Another "mortgage vs pension" post...

hugheskevi

You could consider putting the savings into a stocks and shares ISA (SSISA), invested in whatever you would invest in if it were in a pension. This is a way to effectively invest in a pension but retain flexibility in case it should be needed.

You have around £30,000 of higher rate taxable income, but would only be saving £12,000 p/a. If you put this into an SSISA, you could plan to move it into a pension at a  future date and you could do so over a couple of years, fully benefitting from higher rate relief.

Whereas if you decided you wanted the money to pay a mortgage before you move it into a pension, you could just withdraw it. Obviously, there is a risk that it may have fallen in value, but you have the flexibility and option to withdraw it if it is in a SSISA, whereas if you immediately put it into a pension you lose that option.

Yorkie1

Others have mentioned a rainy day fund. That is usually outlined to be 3-6 months of expenditure at the least. Get this put away somewhere relatively accessible before you plan longer-term, and you can then rest more easily.  You mentioned £12K of savings at the end of the current regular savers - that may not be sufficient to match 3-6 months' outgoings?

Pat38493

If you want to keep the option of paying the mortgage off, even just putting the money in an ISA into a very low risk money market fund will give you a much better return than overpaying your mortgage at the rate you have.  You can then if you like, use the money to pay off the mortgage when your deal is over, if you don't like the new interest rates.

As others have said though, you also have to keep in mind that you are losing tax relief benefits of paying into a pension, so it's likely that your mathematical best strategy long term is to just pay as much as you can into the pension even if you have to make higher mortgage payments later.  However some people like the psychological feeling of being mortgage free as well, even if it's not the absolute best long term thing.

Albermarle

hugheskevi said:

You could consider putting the savings into a stocks and shares ISA (SSISA), invested in whatever you would invest in if it were in a pension. This is a way to effectively invest in a pension but retain flexibility in case it should be needed.

You have around £30,000 of higher rate taxable income, but would only be saving £12,000 p/a. If you put this into an SSISA, you could plan to move it into a pension at a  future date and you could do so over a couple of years, fully benefitting from higher rate relief.

Whereas if you decided you wanted the money to pay a mortgage before you move it into a pension, you could just withdraw it. Obviously, there is a risk that it may have fallen in value, but you have the flexibility and option to withdraw it if it is in a SSISA, whereas if you immediately put it into a pension you lose that option.

Good suggestion, but there is a a risk that 40% tax relief will not be available forever. It costs the Treasury Billions and there is regular speculation it will be removed/reduced, although so far it has not happened.

vacheron

Albermarle said:

hugheskevi said:

You could consider putting the savings into a stocks and shares ISA (SSISA), invested in whatever you would invest in if it were in a pension. This is a way to effectively invest in a pension but retain flexibility in case it should be needed.

You have around £30,000 of higher rate taxable income, but would only be saving £12,000 p/a. If you put this into an SSISA, you could plan to move it into a pension at a  future date and you could do so over a couple of years, fully benefitting from higher rate relief.

Whereas if you decided you wanted the money to pay a mortgage before you move it into a pension, you could just withdraw it. Obviously, there is a risk that it may have fallen in value, but you have the flexibility and option to withdraw it if it is in a SSISA, whereas if you immediately put it into a pension you lose that option.

Good suggestion, but there is a a risk that 40% tax relief will not be available forever. It costs the Treasury Billions and there is regular speculation it will be removed/reduced, although so far it has not happened.

There is also the possobility that the OP may not be a high rate taxpayer forever so the assumption can't be made that the 40% relief option will be available indefinately even if the tax relief benefits are not removed by government.

Furthermore, even if their salary stays the same, the OP may not find themselves with sufficient 40% taxable income "overhead" should they wish to transfer their ISA into their pension in the future as @hugheskevi mentioned.


Assuming the OP has an 80K income with 30K of salary subject to tax at the higher rate.
They put 12k into their pension and 12K into an ISA. 

After just 2 years (assuming only a tiny amount of ISA growth) they would now no longer be able to transfer the entire ISA into their pension without some of it only providing 20% tax relief as they will only have 18K of unused high income available and their ISA will hopefully be worth at least £24K, so they would need to carry over at least £6K to the next tax year. Leave it one year later with the same contributions and some favourable market growth and you may potentially require 4 tax years, which could easily lead to a tricky snowball effect. .

dlevene

This is so helpful, thanks everyone.

Fwiw, I'm confident my emergency/rainy day savings could adequately tide me over if I lost for my job.

So I'm still getting my head round the pension practicalities (my previous approach has been to set my contributions as high as possible to maximise my employer match, then set it and forget it while focusing on getting on the housing ladder). To be clear - what I *could* do over the course of a year, is move my £1000/month into savings, very low risk investment, whatever, and then at appropriate intervals (ie. when my mortgage fix is over, or the tax environment changes, or I'm approaching the relevant annual limit, whenever), then decide what do with that pot - use some of it to pay down the mortgage to hit a lower LTV ratio depending on what happens with interest rates, or plough into pension noting the tax benefit, or something else?

In the case of the pension, what I would be able to do at that point is make an additional contribution as a lump (into either current workplace or a private stakeholder pension), and then realise the tax relief? Assumptions are that I was still a higher rate taxpayer at that point, it was below the annual limit, the higher rate relief was still in place, etc.

My understanding (!) is that whether done monthly directly from my pre-tax salary (I've seen references to both "salary sacrifice" and "net pay" - I assume this is the same thing?), or manually as a lump, the tax benefit is the same? I've read somewhere that the latter might mean I have to claim it back from HMRC (and I would also miss out on some pre-tax savings on NI), but apart from the NI the bottom line wouldn't change, right?

Another thing I'm not *entirely* clear on is what the annual limit actually is. I've seen it variously referred to as £60k, £40k (I'm assuming the discrepancy here is from whether you include the tax relief in the total figure or not?), but I think the key point from vacheron's post below is that only £30k of additional contributions would benefit from higher rate relief, because based on my current salary, that is the value of my income taxed at the higher rate? Right? That's good to know but I think it's reasonably unlikely I'd add >£30k into my pension at any one time (as the total I have to play with across pension/savings/ISA is a total of up to £12k/year not £24k)...

vacheron said:

Assuming the OP has an 80K income with 30K of salary subject to tax at the higher rate.
They put 12k into their pension and 12K into an ISA. 

After just 2 years (assuming only a tiny amount of ISA growth) they would now no longer be able to transfer the entire ISA into their pension without some of it only providing 20% tax relief as they will only have 18K of unused high income available and their ISA will hopefully be worth at least £24K, so they would need to carry over at least £6K to the next tax year. Leave it one year later with the same contributions and some favourable market growth and you may potentially require 4 tax years, which could easily lead to a tricky snowball effect. .

Am I on the right track? 

Thanks all

Pat38493

Salary sacrifice and net pay are not quite the same - with net pay, the pension payment is taken from your salary before tax.

With salary sacrifice, you agree with your employer to take a lower salary, and your employer pays that money into he pension on your behalf.  The practical difference of this is that it saves a portion of your national insurance so you will pay less NI, and also your employer will pay less NI, and in some cases your employer may share some of their savings into your pension as well.

Limits:
- There is a 60K per year limit on pension contributions, and you are allowed to roll over unused amounts from the prior 3 years.  References to 40K are probably because the limit changed from 40K to 60K in April.
- There is a separate limit that you are not allowed to contribute more in any tax year to the pension, than the amount you received from earned income.  Earned income does not include pension income, it’s generally income from employment.  This one does not have any rollover.

Also might be worth mentioning that it’s generally considered advisable to spread your pension contributions over months rather than save up a big sum to pay in all at the same time, only because you will be spreading your volatility risk.  However I guess if your money is invested the same way outside the pension it may not matter.

dlevene

Okay that's helpful. Just one point of clarification, when you say that "you are not allowed to contribute more in any tax year to the pension, than the amount you received from earned income", is the corollary of that, you are limited on the amount that benefits from the higher rate of tax relief, equivalent to the amount of salary taxed at that level? 

I'm just trying to clarify vacheron's comment on what the "overhead" is...

Edit

Okay I think I've got it! This link has a helpful worked example.

One point of additional confusion, logging into my workplace pension, it looks like the tax relief applied has only ever been applied on the basic rate, even though I'm a higher rate taxpayer. I thought it was applied automatically but I guess I'll have to claim it back?

They don't make it easy do they!

Pat38493

dlevene said:

Okay that's helpful. Just one point of clarification, when you say that "you are not allowed to contribute more in any tax year to the pension, than the amount you received from earned income", is the corollary of that, you are limited on the amount that benefits from the higher rate of tax relief, equivalent to the amount of salary taxed at that level? 

I'm just trying to clarify vacheron's comment on what the "overhead" is...

Yes - I believe it means that for example if you earned £40K in the year, you cannot put more than 40K into the pension including any tax relief and employer contributions that were made i.e. the total that went into the pension.

*Technically I think it is that you cannot get tax relief on more than that amount, but that’s just a technicality because there would be no point contributing more, and most providers will not be able to manage it.

hugheskevi

dlevene said:

Okay that's helpful. Just one point of clarification, when you say that "you are not allowed to contribute more in any tax year to the pension, than the amount you received from earned income", is the corollary of that, you are limited on the amount that benefits from the higher rate of tax relief, equivalent to the amount of salary taxed at that level? 

I'm just trying to clarify vacheron's comment on what the "overhead" is...

Assume your taxable income is £80,000 and the income tax threshold for higher rate tax is £50,000.

The 'overhead' is the amount of higher rate relief available in the financial year, in this case, £30,000 inclusive of tax relief.

You are able to contribute a maximum of your taxable earnings (£80,000) into a pension and receive tax relief - assuming you have at least £20,000 of carry-forward available from previous years. However, only £30,000 will be eligible to receive higher rate relief (the 'overhead').

You have £12,000 of post-tax income spare to do something with. If you put this into a SIPP you would get £15,000 into the SIPP inclusive of basic rate relief, and receive a tax rebate of £3,000.

If instead, you put the £12,000 into a savings account or ISA, in the second year you would have that £12,000 plus interest/returns. You would also have an additional £12,000 of savings. If you now decided to put both years of savings into a SIPP you would have £30,000 in the SIPP inclusive of basic rate relief and a tax rebate of £6,000. This would all be eligible for higher rate relief apart from the interest/returns as they would take the amount contributed beyond £30,000.

However, if instead, you had decided to again save the £12,000 from the second year, then in the third year you would have £36,000 of savings plus interest/returns. This would be too much to put into a SIPP and receive full higher rate relief. You could only put in £24,000 (grossed up to £30,000 with basic rate relief) and get full higher rate relief. That would leave you with £12,000 plus interest/returns along with a £6,000 tax refund. In the next year you would have £18,000 plus interest/rates and another £12,000 so again you could not put it all into a pension and get higher rate relief on all of it.

As you can see in the example above, given your £30,000 'overhead' of higher rate relief, if you delay putting savings into a pension for more than 2 years, it would take a long time to be able to put it all into a pension and get higher rate relief. Hence when using strategies such as this, you need to be careful in planning future contributions/decisions and be constantly updating them in light of policy change.