Putting bonus in Pension

The_Palmist

Hello Forumites,

I am on higher tax bracket and for the last few years, I have been putting 100% of any work bonus in Pension pot. My thinking was that 100% of bonus in Pension is better than 60% in hand now.

Is there anything I am missing like paying tax when withdrawing or value of money reducing etc.

Advise welcome.

El_Torro

You need to have an idea of how much you will be withdrawing each year from your pension when retired. Will it be enough to pay 40% tax? If not then saving 40% on the way in and paying 20% on the way out is a big benefit to you.

As long as your pension is invested well then it shouldn’t lose value while in the pension over the long term. In fact its value should grow faster than inflation. 

Grumpy_chap

Usually, paying available additional salary into your pension fund is tax efficient.  You need to stay within the respective contribution limits.  (The most tax efficient way is if you can take advantage of Salary Sacrifice - the rules on which are scheduled to change in a couple of years.)

The money is tied up until you reach the necessary age for accessing the pension.

When you draw the pension down, you can usually take 25% tax free (up to the limit of £268,275).  Above this, the income will be subject to income tax (but not NI) ate your appropriate marginal rate.

In simple terms, if you earn £100 now subject to Higher Rate tax at 40% you get £60 in your hand.
If you pay that into the pension, there is £100 in the pension and, at a future point, you can draw £25 tax free.  The remaining £75 will be subject to income tax at the appropriate marginal rate.  If you are still in the 40% tax band, that means £45 in your hand, plus the £25 tax free, so total £70 in your hand making you £10 up.
If your pension income is standard rate, the win is even more.

The ability of the pension to avoid devaluation with the value of money depends on your investment risk and chosen funds.

By the time you come to withdraw the pension, any number of the current rules may have changed.

Newbie_John

Also the key question - what has more value to you - £60 now or £100 when you're 60+?

If you have some plans for large spend in the near future - house, kids etc. then £60 now could be valued more.

The_Palmist

Newbie_John said:

Also the key question - what has more value to you - £60 now or £100 when you're 60+?

If you have some plans for large spend in the near future - house, kids etc. then £60 now could be valued more.

Thanks, I (wife) can always find reasons to spend now but we don't need the bonus for BAU and I am trying to save as much at source as possible.

The_Palmist

Grumpy_chap said:

Usually, paying available additional salary into your pension fund is tax efficient.  You need to stay within the respective contribution limits.  (The most tax efficient way is if you can take advantage of Salary Sacrifice - the rules on which are scheduled to change in a couple of years.)

The money is tied up until you reach the necessary age for accessing the pension.

When you draw the pension down, you can usually take 25% tax free (up to the limit of £268,275).  Above this, the income will be subject to income tax (but not NI) ate your appropriate marginal rate.

In simple terms, if you earn £100 now subject to Higher Rate tax at 40% you get £60 in your hand.
If you pay that into the pension, there is £100 in the pension and, at a future point, you can draw £25 tax free.  The remaining £75 will be subject to income tax at the appropriate marginal rate.  If you are still in the 40% tax band, that means £45 in your hand, plus the £25 tax free, so total £70 in your hand making you £10 up.
If your pension income is standard rate, the win is even more.

The ability of the pension to avoid devaluation with the value of money depends on your investment risk and chosen funds.

By the time you come to withdraw the pension, any number of the current rules may have changed.

Thank you, that is very good analysis, tax free withdrawal will keep the rest of annual withdrawals within lower tax bracket. It makes sense to put the bonus in Pension.

Newbie_John

I wonder if you've missed the last sentence of Grampy_chap's quote.
It is now that you can withdraw 25% tax free, the tax rates 20%, 40%, 45% are also the rates now, as well as age 57 soon to be 59.

The government debt is growing and pension is a risky but rich area for government to get hold off.

So if your retirement is in 20 years it may be worth looking at it as there's 50% chance it will stay like this and 50% chances it will get worse.

But if you're comfortable now with your finances - then pension top up sounds most reasonable.

Albermarle

An added bonus is that if you retire before state pension age and have no other taxable income, you can utilise your personal tax allowance during those years.
So you could take some of your tax free cash, and £12570 ( at the current level) of taxable income but not pay any tax on it. So 40% tax relief on the way in and no tax on the way out.

 It is now that you can withdraw 25% tax free, the tax rates 20%, 40%, 45% are also the rates now, as well as age 57 soon to be 59.
The government debt is growing and pension is a risky but rich area for government to get hold off.

It is true that pension rules do change, but we should not get too alarmist. This and previous Govts have always expressed support for people building up financial provision for their retirement. If for no other reason than it keeps pensioners off benefits. 40% tax relief in particular is very generous, and a big incentive to save in a pension.
Now the IHT loophole is closing, and the salary sacrifice loophole is partially closing, and with fiscal drag doing its bit on tax rates, I do not see much more change in the pipeline. Maybe the Age 75 rule for beneficiary pensions might get changed.
The extension of the access date to 59 is not due for 20 years, but I suppose that date could creep forward.