How to determine max AVC or reduce the mortage. 25 July 2005 at 10:54PM edited 30 November -1 at 1:00AM in Pensions, Annuities & Retirement Planning 7 replies 766 views

Troubleatmill_2

I'm aware that pension advice is restricted here - but I'm curious as to how I should go about the process of deciding which is best for me.

I'm in a company pension scheme for the last 4 years.
I'm 40 years old.

I contribute 3% the company 7%
For the last year I've been maxing my AVC;s.

So the monthly outgoings are like... ( to the nearest tenner ).

My Pension contribution £150
My Company contribution £380
My AVC £630


I have a final salary pension from my last employer - ( 10 years ) - that will pay about £7K pa and rise with index.

My mortgage outstanding is £150000, costing about £1200 per month.
( 18 years left to run ).


A couple of questions I'm needing help on.

1/ With an estimated final pension pot with current employer of £800K
-How much can I take out as a lump sum at retirement time.
( annuity of £35K pa ) + £6K pa

2/ Should my priority be to focus on the mortage - as final pension pot
will be about £400K without the AVC's.
( annuity of £18K pa ) + £6K pa


What's the suggested way to tackle the AVC / Mortage dilema.

I'm sure putting as much as I can into an AVC is a good thing - but - maybe I'm being a bit green and should be focusing on other financial issues.

Thanks
Troubleatmill

dunstonh

AVCs have been gradually disappearing over the last few years. The introduction of stakeholder pensions and the ability for people to pay into stakeholders and occupational schemes virtually killed new AVC business. However, if you are earning over 30k (and didnt have a basis year below 30k), you couldnt do a stakeholder and and AVC was the best option.

In house AVCs used to be cheaper and that was the main reason for chosing them. The negative is that the AVC had to be taken at the same time as the scheme. I have had a number of cases recently where that has been a problem for clients and they regret ever doing AVCs and wish they had done FSAVCs instead.

When looking for increasing your retirement income, in your case, you would look at the following options as being (potentially) available.
1 - Buying added years - if available, this can be more expensive as a contribution but will usually provide more income at the other end. It also increases spouses pension
2 - Stakeholder - if eligble.
3 - FSAVC/AVC
4 - ISA

That is no particular order but buying extra years would certainly be an area I would investigate first (if it is available to you).

As for mortgage or pension.... You will need to pay your mortgage off before you retire. You also need an income in retirement. As long as you do both, the order you do it is really not important. If you pay the mortgage off early, you save debit interest. However, you lose out on returns on the pension which may or may not be higher than the mortgage interest. It is likely that over the term, the average investment growth on the pension will be around the debit interest paid so not really any difference to be concerned with.

ReportInvestor

dunstonh wrote:

It is likely that over the term, the average investment growth on the pension will be around the debit interest paid so not really any difference to be concerned with.

That sounds like a reasonable working assumption. But in another thread on ISAs v Pensions you asked, while putting the case for pensions.

What about compound growth on the tax relief on the pension?

So does it matter, or doesn't it?

dunstonh

That is comparing the rate of return on pension against mortgage interest. The other thread was ISA vs pension and as the funds on ISAs and pensions are more or less the same, its a different matter.

I think the compound affect of growth on the tax relief in the early years is important but becomes less important later in life as the timescale is less. However, in this case I was offering a generalisation as we dont know the tax rate for relief, we dont know the charges, the provider, the funds invested in or the mortgage details. He could be on a 8% mortgage and getting 3% return on the AVC or the other way round. Tax relief discussions at this stage would be pointless.

ReportInvestor

I'm just curious if your answer to troubleatmill's question differs according to a client's age.

Is the answer the same at 30,40,50 - assuming, for the sake of argument, that there were 15 years to run on the mortgage in each case and the client was in the same tax bracket and likely to stay there?

dunstonh

Its a judgement call really and depends on the goals. Someone in their 20s is going to get a greater benefit from the tax relief than someone in their 50s. Its like the ISA vs pension debates we have. Someone in their 20s will benefit a lot more with a pension rather than an ISA (as far as income is concerned). However, once you get into late 30s, early 40s, it starts to even out and as you go into your 50s, the differences can favour the ISA (on the assumption that personal allowances are going to be used up and the income will be taxable). Especially when capital retention is desirable.

Also, its an AVC and not an FSAVC. So the tax consideration is less likely to have been an impact. i.e. with contributions that people take from payslips, they tend to look at the gross amount as their chosen contribution. With direct debits, they tend to look at the net amount with the tax relief added on top.

You could also throw childrens tax credits into it. Pension contributions lower your income for children tax credit purposes. In effect, it can increase the equivalant tax relief up to 77%. So a £100pm contribution may only really be costing £23pm.

So, there is no absolute answer as to what is best as it depends on the person. Age would be one element of that. At this stage we dont really know enough and that is one of the main reasons you dont get advice on the forum.

MarkyMarkD

Dunston

Is there a decent guide to the tax credit rules anywhere? I've seen various calculators which do more than I want - I want to know, clearly, what the threshholds and withdrawal rates are.

We have the first one on the way and I can't even tell from the sites I've seen whether the tax credit is pro-rata'd in the first tax year, and how the doubled amount for the first year works. All in all, I'm confused! And I should know better as I normally reckon I understand tax matters pretty well.

I am certainly up for 77% effective tax relief if it's available, and never object to upping the AVCs - but I already throw huge amounts into the pension and it might be better to keep the surplus cash for a year when it really would affect the amount of tax credits. In other words, I don't want to over-contribute to the extent that I go beyond the point when I'll get any extra child tax credit.

Your wisdom would be appreciated.

DavidLaGuardia

dunstonh wrote:

I think the compound affect of growth on the tax relief in the early years is important but becomes less important later in life as the timescale is less. .

Dunstonh, I think the above is wrong (though please correct me if I have not interpreted what you are saying correctly)
While growth on any investment does compound over time, the effect of tax relief remains a constant factor (ignoring rate changes)
When comparing a pension fund and another investment that have equal growth the difference between the two based on any tax relief bnefits is going to be the same factor, however long a period of time it has been invested for. There is no componding on this factor. The difference in terms of pounds will depend on the value of the fund, but when comparing a a fund worth X that they have saved over 10 years compared to another worth X that has been saved over 25 years, the amount that is attributable to tax relief would be the same in each case (I realise if working a real life example the person who saved over 25 years would have been likely to have higher reliefs due to the changes in income tax rates, but that is another variable to the one you are focussing on).