Pension Tax Relief of no value in certain scenarios?

Phantom_Investor

Hi all, I'm looking for confirmation of something which seems to be a fundamental gap in the advice available online.  I have searched this forum (and the wider web extensively) but to no avail.

I am still working, and am fortunate in that I have 2 personal pensions, and with the state pension, my overall forecast is an annual pension of around £55k (as well as the standard 25% lump sum). Obviously, this means I will be paying tax on the portion above the threshold of £50,270.

My assumptions are:

1. If I make further contributions to my SIPP, I will benefit from 40% tax relief (as a high earner). But when I come to draw down from the SIPP it will all be taxed at 40%. as I am already over the basic rate threshold
2. So (as an example) If I invest £10,000, the SIPP provider would automatically give me relief of £2,500, and via my self-assessment tax return, I would get another £1,500. So a total investment of £14,000.
3. Sounds attractive. But when I draw down from the SIPP, each £1 would be taxed at 40%  So of my original £10,000 investment, I only see £8,400.
4.  I am therefore much better off just putting the £10,000 into an ISA.

Is this correct? If so, why do the various internet sites not include this scenario in their advice? It must be very a very common scenario.

Or perhaps I have got it all wrong?

Thanks in advance for any advice.

NoMore

Your ignoring the 25% tax free. Which is truly tax free, having no tax on either contribution (ISA is from taxed income), or withdrawal (the other 75% of pension).

Simple example based on basic tax rate:

£100 into ISA is £100 on withdrawal.

£100 into Pension becomes £125 after tax relief. On withdrawal 25% is tax free (£31.25), the rest taxed at 20% (leaves £75) Total withdrawn= £106.24 (75 +31.25). 6.25% better than the ISA. For different tax rates it becomes even better.

ISA is better is you are going to end up withdrawing from pension at a higher rate that you contribute at, but that a rare scenario for most people, see below for all scenarios.

Most Common Scenarios:

Current Tax Band	Pension Tax Band	Retirement Savings Vehicle	ROI
Basic Rate	Basic Rate	Salary Sacrifice Pension	18.06%
Higher Rate	Basic Rate	Salary Sacrifice Pension	46.55%
Basic Rate	Basic Rate	SIPP (or other non-SS pension)	6.25%
Higher Rate	Basic Rate	SIPP (or other non-SS pension)	41.67%
Basic Rate	Basic Rate	LISA	25.00%
Higher Rate	Basic Rate	LISA	25.00%
Basic Rate	Basic Rate	ISA	0.00%
Higher Rate	Basic Rate	ISA	0.00%

Less Common Scenarios:

Current Tax Band	Pension Tax Band	Retirement Savings Vehicle	ROI
Higher Rate	Higher Rate	Salary Sacrifice Pension	20.69%
Higher Rate	Higher Rate	SIPP (or other non-SS pension)	16.67%
Higher Rate	Higher Rate	LISA	25.00%
Higher Rate	Higher Rate	ISA	0.00%

Very Unlikely Scenarios:

Current Tax Band	Pension Tax Band	Retirement Savings Vehicle	ROI
Basic Rate	Higher Rate	Salary Sacrifice Pension	-2.78%
Basic Rate	Higher Rate	SIPP (or other non-SS pension)	-12.50%
Basic Rate	Higher Rate	LISA	25.00%
Basic Rate	Higher Rate	ISA	0.00%

 
From : PSA: Pension Tax Efficiency / Return on Investment - April 2024 : r/UKPersonalFinance

artyboy

Your sums are also wrong, if you add £10k net to your pension, your provider will gross it up to £12,500, and you can effectively reclaim £2,500 via self-assessment, not the £1,500 you stated.

molerat

Only 75% of the gross pension withdrawal amount would be taxed.

Put £10K into the pension and it will be grossed up to £12500.  HMRC will increase your 20% band by up to £12500 depending on your actual income level so saving up to another £2500 so £12500 in your pension costing you as little as £7500.  When you withdraw that £12500 you get 25%, £3125, tax free and £9375 taxed at 40% receiving a total of £8750 so up to £1250 gain.

Dazed_and_C0nfused

1.  Only if you have already used all your 25% tax free cash (~£268k)

2.  If you are due full higher rate relief where are you getting an extra £1,500 from?  The total investment would be £12,500.  Any personal tax savings benefits you, it isn't added to your pension.

3.  You have a pension fund of £12,500.  And see 1 above.

4.  You might want to check your maths.

kempiejon

I don't follow your sums. £10k becomes £14k becomes £8.4k?

I thought you invest £1 into a SIPP get relief. On the way out you pay tax on withdrawals. Isn't that neutral? I've thought SIPPs have been inaccurately described as tax relief, It's actually deferral. One can wrangle it to pay less on the way out than the way in but that's not the point.

The point was made, 25% is always tax free.

Albermarle

Is this correct? If so, why do the various internet sites not include this scenario in their advice? It must be very a very common scenario.

I doubt it is very common.

Although a significant % of people pay some higher rate tax ( 20% of workers?), only some will be exploiting the full benefit of 40% tax relief. Either because they are only just above the higher rate threshold OR can not afford more contributions OR are just not aware of the benefit .

Then the amount of people who are 40% taxpayers in retirement is rather low, and most will probably be in receipt of final salary pensions ( senior public sector types mainly) . Those with big DC pots will often just not take any income that takes them above the higher rate threshold, by using tax free cash, money in savings/ISA etc.

So probably a rather uncommon scenario, even if you ignore the tax free cash element.

Veteransaver

A 55K pension suggests you may already be above or close to the tax free lump sum limit of c£268k doesn't it?
So saving 40% on the way in (assuming you are of course getting the full 40% by only paying in your earnings above £50270) and then paying 40% on the way out would be neutral. Of course the 40% rate may rise in future so it would then negative for you

Qyburn

Phantom_Investor said:

2. So (as an example) If I invest £10,000, the SIPP provider would automatically give me relief of £2,500, and via my self-assessment tax return, I would get another £1,500. So a total investment of £14,000.

If you contribute £10,000 the scheme will add BR tax relief of £2,500. Tax return will credit you back another £2,500.  So you've added £12,500 to your pension at a cost to you of £7,500.

If you drew it all out you get 25% tax free (£3,125) and the balace taxed at your marginal rate, if that's 40% then you'll pay £3,750 tax.  So you get back £8,750.

Phantom_Investor

Hi all,

Many thanks for your quick responses.
Sorry, I should have been a bit clearer. When I said 'annual pension of around £55k (as well as the standard 25% lump sum)", what I should have said was, AFTER I take the full lump sum of £268k, I will STILL get a pension of £55k. So 25% tax free on withdrawal doesn't apply.

But as a couple of you have pointed out, I have got my sums wrong. So I guess it looks like:
I pay £10,000 into my SIPP, total investment is then £12,500 and taxed at 40% in withdrawal which leaves £7,500. I also get a refund in my self-assessment, but as Dazed_and_C0nfusd has pointed out, this doesn't get added to my pension. 

So in this clarified scenario, I put in £10,000 I get £7,500 back, then £2,500 via my tax return, so it's neutral. No different to putting it into an ISA.

Is that now correct?

It may not be a common scenario, and I appreciate I am very fortunate, but I think the various website should point out that the benefits of tax relief do disappear once the lump-sum threshold is reached.

Sarahspangles

As others have said, you’re forgetting the 25% tax free.

If someone retires before reaching State Pension Age, after going part time or working a part year, they might contribute for a few months with relief at basic rate and end up drawing that while paying higher rate tax.

A widow(er) with a good pension in their own right could also end up paying higher rate tax on a spouse’s pension even though both built their pensions as a basic rate taxpayer.