Pensions is it worth it if you only have 10 years until you retire?

Chantellesquandry

Can someone who knows about pensions and tax take a look at the below and tell me if I am missing something?

As a background I live in Jersey.  In Jersey we have ITIS (same as income tax in the UK).  They recently changed the law here that when you retire, if you don't retire in Jersey or a country with a double taxation agreement with Jersey (which is hardly any), you have to pay 20% tax on the whole of the pension you receive, with no personal allowance applied (the amount you can earn before paying tax), to the government.  Cost of Living is out of control in Jersey, groceries costing a extra 25% on average and a studio flat costing £300,000, average 3 bed house now over £1m so aim would be to retire to a country with a much cheaper cost of living.

If I put into a pension £20,000 and in 10 years time, less 1% management fee, assuming a return of 5% my money will be worth £32,252.11.  The tax man will take 20% - £6450.42 leaving me with £25,801.69.

If I save the same amount now and pay 13% tax (ITIS rate) my £20,000 becomes £17400 x 5% fixed rate x 10 years = £28,342.77.  Allow for tax on the interest earned (I don’t know how to work this out so I’m going for 13% = £1422.56) leaving a return to me of £26,920.21.  

I would be better putting it into a savings account by £1,118.52.  And have the freedom to go wherever I want and take out the money without some pension company holding onto it forever while they mess around (took me 1 year to move my Opted Out Aviva pension (from when I lived in the UK) to Jersey because they kept losing the forms).

What am I missing here as it seems like a no brainer.

LHW99

Over here, (if you pay into a pension directly) you get basic rate tax relief added to the pension by the governent, and if you are employed, and earn over a certain fairly low amount your employer would also pay in under autoenrollment.

Do either of those happen in Jersey?

Chantellesquandry

LHW99 said:

Over here, (if you pay into a pension directly) you get basic rate tax relief added to the pension by the governent, and if you are employed, and earn over a certain fairly low amount your employer would also pay in under autoenrollment.

Do either of those happen in Jersey?

Over here you can pay up to £50k annually into your pension and that amount is not classed as taxable income.  So if you earn £30k and pay £10k in our pension you only pay tax on £20k - is that what you mean by tax relief?

We do not have any employer autoenrollment in Jersey and employers do not have to provide pensions. 

Aretnap

Where are you getting your assumption of 5% growth for your pension fund from? It sounds very low - the long term average return on the stock market is of the order of 5% above inflation.

That may be the answer. Projected returns on pensions are generally quoted net of inflation, whereas interest on a savings account will obviously not account for inflation. The two "rates" are not really comparable - especially in a time of high inflation.

5% above inflation would arguably be an over-optimistic assumption about pension growth just now, especially over a relatively short 10 year period where you would not want too risky a set of investments - but it is still likely to return significantly more than a savings account over 10 years.

In the UK at least there are also tax advantages that you have missed - you can take 25% of your pension entirely tax free, and if your other income (eg state pension) is less than your personal allowance you can time your withdrawals to make use of your personal allowance and reduce your tax bill further. I don't know if these things with the same way in Jersey though.

Chantellesquandry

@Aretnap I chose 5% because my son has money invested (litigation funds from a brain injury to cover his future care needs so a significant sum) and over the past 4 years they have grown just 4.9% (although hardly surprising in this climate)  I had to pick a figure so I chose 5%.  Because we have such a small time available to save, and because of my rudimentary understanding, I'm trying to figure out which would be better.  If we had longer I would definitely put it into a pension and I would still do this if we are going to retire in Jersey.  It's the bit about the fact that if we leave here then we pay an automatic 20% on the income.

I had forgotten about taking out a lump sum - we can withdraw 30% tax free in Jersey.

If we stay in Jersey our retirement income will not go far so although we will lose less in tax that saving will be eaten up by the high cost of living here.

Can you explain to me why a pension growth of 5% would be worth more after 10 years than a savings account with a 5% interest rate for the same period of time?  I would be really grateful.

I'm also conscious that pensions are investments which can go up or down and in the short period we have left we may end up with less than we put in - is that possible?

Thanks
Emma

QrizB

Chantellesquandry said:

Can you explain to me why a pension growth of 5% would be worth more after 10 years than a savings account with a 5% interest rate for the same period of time?  I would be really grateful.

Very generally speaking, averaged over several years, savings interest rates end up lower than inflation. So your savings lose value in terms of what you can buy with them.

Also very generally speaking, investment returns (including pensions) beat inflation. So your investments gain value in terms of what you can buy with them.

You'll be unlikely to see a period like the one you describe, where (on average) savings return 5% and investments also return 5%. If you have ten years averaging 5% savings returns, it's more likely that investments will return 7 or 8% over the same period.

Pat38493

If you are investing for the long term, you won't be making any withdrawals for a good while,  and you need the money to last decades, looking at what happened over the last 4 years is much too short to give a good indication - you would need to look at it over 10-15 years.

Albermarle

Over here you can pay up to £50k annually into your pension and that amount is not classed as taxable income.  So if you earn £30k and pay £10k in our pension you only pay tax on £20k - is that what you mean by tax relief?

Basically yes. Then here you get 25% of the pension tax free and pay tax on the rest IF you have enough income to actually be a taxpayer. So there is an immediate minimum tax gain of 6.25%.

 I chose 5% because my son has money invested (litigation funds from a brain injury to cover his future care needs so a significant sum) and over the past 4 years they have grown just 4.9% (although hardly surprising in this climate)  I had to pick a figure so I chose 5%.

There are thousands of different investments and millions of combinations of them, so you can pick any figure you like ! Generally on the forum most of us are looking to make a couple of percent above inflation. In periods ( like now) it is a lot more negative, and previously it was a lot more positive, but long term it should average out.

Can you explain to me why a pension growth of 5% would be worth more after 10 years than a savings account with a 5% interest rate for the same period of time?

It would not, but over a long period of time you would expect ( hope) that investments will grow faster than cash interest. Plus with a pension you have a tax gain.

I'm also conscious that pensions are investments which can go up or down and in the short period we have left we may end up with less than we put in - is that possible? Yes it is, but the longer the period the lower the chance of a loss and an increasing chance of a gain. Remember that when you retire it would not be normal to take all the pension at once. It will remain invested until you need it so could be for a long time.

Remember these things are usually not all or nothing and a balance between investments/pensions and cash is usually best. The exact balance is up to you .

MallyGirl

Chantellesquandry said:

@Aretnap I chose 5% because my son has money invested (litigation funds from a brain injury to cover his future care needs so a significant sum) and over the past 4 years they have grown just 4.9% (although hardly surprising in this climate)  I had to pick a figure so I chose 5%.  Because we have such a small time available to save, and because of my rudimentary understanding, I'm trying to figure out which would be better.  If we had longer I would definitely put it into a pension and I would still do this if we are going to retire in Jersey.  It's the bit about the fact that if we leave here then we pay an automatic 20% on the income.

I had forgotten about taking out a lump sum - we can withdraw 30% tax free in Jersey.

If we stay in Jersey our retirement income will not go far so although we will lose less in tax that saving will be eaten up by the high cost of living here.

Can you explain to me why a pension growth of 5% [above inflation] would be worth more after 10 years than a savings account with a 5% interest rate for the same period of time?  I would be really grateful.

I'm also conscious that pensions are investments which can go up or down and in the short period we have left we may end up with less than we put in - is that possible?

Thanks
Emma

Although the rules are somewhat different between UK and Jersey it sounds like you get some tax relief when putting money in a pension.
This means that, in your first post example, putting £20k into a pension will not cost you £20k due to the tax relief whereas putting £20k into savings will cost you £20k.
Then savings growth is likely to lag behind investment growth over the long term. You are unlikely to want to withdraw the whole pot the day you retire so some of those investments will run for 20/30/40 years depending on how long you live.
In the UK there is a tax free element on withdrawal from a pension so you don't pay tax on the lot - it doesn't sound like you will get something like that unless you retire and stay in Jersey. So you have the choice of higher cost of living but getting a personal allowance vs moving from Jersey to somewhere cheaper but losing the personal allowance.

af1963

If you can take 30% taxfree, and then have to pay 20% on the remainder (if that's the rules when you move away), the effective overall rate of tax is 20%*70% = 14% , so using the figures from your original post, your £32252 would become, after tax, £27736.  

You could also probably do better than a 1% management fee, and that would add up over 10 years as well. Depending on how the pension is invested and how markets perform, it could do better or worse than 5% per year.

Chantellesquandry

@MallyGirl

I guess what I am trying to work out is which direction will leave me financially better off when you only have a limited time to invest. 

Knowing that I will lose 20% of my money (saved via a pension) as opposed to 13% now (based on investing the £20k less 13%).  Then moving to a country which also taxes me on my income.  Jersey takes 20% then the other country also taxes me on the income - it's more complicated to work out which will leave me with more money at the end of the day.

Or would it be better to avoid a pension and invest the money instead? I know I will not get the tax benefits of investing into a pension but at the other end I will have the money.  There is no Capital Gains Tax in Jersey.