Does pension tax relief & employer contribution really benefit me?

Exodi

webangel said:

Hi, pensions-wise I have contributed approx. £20k to mine, with an additional £5k being added for tax relief, and £6k by my employer. Pot worth approx 40K in value apparently. My question is, don't I just get penalised anyway by them taxing the tax back off my saved amount? In my workings out, if I can only take out 25% of the value tax free (i.e. about £10K currently) and the rest is subject to tax if I wanted to withdraw it, then the remaining £30K I would have to pay £7,500 tax on (25%?), so am left with £22,500. Add the original £10K of tax free income then that only works out as £32,500. So, I could have just saved up my original £20k contribution in a savings account for 15 years and had full access to it whenever I wanted (not waited until the govt tell me I am allowed to have it)? Unless I have missed something!

So you contributed £20k, £5k has been added for tax relief and £6k by your employer. You've then seemingly had growth of around £9k on the £31k of total contributions giving you a pot worth £40k, over what appears to be 15 years.

It's hard to estimate return rates, as we don't know how your contributions have varied over the years, but just to put some numbers out, assuming you made employee contributions of £1000 per year 15 years ago, and increased your contributions by ~4% every year, which marries up to your numbers, your investment return would be about 3.86% per year.

Not the best return ever (this depends on what you were invested in), but undeniably better than savings (which have only been competitive with this rate of return in the last couple of years). Savings rates have averaged much lower at around 1.5% (and this is being generous - what this means is the average UK savings account has decreased in value in real terms when considering inflation), meaning instead of having £40k in a pension pot as you would now, you'd instead have £20k+ about £3.5k of interest (and of course no tax relief or employer contributions) = £23.5k in savings.

This is why pensions are pretty much no brainers for everyone, employer pension contributions are effectively free money.

Regarding your workings, yes you can take out 25% tax free - so £10k.

£30k is then subject to tax, however you forget that the first £12,570 of income is tax free. So even if you took the rest out in one go, you'd only pay 20% on £17,430, or £3486 in tax. You could pay even less if you took it over many years.

webangel said:

Thanks for your replies everyone. I don't get to retire for about 20 years but I keep seeing the age pushed up and up and with the over 55 thing being increased to 57 etc.

I think what is really bothering me, as an underlying thought is the "will I ever get to access this money?" question. I've seen quite a few people die before they have even had a chance to retire (so they've just worked their whole lives) and it just seems like pie in the sky - saving money but never getting to enjoy it while you're fit & healthy and then getting taxed if you try to enjoy it too much! 

Seems the goalposts have been moved somewhat (perhaps you want someone to tell you it's a good idea not to save for retirement), but this latest rebuttal sounds like 'YOLO' mentality.

If you live by this logic, then you could wonder why you would bother saving for anything, you could die tomorrow after all, so may as well take loans out and live for today.

Until you do make it into retirement, as most people do, and then you're stuffed.

For those unfortunate enough to die before they access their pension pots, the money is not 'wasted', as the pot can still be passed down to love ones, though of course it is terribly unlucky that they never got to personally enjoy the fruits of their labour.

I know we like to grumble about tax, but I personally think pension tax policy is extremely generous, I wouldn't begrudge having to pay 20% tax on part of my income in retirement (assuming I keep my annual income below ~£50k, which is hardly bread and water money), especially as I get 25% off my pot tax free and if I were to be paid it now as income I'd need to pay 42% in tax.

dunstonh

Thanks for your replies everyone. I don't get to retire for about 20 years but I keep seeing the age pushed up and up and with the over 55 thing being increased to 57 etc.

It is 10 years less than state pension age.   

I think what is really bothering me, as an underlying thought is the "will I ever get to access this money?" question.

Don't worry, time speeds up as you get older and you will hit a point that you wish you had paid in more earlier.

I've seen quite a few people die before they have even had a chance to retire (so they've just worked their whole lives) and it just seems like pie in the sky

You have seen far more people not die though.  About 1 in 5 wont make retirement.   So, you are thinking about the 1 in 5.   Not the 4 in 5 that will make retirement.

Free money from the employer
tax free growth (no income tax, dividend tax or capital gains tax)
tax relief on contributions
personal allowance when drawing and then only taxed on 75% (giving a net effective basic rate of 15%).     Of all the tax wrappers you can use to put money aside for retirement, the pension wrapper is best.

Sarahspangles

webangel said:

Thanks for your replies everyone. I don't get to retire for about 20 years but I keep seeing the age pushed up and up and with the over 55 thing being increased to 57 etc.

I think what is really bothering me, as an underlying thought is the "will I ever get to access this money?" question. I've seen quite a few people die before they have even had a chance to retire (so they've just worked their whole lives) and it just seems like pie in the sky - saving money but never getting to enjoy it while you're fit & healthy and then getting taxed if you try to enjoy it too much! 

I heartily recommend enjoying your life, including when you’re working age. This is ‘Do as I say not as I do’ because I’ve always struggled to get a good work life balance. It’s one reason I’m retiring in my late 50s. Being able to is a trade off for the amounts of stress I’ve always faced. I don’t think enjoying your life  means you shouldn’t save for retirement though.

When you contribute to a pension of the ‘pot’ type you get tax relief. It’s true that you will pay tax when you take the pension. Assuming your current income is taxed at the basic rate of 20%, and you pay tax at the same rate when you draw your pension, you do get the first 25% tax free. That actually leaves you with a 6.25% gain on what you contributed (if you play with the maths you’ll understand why it’s not 5%)

While the pension contribution is locked away until you take it, the tax relief part of it - 20% of the running total - is a bit like a ‘loan’ from HMRC. You get to invest that alongside your own money. We all know that the value of investments can fall, but for most, over the long term, their pension pot grows. Usually over long periods growth exceeds savings interest rates and inflation. So that growth - including on the ‘loan’ bit - is on top of your 6.25% gain.

Most employers will also make a contribution to your pension. There are lots of scenarios but for most, choosing not to contribute to a pension won’t result in the employer paying their contribution to the employee. So if you opt out, you’re giving away part of your salary. If the employee increases their contribution, some employers will ‘match’ some of that. I used to have a role where the minimum was something like 3% but I contributed 10% and my employer matched that. It was like getting an automatic 7% pay rise - but I could look at it that way because I was within five years of minimum retirement age.

When you get to 57, or whatever the minimum retirement age is in 20 years, you may have enough in your pot to give up work. So you then have a tax free allowance you’re not using against salary. At the current rates, someone can take £12,570 (their personal allowance) plus 25% tax free and pay no tax. So you’re getting more out of your pension tax free. Other people welcome the opportunity to go part time in their late 50s, and supplement their income with pension.

If you want to retire earlier than the minimum retirement age you still have the option of paying into savings instead, or a S&S ISA. Maybe switch to that later in your working life though, so that from 57 you’re getting the advantages given above of having pension stashed in a pension vehicle.

webangel

eastcorkram said:

@webangel

If you die before you access any of it, it's not going to bother you. 

I know what you mean - it bothers me but because I can't access it if I really needed it and then I think have I wasted £20k (I know that's my choice to have opted into it in the first place though) . But yeah, same with insurance and all that if you add it up. Ho Hum!

Moonwolf

webangel said:

Thanks for your replies everyone. I don't get to retire for about 20 years but I keep seeing the age pushed up and up and with the over 55 thing being increased to 57 etc.

I think what is really bothering me, as an underlying thought is the "will I ever get to access this money?" question. I've seen quite a few people die before they have even had a chance to retire (so they've just worked their whole lives) and it just seems like pie in the sky - saving money but never getting to enjoy it while you're fit & healthy and then getting taxed if you try to enjoy it too much! 

When the state pension was first introduced, 50% of men died before taking the pension.  Now 50% of people live to their mid 80s.

If you are married, the chances that at least one of you will live to that age is even higher. (I think for a couple it is 80% one will live to 85 but I can't find the reference)

My partner was watching an early episode of Bergerac the other day, I'm the same age as Terence Alexander was in the first series.  I suspect it is typical and I am not particularly boasting when I say I look younger than he did then.  Not only are people living longer, they are living a fit and healthy life longer.

Despite the slowdown in age improvements, in the next 20 years, it is quite probable that those figures will push out further, even if the minimum and state pension retirement ages go out as well.

Yes, there is a risk that you will die early but but it is more likely that you will want money to do things and equally likely that future you will be glad you put enough in to take advantage of extra money saved to retire early. 

When I think back on all the idiot things I've done, this is one of those I am very grateful for.

LHW99

it bothers me but because I can't access it if I really needed it

That's why it is usually recommended to make sure you have an easily accessed "emergency pot" 3-6 months or more of salary, depending on how cautious you are.

Cobbler_tone

This a such a common dilemma for anyone south of 50, or even some until they hit 55.
55 was such a watershed moment for me and I suddenly wanted to maximise every spare penny I could (whilst having a good lifestyle) into my pot.
If you are 30 or 40 it is a long time to squirrel your money away. I'd just say make sure you maximise any company contributions as a minimum. 
I explained the tax implications to a 62 year old yesterday, who was putting the bare minimum in. He still may continue to but you should at least understand the options available and associated impact.

As someone said, if I do die I'm not going to be bothered!  

kempiejon

webangel said:

Thanks for your replies everyone. I don't get to retire for about 20 years but I keep seeing the age pushed up and up and with the over 55 thing being increased to 57 etc.

I think what is really bothering me, as an underlying thought is the "will I ever get to access this money?" question. I've seen quite a few people die before they have even had a chance to retire (so they've just worked their whole lives) and it just seems like pie in the sky - saving money but never getting to enjoy it while you're fit & healthy and then getting taxed if you try to enjoy it too much! 

What do you mean you don't get to retire for about 20 years? I set my own retirement date(s) save money, invest well and financial independance comes when you can afford it. For me that was irrelevant to any ligislation, I gave up work several times between 20 and 50 because not all my funds were in pensions. 

If you're sure you'll not get to 57 don't bother, odds are you will but it's not certain play the percentage game there. Most of my planning was based on a pre 55 retirement date so although I used pensions I had other investments.
As for being taxed I was able to manipulate my net tax position to zero on my wages whilst working using pensions and I will not be paying tax on my pension income this year or next, when you understand the system you can game it if you have a few quid. 
Pensions are not the only game in town but they have significant financial advantages like defered tax, employer contributions and tax free growth.

MEM62

webangel said:

Thanks for your replies everyone. I don't get to retire for about 20 years but I keep seeing the age pushed up and up and with the over 55 thing being increased to 57 etc.

I think what is really bothering me, as an underlying thought is the "will I ever get to access this money?"
Of course you will and you will get it when you need it - to provide for your retirement years. 
 
 question. I've seen quite a few people die before they have even had a chance to retire (so they've just worked their whole lives) and it just seems like pie in the sky - saving money but never getting to enjoy it while you're fit & healthy and then getting taxed if you try to enjoy it too much! 
The amount of times people quote this is ridiculous, as is the statement itself.  The statistical chance of you dying before retirement is small.  Why make your financial planning on being the exception rather than the rule?.- particularly as not providing for your retirement means you are likely to spend your twilight years in poverty.  It's nonsense.  

Qyburn

webangel said:

Hi, pensions-wise I have contributed approx. £20k to mine, with an additional £5k being added for tax relief, and £6k by my employer. Pot worth approx 40K in value apparently. My question is, don't I just get penalised anyway by them taxing the tax back off my saved amount?  Unless I have missed something!

Regarding your question "Does pension tax relief & employer contribution really benefit me?" it's probably easier to disregard growth and just look at the effects of tax relief and employer contributions. In your example you paid in £20k to which was added £5k of tax relief and £6k from your employer. A total of £31,000.

If you drew that out as income and even assuming your personal allowance was used elsewhere, the effective tax is 15% meaning you get back £26,350 for your original investment of £20k. If you had no other earnings you'd get £28,864.