account?

Your example is 'assume I am retired and have enough other income to put me in the 45% tax bracket' - i.e. you are assuming in retirement you are going to be on a higher annual income than you are while working, in fact your income is going to be over £150k a year to get you into that top tax bracket? I don't know whether to read that as you being either very pessimistic that you will be on such a high rate of tax, or very optimistic that as a retiree you are going to have so much unearned income that you will be on enough money every year to be in the 45% tax bracket for all your pension drawings rather than 40% or 20% or 0%. 

But yes if you are paying 45% tax on all your pension income while only being in the 40% tax relief bracket now, you'll not make much money on the tax relief side, because the benefit only really comes on the quarter of it that can be taken as a tax-free lump sum.

However most people getting the 40% tax relief now will find that in retirement they get some of their income at 0% (personal allowance), some at 20% (basic rate) and if they are bringing in over £50k in retirement, some at 40%.  Very few will be making so much money from other sources that the entirety of their annual pension income is taxed at 45% after taking the tax free lump sum.

Still, you don't know what successive governments will do to the tax rates.  I suppose they could make it a flat rate 45% for all, and scrap the 0%, 20% and 40% tax rates for all but the very poorest, but seems somewhat unlikely.

firstly sorry for late followup on this.
thanks for your response and confirmation on my understanding.

the reason i chose 'entire pension in 45% tax bracket' is because i do have other pension from my employer. and now i am thinking of SIPP. and i am considering a scenario that i would withdraw both in full at my retirement. and my employer pension will consume my 150k limit (0%, 20% and 40% tax).
hence i considered worst case scenario and calculated tax at 45% to see if SIPP is worthwhile or not.
hope it make sense.
 

happypie

happypie said:

bowlhead99 said:

now lets say at the time of retirement, assuming pension (investment) didn't grow at all/grew only to cover fund charges. and i have got 100 pounds in my pension pot. assuming i have other income which puts me in 45% tax bracket at that time, now i can take 25 pounds (25%) as tax free, on remaining 75 pounds i would pay 45% tax (33.75 pounds) so i effectively would get 25+41.25 = 66.25 pounds in my account?

Your example is 'assume I am retired and have enough other income to put me in the 45% tax bracket' - i.e. you are assuming in retirement you are going to be on a higher annual income than you are while working, in fact your income is going to be over £150k a year to get you into that top tax bracket? I don't know whether to read that as you being either very pessimistic that you will be on such a high rate of tax, or very optimistic that as a retiree you are going to have so much unearned income that you will be on enough money every year to be in the 45% tax bracket for all your pension drawings rather than 40% or 20% or 0%. 

But yes if you are paying 45% tax on all your pension income while only being in the 40% tax relief bracket now, you'll not make much money on the tax relief side, because the benefit only really comes on the quarter of it that can be taken as a tax-free lump sum.

However most people getting the 40% tax relief now will find that in retirement they get some of their income at 0% (personal allowance), some at 20% (basic rate) and if they are bringing in over £50k in retirement, some at 40%.  Very few will be making so much money from other sources that the entirety of their annual pension income is taxed at 45% after taking the tax free lump sum.

Still, you don't know what successive governments will do to the tax rates.  I suppose they could make it a flat rate 45% for all, and scrap the 0%, 20% and 40% tax rates for all but the very poorest, but seems somewhat unlikely.

firstly sorry for late followup on this.
thanks for your response and confirmation on my understanding.

the reason i chose 'entire pension in 45% tax bracket' is because i do have other pension from my employer. and now i am thinking of SIPP. and i am considering a scenario that i would withdraw both in full at my retirement. and my employer pension will consume my 150k limit (0%, 20% and 40% tax).
hence i considered worst case scenario and calculated tax at 45% to see if SIPP is worthwhile or not.
hope it make sense.
 

so for example if i just have employer pension and at retirement its 200k and i withdraw full. i will get 50k tax free. rest 150k at various tax brackets (0%, 20% and 40%).

now if i invest in SIPP on top of this. and my SIPP is 100 pounds at retirement. then 25 pounds is tax free. and rest 75 pounds is taxed at 45%.