Pension Myths and Misunderstandings

Itsme01x

Myth: that you can put up to £60k into your pension each year

Reality: The standard pension Annual Allowance is £60,000 or 100% of your relevant UK earnings per tax year (whichever is lower) for tax relief purposes. (Allowing that you can use unused annual allowance from the previous three tax years if you need to make contributions larger than the current year's limit)

Brie

Another myth: I don't need to contribute to a pension or enroll in the pension at work as I'll get the full state pension which will be more than sufficient as the government wouldn't let people starve/freeze/etc.

kermchem

It is a myth that the State Pension is not taxable. Lots of variations of this one.

barnstar2077

https://forums.moneysavingexpert.com/discussion/comment/82180633#Comment_82180633

Yep. I thought this one back in the day myself! : )

Marcon

https://forums.moneysavingexpert.com/discussion/comment/82180718#Comment_82180718

…and the other problem with this type of thread is that correcting myths has to be done fully, comprehensively and accurately, or you just generate another myth! I'm afraid this post is wrong/misleading on various points.

Myth: that you can put up to £60k into your pension each year

Reality: There is no limit on the amount you can contribute to your pension each year (assuming the provider will accept non-relievable contributions; most won't) - but there is a limit on the amount of tax relief you can receive.

Myth: The standard pension Annual Allowance is £60,000 or 100% of your relevant UK earnings per tax year (whichever is lower) for tax relief purposes. (Allowing that you can use unused annual allowance from the previous three tax years if you need to make contributions larger than the current year's limit)

Reality: It's considerably more complicated than that - and it's important not to conflate two different limits (the one on personal contributions, and the Annual Allowance). Have a look at the following thread, most especially what @hugheskevi has to say:

https://forums.moneysavingexpert.com/discussion/6659623/annual-allowance-and-salary

af1963

Myth: that a 40% taxpayer can get 40% tax relief on everything they put into a pension.

Reality: you can get 40% tax relief (often consisting of 20% via the pension provider claiming relief at source, and 20% returned to you as a tax refund or lower tax bill) only on the portion of your income on which you actually pay 40% tax. So you can't earn £60k, put £30k into a pension, and get 40% relief on all of it.

Myth: 20% tax relief boosts the value of your pension contribution by 20%

Reality: it boosts it by 25% initially - surprising how many people get the maths wrong. You pay £80 and end up with £100 in the pension.

How much you get eventually depends on how much tax you're paying when you withdraw it. Could be £100, could be £85, could be less if you end up taking it out as a higher rate taxpayer …

Marcon

if you take taxable money from pension you trigger MPAA limiting your contributions to 10k. I think most know of that.

Another answer which needs to be expanded to avoid yet more confusion….

If you take taxable money from a DC pension you trigger the MPAA, unless:

• you make the withdrawal using the 'small pots' rule; or
• you use your funds to buy an immediate lifetime annuity.

If you trigger the MPAA, you don't just limit your contributions - the limit applies to ALL contributions: personal contributions + tax relief, + any employer contributions (whether 'true' employer contributions, or made by salary sacrifice') made to a DC scheme.

The MPAA is not triggered by taking DB funds.

If you do trigger the MPAA, it only applies in respect of future contributions to a DC pension.

Marcon

https://forums.moneysavingexpert.com/discussion/comment/82180567#Comment_82180567

That's assuming some fairly hefty (and consistent) dividends, and that equities hold up/grow - in other words, a very real lack of certainty and direct exposure to market fluctuations.

Fixed term annuities can go a long way towards helping the overall planning, as these figures demonstrate:

https://www.pensions-expert.com/defined-contribution/is-the-era-of-annuities-over-the-data-which-tells-a-different-story/70488.article

Marcon

Myth: pension tax relief on contributions stops when you hit age 75.

Reality: tax relief on personal contributions stops when you get to 75. If you are still an employee (which could include being an employee of your own limited company), then the employer can make contributions to a pension scheme on your behalf, including contributions by salary sacrifice. Employer contributions are always paid gross to a pension, and are tax-deductible as a trading expense.

For clarity, being self-employed does not count as being an employee.

OldScientist

https://forums.moneysavingexpert.com/discussion/comment/82180567#Comment_82180567

You can purchase annuities with longer guarantee periods than 5 years, although this does reduce the payout rate. For example, using the moneyhelper tool, a joint lifetime RPI annuity with 100% beneficiary for a couple both aged 67yo and a 5 year guarantee currently has a payout rate of 5.1% while increasing the guarantee period to 25 years reduces the payout rate to 4.8%. For a sufficiently long guarantee period, the payout rate will approach that of a collapsing ILG ladder - currently 4.2% for a 33 year ladder - taking our retirees to 100yo. I note that the reduction will be greater for a single life annuity.

The real value of dividends varies with time, so the income stream cannot be guaranteed (e.g., see https://finalytiq.co.uk/natural-yield-totally-bonkers-retirement-income-strategy/ - btw I do not agree with the author that natural yield is an invalid approach) nor can the real value of the estate.

Different tools, different outcomes.

For me the biggest myth is that there is a single 'magic' solution to retirement. There isn't, there are a number of tools (e.g., the very large number of different portfolio withdrawal strategies, including natural yield, annuities, gilt ladders, etc.) each of which have strengths and weaknesses that can be combined (or not) to form an appropriate plan.