In simple terms is it worth increasing my pension contribution?

isayhello

I have a work option in a new job to increase my pension contribution, work will contribute 5% regardless of what I do.

I know that by increasing mine, I will save on the tax and national insurance (hopefully if the contribution is deducted at source, I'm not sure it is yet).

However in the long run when I withdraw the money I'll have to pay tax when I withdraw it if my annual income is above the personal allowance or if I withdraw more than 25% so am I not just shifting the moment where tax gets taken from now till later? I feel I might be missing something but that seems to be how I understand it.

eskbanker

Assuming you're a basic rate taxpayer, being paid the money now as salary involves deduction of 20% tax.

If accessing that from a pension, you have the first 25% as tax free, so only pay 20% on the other 75%, i.e. effectively 15% tax instead of 20%.

Plus the NI savings if your scheme facilitates this.

Money within the pension will also be excluded from your assets if needing to be means tested, for example.

dunstonh

In simple terms is it worth increasing my pension contribution?

in simple terms, yes.

However in the long run when I withdraw the money I'll have to pay tax when I withdraw it if my annual income is above the personal allowance or if I withdraw more than 25% so am I not just shifting the moment where tax gets taken from now till later? I feel I might be missing something but that seems to be how I understand it.

Only the amount above the personal allowance is taxed and only 75% of it.  25% is tax free.   i.e. if you drew £1000 per month in retirement then £750 would be subject to tax above the personal allowance but £250 would be tax free.  That equates to 15% tax (ignoring the personal allowance).

That makes pensions more tax-efficient than ISAs or anything else that you would typically use for long term investments. 

Albermarle

The above calculations ( of 15% tax instead of 20% ) means you will get a 6.25% tax benefit.
This is a minimum .
If you are a higher earner and pay 40% tax and get 40% tax relief , the benefit is much higher.
Alternatively if you can utilise some of your personal allowance when taking the pension , the benefit is also significantly higher .

steampowered

By contributing into a pension:

- You are paying tax at the point of withdrawal, rather than at the point of investment. As most people have lower incomes in retirement this could mean paying less tax.

- You are saving the NI.

- You can get 25% tax free, as others have explained.

- Your investment is accruing returns based on the "before tax" figure. A pension invested in the stock markets might expect a return of 7-8% per year on average. Taking a crude example, let's say that you get £133 in your pension for what would have been £100 in your pocket if you had paid the tax up front. This means that your investment is getting a 33% higher return than it would have done if you had made the same investment outside of your pension. When you consider that this higher return is compounding over a number of decades, that's actually quite significant.  

Grumpy_chap

Yes, it is nearly always worth putting extra into a company pension scheme, unless restricted by annual contribution limits or lifetime allowance.

isayhello

eskbanker said:

Assuming you're a basic rate taxpayer, being paid the money now as salary involves deduction of 20% tax.

If accessing that from a pension, you have the first 25% as tax free, so only pay 20% on the other 75%, i.e. effectively 15% tax instead of 20%.

Plus the NI savings if your scheme facilitates this.

Money within the pension will also be excluded from your assets if needing to be means tested, for example.

@eskbanker Can I ask how you worked out the 15%? also how would this work out if I was a higher rate payer?

What do you mean about the means tested part? sorry I didn't follow? don't you have to declare pensions for everything e.g. applications for means tested benefits?

eskbanker

isayhello said:

eskbanker said:

Assuming you're a basic rate taxpayer, being paid the money now as salary involves deduction of 20% tax.

If accessing that from a pension, you have the first 25% as tax free, so only pay 20% on the other 75%, i.e. effectively 15% tax instead of 20%.

Plus the NI savings if your scheme facilitates this.

Money within the pension will also be excluded from your assets if needing to be means tested, for example.

@eskbanker Can I ask how you worked out the 15%? also how would this work out if I was a higher rate payer?

What do you mean about the means tested part? sorry I didn't follow? don't you have to declare pensions for everything e.g. applications for means tested benefits?

If you earn £100 in taxable salary then (ignoring personal tax allowance) you pay 20% tax, i.e. £20, leaving you with £80.

If you take £100 from a pension, you can take £25 tax-free, leaving the £75 as taxable.  You pay your 20% tax on that £75, which is £15, so your tax bill for that £100 is £15, i.e. 15%, leaving you with £85.

Pensions are largely protected from means testing because they're inaccessible, so if you've put that money into a pension it's not regarded as an accessible asset for means testing purposes (prior to reaching pension age), whereas if you've taken it as salary and it's in a savings account or invested, then it is an accessible asset.

isayhello

dunstonh said:

Only the amount above the personal allowance is taxed and only 75% of it.  25% is tax free.   i.e. if you drew £1000 per month in retirement then £750 would be subject to tax above the personal allowance but £250 would be tax free.  That equates to 15% tax (ignoring the personal allowance).

That makes pensions more tax-efficient than ISAs or anything else that you would typically use for long term investments. 

Sorry for not following but how is it more efficient than an ISA where you keep everything and don't pay any tax? I still didn't get how the 15% was arrived at. 

isayhello

Albermarle said:

The above calculations ( of 15% tax instead of 20% ) means you will get a 6.25% tax benefit.
This is a minimum .
If you are a higher earner and pay 40% tax and get 40% tax relief , the benefit is much higher.
Alternatively if you can utilise some of your personal allowance when taking the pension , the benefit is also significantly higher .

Sorry @albermarle maths isn't my strong point here so not sure how you got the 6.25%? I'm sure it will click once I see an example. Also does the 40% relief happen automatically? so I contribute to my pension and automatically it's topped up by 40%?

Cus

You paid income tax first before you put it in an isa