Pension and tax relief - dumb question!

[Mouse]

Here's what I know......

You pay into a workplace or private pension and you get 20% added in the form of Gov tax relief.

Let's say you retire at statute age and get the state pension. Let's say that the state amount is already pretty much at the lower rate tax allowance limit (£12570 atm).

Leaving any 25% tax free lump where it is, then you're going to be paying 20% income tax on any withdrawal that takes you over the lower rate. So basically, it's a zero sum game. I don't understand how the initial tax relief is of any benefit at all - other than maybe/hopefully earning some extra interest/earnings or whatever, which could increase the pot amount over time.

This all just seems a con to me. The gov are going to get their 20% back one way or another. Can someone explain - in simple terms?

EDIT: Ok, so you're only going to effectively get taxed once on income rather than twice. Hmm....is that it?......you're still going to get taxed though, so I still don't see the 'free gov money' thing.

[noTAGlove]

Don’t forget massive NI saving from salary sacrifice.

My wife is a lower rate tax payer but got over 40% tax relief from income tax, NI and employers NI which her employer kindly donated (not all do).

She will take out £16,760 every year tax free from aged 55-67 completely tax free, staring Jan 2025.

Then she will run out of private pension at 67 and she will take state pension once again paying no tax.

Be smart and the system will reward you even as a basic rate tax payer. 40% tax relief on the way in. Zero tax on the way out.

Edit - Forgot about the 15% employer contributions my wife got as well (as per comments below). So as a basic rate tax payer she wss getting well over 50% equivalent tax relief/contributions as a basic rate tax payer.

[Halitosis]

If you happen to be a higher rate tax payer then your saving in the first instance is 40% not 20%.

The compound growth of the pension investment is being enjoyed on the higher (gross) amount, as opposed to say an ISA which would be compounding on the lower (after tax) initial investment.

As already pointed out, you save NICs on the initial pension contribution if its done via salary sacrifice.

Not sure what you mean by "leave the 25% tax free lump sum where it is". This is definitely a benefit as, even ignoring the above two points, means your net tax charge would be 15% rather than 20%. In case you aren't aware, if you don't take the lump sum, you enjoy 25% of all pension withdrawals tax free thereafter.

In my own case, I'm paying a marginal tax rate of 40% (actually Scotland so 42% but ignore that), plus NICs on my salary. When I start drawing my pension I expect to be a basic rate tax payer, so my tax saving will be 25% (40% saved on my salary, minus 15% at withdrawal)

[David_D]

Did a Google search and a recent Guardian article said “only about 5% of small- and medium-sized enterprises (SMEs)” offer salary sacrifice for pensions. No idea what proportion of employers who do offer it then give the ER’s NI saving to the employee.

Don’t know whether NI has a long-term future. Conservatives appear to want to get rid.

[Mouse]

Thanks for the above.

I'm a little the wiser, but financial stuff (and maths in general) tends to go way over my head.

[M1011]

(1) Employers are legally obligated to contribute towards your pension if you do, I believe the minimum is 5%/3% if I remember correctly. That means if you put in 5% (which in real cost will cost you 4% of less due to tax saving), they have to top it up with another 3% minimum at no cost to you. So essentially even a basic rate tax payer is immediately doubling their money through employer contributions.

(2) Beyond the employer matched amount mentioned above (and any additional incentives your specific employer may offer), any additional contributions will get 20% relief for basic rate tax payers, higher rate tax payers will save 40% / 45% respectively. (and actually potentially considerably more based on the hidden 60% bucket, NI savings and various schemes for parents)

(3) Even at 20%, by putting it into a pension you have that money earning for you throughout your working lifetime, rather than having that money in the governments hands.

(4) You get a personal allowance each year, so by drawing your earnings in the future via pension you benefit from that new tax free personal allowance each year you draw from your pension.

(5) There are benefits to having your money in a pension from an inheritance tax perspective, if required.

Basically pensions are excellent.

[Mouse]

(1) Employers are legally obligated to contribute towards your pension if you do, I believe the minimum is 5%/3% if I remember correctly. That means if you put in 5% (which in real cost will cost you 4% of less due to tax saving), they have to top it up with another 3% minimum at no cost to you. So essentially even a basic rate tax payer is immediately doubling their money through employer contributions.

(2) Beyond the employer matched amount mentioned above (and any additional incentives your specific employer may offer), any additional contributions will get 20% relief for basic rate tax payers, higher rate tax payers will save 40% / 45% respectively. (and actually potentially considerably more based on the hidden 60% bucket, NI savings and various schemes for parents)

(3) Even at 20%, by putting it into a pension you have that money earning for you throughout your working lifetime, rather than having that money in the governments hands.

(4) You get a personal allowance each year, so by drawing your earnings in the future via pension you benefit from that new tax free personal allowance each year you draw from your pension.

Basically pensions are excellent.

Point three - that always assumes that the pension fund performs well over time. Doesn't have to be the case.

Point four - virtually everyones personal allowance is going to be eaten up by the state pension (it's pretty close even now), so there is no getting away from being taxed on any income above that. Hence my comment that the gov just grabs the 20% back again (though I note the advice by the earlier poster about the 25% of untouched lump sum)

I agree that pensions are a good thing. But I still don't fully understand why!

[xxnick1975]

I think you need to compare it with other ways to save for your retirement to appraise the value

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[MartynJC (UK)]

There are other benefits to pensions. They are outside IHT (tax gets complicated if you live over 75 please seek professional financial advice) so the pot doesn’t contribute to the value of your estate and can be passed direct to beneficiaries.

[ryanb741]

The issue with most workplace pensions is employees get signed up to a scheme with, say Aviva, and keep it in the default fund. That's always a poor performer as it is very risk free but sadly most folks aren't savvy about investing and just keep it in a 'balanced' portfolio fund meaning they get a mediocre result. You should be aiming for 10% return per year (which will be around 7% after inflation and fees). People will say 'you can't guarantee that' - well no you can't but you do have decades of data showing that's what an index fund should achieve.

Best to have it in something as closely following a global tracker as possible, then it will grow faster assuming a 10+ year investment window.

Also you get the personal allowance before you pay tax on pension withdrawals.

[beechcustom]

The issue with most workplace pensions is employees get signed up to a scheme with, say Aviva, and keep it in the default fund. That's always a poor performer as it is very risk free but sadly most folks aren't savvy about investing and just keep it in a 'balanced' portfolio fund meaning they get a mediocre result. You should be aiming for 10% return per year (which will be around 7% after inflation and fees). People will say 'you can't guarantee that' - well no you can't but you do have decades of data showing that's what an index fund should achieve.

Best to have it in something as closely following a global tracker as possible, then it will grow faster assuming a 10+ year investment window.

Also you get the personal allowance before you pay tax on pension withdrawals.

I'm in exactly this position. I opened a pension with aviva via the MU and am making significant contributions to reduce my tax liability. It's all sitting in the default low risk fund and I know I need to get wise and move it to a 'better' fund. Will have a look at global tracker options within Aviva.

[noTAGlove]

I'm in exactly this position. I opened a pension with aviva via the MU and am making significant contributions to reduce my tax liability. It's all sitting in the default low risk fund and I know I need to get wise and move it to a 'better' fund. Will have a look at global tracker options within Aviva.

Depends on your age and years to retirement and drawing in the pension.

You want less risk and more certainty the closer you are to taking the money.

Leave high risk strategies to younger people.

[MartynJC (UK)]

Depends on your age and years to retirement and drawing in the pension.

You want less risk and more certainty the closer you are to taking the money.

Leave high risk strategies to younger people.

I’ve decided to keep my Aviva split over various risk factors even though I am already retired. I want my funds to work for me. Saying that I have about 50% in the lower risk bonds / gilts fund as a buffer. The rest are tracker US/UK/consolidated and a punt on high risk commodities fund.

Do need to look at long term >5y investments though.

PLEASE do seek professional advice rather than relying on (random) TZ folks! Maybe some can backup their advice with their credentials? I am just a guy who used to work in the IT department of a large US fund manager.

I couldn’t see the point of a managed fund compared to a tracker fund tbh considering the fees involved and returns - but that is my personal opinion.

[westberks]

another potential benefit with pensions is if you decide to retire prior to the state pension age; you can then take the personal allowance tax free from the pension fund too.

Obviously this only applies to those able or planning to go early and that aren't in receipt of other incomes.

Salary sacrifice helps with reduced NI contributions, also if you fall or fell under the income traps levels for child benefits or have income in the £100k-£125k and lose your personal allowance; larger pension contributions can often circumnavigate these.

[beechcustom]

Depends on your age and years to retirement and drawing in the pension.

You want less risk and more certainty the closer you are to taking the money.

Leave high risk strategies to younger people.

I'm 50 this year. Likely to be working to 65 (it's not really work) so 15 years at least. Assuming things go as planned I'll take it back as tax efficiently as possible. Doesn't need to be an annuity.

[beechcustom]

I'm in exactly this position. I opened a pension with aviva via the MU and am making significant contributions to reduce my tax liability. It's all sitting in the default low risk fund and I know I need to get wise and move it to a 'better' fund. Will have a look at global tracker options within Aviva.

I've just moved half of my pot to a mixed investment 'balanced' portfolio at level 4 risk. Remaining pot sits in level 2 default. Let's see how that goes.

[M1011]

Point three - that always assumes that the pension fund performs well over time. Doesn't have to be the case.

Point four - virtually everyones personal allowance is going to be eaten up by the state pension (it's pretty close even now), so there is no getting away from being taxed on any income above that. Hence my comment that the gov just grabs the 20% back again (though I note the advice by the earlier poster about the 25% of untouched lump sum)

I agree that pensions are a good thing. But I still don't fully understand why!

3 - Nothing is ever certain, but historic data suggest if you make sensible choices you're unlikely to end up upside-down over the long term (i.e. a pension timescale).

4 - You can access your private pension c.10 years earlier than your state pension, if you wish too. Personally I'm not convinced the state pension will be available to me by the time I get there, that's conjecture but it doesn't seem to be sustainable. I'm not sure on your age so perhaps that's more or less relevant to you.

Also isn't point 1 on my previous list enough on it's own really to make the case for pensions?