Why pay into a pension at present

anderson18

If I pay in £8K + tax relief £2K = £10K

If in 5 years I draw out 25% = £2.5K Tax Free

Assuming remaining £7.5K is subsequently taxed as income above the basic allowance = Tax £1.5K, therefore £6K remaining free of tax

Total tax free amount = £8.5K

However if pension company charges a 1% handling fee per year on £10K over 5 year = £0.5K

Total a repayable = £8K + minimal interest currently.

Sure a 5 year fixed rate bond would offer a better return and lots less hassle.

What am I missing?

sheslookinhot

You may expect growth of the initial contribution into a pension.

Dazed_and_C0nfused

What am I missing?

Not sure you are missing anything just opting for a very very strange way of doing things.

Why would you invest the money (and voluntarily choose to pay 1%) if the investment is only going to pay minimal interest?

Interest is usually associated with savings, not investments so I'm not sure you have thought this through.

You would be better off considering leaving the fund in cash, avoiding the 1% fee and getting no interest if that's the best you can do.  Of course your money will lose value due to inflation.

Alternatively do what the majority and investor the money in equities of some sort.  You don't have to go 100% in risky funds, there is a lot of choice with most providers.

400ixl

Pension funds get tax relief and that is then invested.

You say minimal interest currently, that would assume the fund is invested in cash only, so therefore your comparison should be the same outside of the pension. So your £8k would have minimal interest as well.

So given like for like investment, the pension will win out (as the invested amount will be £10k not £8k and compounded over time). Even more so if you are a higher tax rate payer.

cloud_dog

anderson18 said:

If I pay in £8K + tax relief £2K = £10K

If in 5 years I draw out 25% = £2.5K Tax Free

Assuming remaining £7.5K is subsequently taxed as income above the basic allowance = Tax £1.5K, therefore £6K remaining free of tax

Total tax free amount = £8.5K

However if pension company charges a 1% handling fee per year on £10K over 5 year = £0.5K

Total a repayable = £8K + minimal interest currently.

Sure a 5 year fixed rate bond would offer a better return and lots less hassle.

What am I missing?

Your assumption on being taxed on all the remaining 75% is possibly also slightly out of line with reality.

Assuming you draw state pension, then you will still have approximately £3k of personal allowance left to use up on some of the hypothetical taxable 75%.  If you drew the money over more than one FY you may end up paying virtually no tax on it.

If tou retire before SP age then the whole of your Personal Allowance can be used by pension drawdown with you paying zero in tax, based on this hypothetical.

Albermarle

Total a repayable = £8K + minimal interest currently.

The large majority of money held in pensions is invested , mainly in funds linked to global stock markets , plus other investments like bonds. So it is investment returns that you get , not interest.

You can hold cash in a pension but normally this is only recommended in certain circumstances and is not the norm.

Just the same as it is not recommended to keep all your money in savings accounts as its value gets reduced by inflation. 

Although investments perform differently over different periods, you can reasonably hope that a medium risk portfolio will return a couple of per cent above inflation in the long term , after fees. So to be clear 2% + inflation . Probably that might not happen this year, but long term it should be thereabouts ( hopefully) .

You should look at a pension as a way of investing, but with tax advantages 

dunstonh

However if pension company charges a 1% handling fee per year on £10K over 5 year = £0.5K
<snip>
What am I missing?

You are treating the return as if it is interest.  Not investing.  i.e. a negative return over 5 years.
You are probably disregarding the charges that exist on savings accounts as a comparison.  Yes, they are not explicitly charged but they exist implicitly.   Whereas you are overstating the impact of explicit charges (and 1% explicit charges is lower than the net interest margin banks typically use on savings).

Sure a 5 year fixed rate bond would offer a better return and lots less hassle.

It would have higher charges than the 1% you are using in your pension example.
Over the majority of 5 year periods, you would have returned less than a middle of the road investment fund.
You would have missed out on tax relief.