Tax benefits for SIPP - additional tax rate band

CoolGeek123

I was trying to calculate the ROI for additional tax rate payers (45%) when they invest in SIPP from their net income. 
If the person invests 80 GBP, the government puts in 20 GBP in his SIPP account. He can then claim back 25 GBP in tax credits. So what is his total return in that year? Only focus on ROI in that tax year and ignore all future years. 

Perspective 1: On an investment of 80, he gets back 45 that year. So 45/80 = 56.25% ROI

Perspective 2: He is only paying 55 as he has got back 45. Hence 45/55 = 81.81% ROI

Which calculation is correct? Are both just different perspectives or something wrong in one of them?

af1963

You could do the same with any investment that pays some money back during the year.

Invest £100 in a bank account on the first day and get 5% interest on the last day of the tax year, with the interest paid out to you from the account.

Is your return:  £5 earned on an investment of £100, giving exactly 5%

or: You only put in £95 net during the year and you now have £100 in the account, you have gained £5 on a net investment of £95, giving 5.26%

Qyburn

In that example £100 was added to the pension for £55 reduction in take home. I make that an 81% return.

If you're a basic rate payer in retirement then you'd get back £85 after tax, a 54% return.

artyboy

Although of course, that 81% 'immediate' return could only ever be realised if one were able to fully withdraw it free of income tax...

Which, for the average additional rate taxpayer is unlikely to be the case. I made close to a 200% return in previous employments due to generous employer matching and NI savings from salsac, but it will be tempered on the way out by 40% tax on some of the withdrawals. And that I've already maxed out my TFLS.

ETA: just realised Qyburn was making basically the same point, ie best not to simply look at one part of the return here...

NoMore

Here's a useful link where somebody has figured out the ROI after contribution and withdrawal for all sorts of scenarios (eg higher rate contribution, basic rate withdrawal) and accounts (pension, isa, lisa).

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

CoolGeek123

NoMore said:

Here's a useful link where somebody has figured out the ROI after contribution and withdrawal for all sorts of scenarios (eg higher rate contribution, basic rate withdrawal) and accounts (pension, isa, lisa).

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

I think this calculations are old and no longer valid with the new rules

CoolGeek123

Qyburn said:

In that example £100 was added to the pension for £55 reduction in take home. I make that an 81% return.

If you're a basic rate payer in retirement then you'd get back £85 after tax, a 54% return.

Thanks. What do you think is the flaw in the calculations for 56.25 percent

NoMore

CoolGeek123 said:

NoMore said:

Here's a useful link where somebody has figured out the ROI after contribution and withdrawal for all sorts of scenarios (eg higher rate contribution, basic rate withdrawal) and accounts (pension, isa, lisa).

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

I think this calculations are old and no longer valid with the new rules

I did post it before the budget, give them time to update it. All the other comparisons apart from the Salary Sacrifice ones are still valid.

Edit, actually they are still valid until 2029.

Qyburn

CoolGeek123 said:

Qyburn said:

In that example £100 was added to the pension for £55 reduction in take home. I make that an 81% return.

If you're a basic rate payer in retirement then you'd get back £85 after tax, a 54% return.

Thanks. What do you think is the flaw in the calculations for 56.25 percent

Presumably referring to
"Perspective 1: On an investment of 80, he gets back 45 that year. So 45/80 = 56.25% ROI"

If do I'm just not sure why you use those figures. Probably easier to explain why I used the figures that I showed. We're speaking about return on investment. So in my calculation..

  "Investment" is £55 as that's the final reduction in take home pay after tax relief
  "Return" is the value less original investment 100 - 55 = £45. 
   ROI therefore 45/55 = 81.81818182%

CoolGeek123

Qyburn said:

CoolGeek123 said:

Qyburn said:

In that example £100 was added to the pension for £55 reduction in take home. I make that an 81% return.

If you're a basic rate payer in retirement then you'd get back £85 after tax, a 54% return.

Thanks. What do you think is the flaw in the calculations for 56.25 percent

Presumably referring to
"Perspective 1: On an investment of 80, he gets back 45 that year. So 45/80 = 56.25% ROI"

If do I'm just not sure why you use those figures. Probably easier to explain why I used the figures that I showed. We're speaking about return on investment. So in my calculation..

  "Investment" is £55 as that's the final reduction in take home pay after tax relief
  "Return" is the value less original investment 100 - 55 = £45. 
   ROI therefore 45/55 = 81.81818182%

Thanks. Found the flaw in my calculation. The numerator + denominator should actually give the final amount --- for any ROI calculation.

Hence 45/55 is the correct representation, as the final amount is 45+55=100

In my flawed calculation of 45/80, the final amount would be 45+80=125 -- which is wrong. 

af1963

Thanks. Found the flaw in my calculation. The numerator + denominator should actually give the final amount --- for any ROI calculation.

Hence 45/55 is the correct representation, as the final amount is 45+55=100
In my flawed calculation of 45/80, the final amount would be 45+80=125 -- which is wrong. 

I'm not convinced it's as straightforward as that ... the different ways in which the tax relief is delivered may confuse things, but you can make a case for saying the final amount is 125.   You put 80 in the pension and got 20 added, so you now have 100 in the pension. And you received 25 via a refund of tax paid on other income.

The difference is in what you consider to be your initial investment.  

Above, you're deducting the money you later got back, effectively saying " I paid x=80 but got back y=25 later, so my  true investment was x-y=55".  Using that logic, how would you calculate your ROI on, say, a 5% bank account where you paid x=100 and took out y=100 a year later, so your true investment was x-y=zero but you got 5 interest on a zero investment?  Infinite ROI ?

The factor being ignored is time.  For the bank example, 100 needs to be kept in the account for a year.  For the pension, there is ambiguity about how much you have tied up for how long.

If you're making a pension payment early in the tax year, and not claiming the additional 25 tax refund until your tax return for that year goes in, potentially 20 months later, I would view that as investing 80 and getting 45 added. (20 in the pension and 25 outside) If you reclaimed the extra tax immediately so you you got the 25 back in a few days, I'd probably consider it as an investment of 55.

But the choice is pretty subjective and there's a whole range of potential timescales in between to think about - what if you claim it back after 3 or 6 months ...  ?