In simple terms is it worth increasing my pension contribution?

daveyjp

isayhello said:

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. 

ISAs contributions are paid from taxed income.  So whilst you don't pay interest on any gains, you have paid income tax on the amount you invest.  Pension contributions aren't taxed.

eskbanker

isayhello said:
how is it more efficient than an ISA where you keep everything and don't pay any tax?

You can only pay into an ISA with money that's already been taxed, although it's tax-free from that point onwards, so using ISAs is a good idea for money that you've already taken as salary, but putting it straight into a pension instead of being taxed initially works because of the lower effective tax rate explained above....

isayhello

eskbanker said:

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.

Thanks, great example and definitely helped. I'll try to apply it to a higher rate and see how it works out, so it would be 40% on £75? so 30% tax on £100?

Ok, so once you reach pension age then it isn't protected from means testing?

isayhello

eskbanker said:

You can only pay into an ISA with money that's already been taxed, although it's tax-free from that point onwards, so using ISAs is a good idea for money that you've already taken as salary, but putting it straight into a pension instead of being taxed initially works because of the lower effective tax rate explained above....

Is there a way I can easily tell if the current pension contribution is paid before being taxed?

eskbanker

isayhello said:

Ok, so once you reach pension age then it isn't protected from means testing?

Depends on exactly what you do with it and when, and benefits availability in later life will change anyway, but probably not worth sweating that aspect, it's really only a minor point that I mentioned in passing.

isayhello said:

Is there a way I can easily tell if the current pension contribution is paid before being taxed?

Your pension scheme administrator should be able to clarify the basis on which contributions are paid, and it should be shown on your payslips....

Dazed_and_C0nfused

isayhello said:

eskbanker said:

You can only pay into an ISA with money that's already been taxed, although it's tax-free from that point onwards, so using ISAs is a good idea for money that you've already taken as salary, but putting it straight into a pension instead of being taxed initially works because of the lower effective tax rate explained above....

Is there a way I can easily tell if the current pension contribution is paid before being taxed?

If the pension company is adding 25% then they are "relief at source".

If not they are "net pay".  Or if you have given up salary in return for your employer contributing more then that is salary sacrifice 

isayhello

Dazed_and_C0nfused said:

If the pension company is adding 25% then they are "relief at source".

If not they are "net pay".  Or if you have given up salary in return for your employer contributing more then that is salary sacrifice 

Thanks, I only have my payslips to hand at the moment and I have an AV EE contribution and AV ER, I'm not sure what these are.

There is a label of basic pay from which the AV EE is being deducted then this amount is under the title of Earnings. Is that what is being used for NI and tax deductions or would they be using the basic pay figure?

bostonerimus

isayhello said:

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.

Are you in a salary sacrifice agreement of just making pension contributions. You only get to pay less NI if you have signed up for salary sacrifice.

isayhello

bostonerimus said:

Are you in a salary sacrifice agreement of just making pension contributions. You only get to pay less NI if you have signed up for salary sacrifice.

So at the moment, I don't think I am, the company seem to pay 5% and I'm not adding anything yet. I've just seen a form for contributing by salary sacrifice so I think I'll start to do that a bit.