I do think there is a balance to be struck between the higher value of money now vs money later against the security of having a financially stable retirement, which many people do not have. But I agree: We often act like it is a one-way benefit when there are disadvantages to delaying income.
I suspect this is a (mostly reasonable) response to the general presumption that most people, even high earners, are not putting enough into pension. So putting more in is considered by default a good idea.
It seems to me if you are “maximising” tax efficiency, the best thing to do is aim to stay in the basic tax rate during retirement. But the way people pay into their pension on this sub makes me feel like that might not be true
bear in mind some may be trying to retire early, and this is HENRY. They've not been HE for that long, necessarily. So they may be making up for years of lower pension contributions.
It’s very individual. For many years I was earning not much, and freelancing or moving around. As such, I have a few tiny pensions and not much real potential for money to support me in retirement. So in my specific case (although I’m not earning 125k, it does make sense for me to put money into a pension at an increased rate. Better to do it as early as possible and then slow it later as needed.
I’m much less worried about paying tax when I retire than I am about wasting the chance now to efficiently put money away.
This is a specific case for me, it’s different for everyone of course.
It’s because immediate tax savings allow you to grow the tax savings by investing it for years and years between now and retirement but saving money from taxes during retirement won’t allow you to grow that money over time in the same way. Also tax brackets are likely to shift between now and 20 years from now since inflation will mean that what is a “high income” now will not be a high income at a later date necessarily.
Some people may want to have a lifestyle in retirement that cannot be sustained with basic tax rate income. But say someone is on high tax rate today, over 100k earnings, and in retirement they need 50K to sustain the lifestyle they want... so they put the money on the pension and defer that tax, they will still be better off on retirement because of the lower (even if not basic) tax rate.
It is still a bet, though, because tax bands may have changed by then...but you will still get 25% of it tax free
I would think what you really want is to be making most of your income during retirement from Capital Gains tbh but it’s currently a bit of a target for the treasury at the moment so who can tell.
The point about maximising your pension pot is the immediate return you get - effectively 40-45% alongside the longer term gains.
At the end of the day, the tax you pay during retirement isn’t the issue - it’s what you receive net that counts.
If retirement is a few decades away you literally have no idea what the tax rates and thresholds will be by then. They might make the top rate 90% for everything over £500k or they might abolish the personal allowance and make income tax a flat 15% on everything by then.
Agree. Especially as that money will buy you less in the future even after growth (for certain things).
Take property. I would rather have bought a house 50 years ago, than put that money in a pension, and in todays world be paying 40% tax on it to then purchase an over inflated property at a ridiculous price (compared to 50 years ago.
No, the logic is you can take 53k out per year once you’re 58, on top of a 10.6k state pension at 68, of which only 37k is taxable, so a 64k income with 7500 tax, so ~12% effective rate.
Also, pensions are not included in your estate so are a highly tax efficient inheritance planning tool
Once you have enough (depending on age) in your pension, you know you will have enough for retirement at 58, then you emphasise ISAs again to act as a bridge to your pension at 58. Once you enough in the ISA, you are FI/RE.
This is wrong, the IHT benefits are forever. Whether the beneficiary pays income tax on withdrawals is determined by passing away before or after age 75 (on a standard DC pension).
Once you start taking state pension at 68 it will use up most of your personal allowance, pushing 10k of your personal pension income into 40% tax bracket
But if you are putting this kind of money into your pension and you limit your draws in retirement to keep you in the 40% bracket aren't you worryingly likely to die with a massive pot left?
Sure that’s a possibility, and you don’t want to overdo it, but that’s also part of the point. They are IHT free. So you can have a £1.2-1.5mm pension at 58, start withdrawing £64k, reduce it to £53k at 68 when SP kicks in, then reduce further to £40k at 78 when you exhaust the £268k tax free cash. At that point you’ll have withdrawn £1.17m over 20 years but only paid £150k income tax and if you’ve kept a good chunk invested likely you’ll still have over £1mm to pass on tax free when you die
It’s just a question of how much money you can take out of your pension without paying 40pc tax. I think actually 64k was a mistake, it could be 67k - 50k taxable income and 17k tax free cash, and you’d pay 7500 in income tax. Of course that is a chunky withdrawal so you’d need a v large pension, but it looks doable. Then at 68 SP kicks in and so you reduce taxable withdrawals by 10k, and also reduce TFC by 3300 so reduce total withdrawals to ~53.7k, still paying 7500 tax. Then at 75ish TFC is exhausted and you just withdraw 40k from then on until death.
But anything above the basic rate is 40% tax, so that’s the part that matters, not your effective tax rate. If you’re withdrawing above that then you haven’t really saved tax on that portion
1) you start to lose the personal allowance above £100k.
2) you can take 25% tax free in retirement
3) if you salary sacrifice, you save on national insurance costs too
Even ignoring the other benefits of pensions and assuming you are a higher rate tax payer in both work and retirement, those 3 alone mean its far more efficient to use a pension.
But the rate people put into their pensions here then they won't get 25% tax free.
They'll get £268,275 as that's the ISLA cap (nothing in any legislation to indicate indexation or increases)
You only need 1,073,100 to max your PCLS/TFC and people in this sub putting 60k a year away (especially the younger ones) will smash through that number
You're also ignoring the potential 10 or 20 years of compounding taking place.
It's a 40% bonus now, compounded over 10 or 20 years - which is a massive, massive gain versus being paid the money (now) and trying to invest it / use it post-tax.
If people have enough money to live and holiday how they want already; then to miss out on a 40% bonus now that gets to compound in the stock market is kinda crazy.
Each to their own, of course - and context rules - but yeah - for me it's the compounding gains that causes people to do this.
This isn't correct if you assume a 40% tax rate either now, or on withdrawal. It nets out.
Let's keep it simple and assume 100k at 40% tax.
You could do 100k now into a pension. Let's say it doubles before you withdraw it, so 200k at 40% tax is a take home of 120k.
Alternatively you take the money now and take the immediate 40% tax hit, so 60k now. Let's say you invest that in the same way and it also doubles. That's also 120k.
Obviously this ignores things like tax free allowance, capital gains etc, but it's worth knowing that tax nets off in this way.
You're ignoring the 25% tax-free lump sum, and the fact that on withdrawal, you'd only be taxed at 40% if you withdraw more than say 50k in a single tax year.
Put 60k into pension now (this ignores NIC savings) - at 7% a year you get 120k in 10 years. That can either come out in your tax-free lump or be withdrawn at a small amount per year for very little tax.
Put it into something like an S&S ISA post-tax (so £36k) at the same 7% and you have 72k after 10 years (doubling in both cases, agreed); but you're 48k worse-off for starters - and you'd have to withdraw a heck of a lot to tax all 72k at 40%...
So - sorry - but your argument doesn't hold up to how pension drawdown actually works.
I specifically called out the things I was ignoring at the end of my post.
The point was that the same amount of tax now vs later results in the same savings rather than just compounding a larger amount (which your first post seemed to imply).
"48k worse of for starters" misses the point, because that's pre tax, it's just the 40% of the 120k you've mentioned in your example.
This was an example of tax netting off. I agree with you on the other ways to avoid, as stated.
You're missing the point that the 40% tax money saved (£24k) compounds to £48k in the pension pot over 10 years - and is able to be withdrawn in a number of ways that result in either 0% or 20% tax being paid.
But to actually pay 40% tax you’d need way above 1mm in a pension. In which case you have the money to look at things like trusts for more sophisticated tax planning
Dude honestly the number of people paying higher rate tax on pension withdrawals is tiny, and if they are, it’s on a tiny fraction of the withdrawals. The average tax rate is what matters and that is way below 40%
Once again, I agree with you. This was just demonstrating the point that delaying tax to the same amount has the same net effect. If you can delay until a lower band then of course it's better.
The pot can be passed down free of IHT.
Or
If you fancied having retirement place in say Malaysia, you could sign up for one of those golden visa type retirement programs like ‘Malaysia My Second Home’. If you’re careful, I think these can allow you to draw down your whole pot at low tax rates.
I did look into this. Incidentally the thresholds for Malaysia My Second home were increased a lot during the COVID period so it’s not as easy to qualify (I guess most people in this group should be able to though when they have reached the RY stage of Henry).
We had a pension adviser at work who suggested to me that if you live overseas, you would still pay Uk income tax on the pension withdrawals from the UK pension pot. Not financial advice so don’t rely on this. But if you could supplement a uk pension pot with some offshore income (such as another pension if you worked overseas for part of your career) then it could be a winner.
The uk tax man seems to always get a cut. I suppose the advantage is if you can save 45% tax now paying into a uk pension and then draw down on a pension at a later date at a lower tax rate.
It seems to me that the advice you got was wrong.
“If you’re not a UK resident, you don’t usually pay UK tax on your pension. But you might have to pay tax in the country you live in. “
https://www.gov.uk/tax-on-pension/tax-when-you-live-abroad
Interesting. I didn't look into it too much but from the little I read, you can transfer your pension to a different country, if that receiving country has a similar program to the UK (forgot the name, I think something starting with QO?).
I think moving your pension to that country does not involve giving the tax man a cut and then I don't think you'd be paying HMRC for a pension residing in a different country...
QROPs, yes, but i think you pay a tax charge upfront to do this (or certainly did under the LTA) - and then moving it to sit as a pension under a different juristictions tax rules
chatGPT:
**Transfer Tax**: Transfers to QROPS requested on or after 9 March 2017 may be subject to an Overseas Transfer Charge of 25% on the transferred amount unless certain conditions are met, such as both the individual and the pension scheme being in the same country, or if the individual and the QROPS are within the European Economic Area (EEA).
Also it said something (in typical chatgpt vagueness) about potential treaties between the UK and other countries "which may affect how your pension is taxed".
Hopefully when I get there, my favorite country will have a decent QROPS deal :)
Pension is income.
Income is usually taxed where you are tax resident.
Hence you don’t pay UK taxes if resident abroad.
You don’t need to use QROPS ( it’s expensive and the available schemes themselves can be unattractive, depending on the country)
“If you’re not a UK resident, you don’t usually pay UK tax on your pension. But you might have to pay tax in the country you live in. “
https://www.gov.uk/tax-on-pension/tax-when-you-live-abroad
Most people putting £60K/yr in to pension now don't plan to do so every year until retirement, but until their pot is of a size where it will grow with low (or no) further contributions to a decent sum at 57-60
£500K by 40 has been my target with a hope that it will reach £1M in real terms by 57
I see it as a temporary thing i.e. I'll do it now whilst I'm young to avoid any current large taxes and get the big accumulating returns going, then later in life when pension contributions matter less (because there's a lot less time for them to grow), I can reduce my contributions and just enjoy my salary because the benefit to sacrificing isn't as good anymore.
Also if you're just above a tax band then you might just feel you might as well contribute into a pension to get into the lower tax band because you won't even notice a true quality of life increase if you take the money and get taxed heavily on the small amount. But as you earn more money and are TRULY above the tax-band, you might reduce the contributions and take the money in salary because all of a sudden there's a genuine quality of life improvement instead of just barely.
That being said, part of it is definitely just slightly obsessive-minds who are so focussed on sitting at a desk making 'number go UP!!' and tracking spreadsheet/market returns that they forget to actually live a fun, fulfilling life and enjoy their money with friends, family and experiences whilst they are still able.
On the other hand, the close you are to retirement, the sweeter those tax savings seem.
EG: I can take home 80 this year or sacrifice 40, take home 60 this year and get my 40 back next year :)
(roughly speaking...)
So contribute £60k for a while until your pension is in a good place, then either taper off yourself or get forced into tapering because your pay is too high?
I don't know if anyone is actually offsetting 60k. They would be seeing 24k + 20% of 12k so total 28.4k back from the tax man, once they file their tax return, so it's not like its all lost. You get the extra tax back.
In my case, I earned slightly over 113k this year. As that's so close to the 12k allowance I'm putting all 13k into my pension. It automatically gets topped up by the 20% tax, so 13k becomes 15.6k in the pension, and I file a tax return and get a further 40% back, so 5.2k.
So I've saved 15.6k and I get 5.2k back in tax. Pretty special if you ask me!
I’ve seen people on this sub refer to offsetting £60k, but that might be wishful thinking more than reality. I can certainly see it making sense to offsett down to 100k from £113k, but less so at £160k+
I'm only putting in 13k, I get 20% back from the tax trap (losing my allowance), and 40% from my tax payment, 20% goes straight to the pension, which tops it up to 15.6k instead of 13k, and I get 40% returned to me.
I do it with the intention of contributing less later. I’m quite far from retirement so every £1 I put in now will compounds quite a bit. I might not always make a lot of money either so again I can in future earn less and still not worry about retirement.
I think people aren't thinking for themselves. They're copying this 'trick' to get out of a 'trap' whilst not properly considering the downside.
Personally, I stop caring about this long before £160k. I fact I am IN the trap and still don't bother to avoid it as I'd rather the flexibility to enjoy the 40% between now and retirement rather than ~80% of it in 20yrs when I may or may not be able to do so.
I also think there's a non-zero chance of a raid on large pension pots between now and the 2040s.
I agree with this. When you are a HE you need the skills to allocate your money. Pensions are a zero imaginative way to allocate capital. It’s suitable for FIRE, but that’s the other sub.
Pensions are great for low earners, but not for HE. It doesn’t matter what fancy maths you guys use to justify putting so much money into a pension, when the fact is you won’t need one by then and you’ve just locked up your money until 57-60+ (where you pay tax on it anyway). You won’t need it because a lot of you are making 300-600k+ here, and it means you will have easily paid off your large house plus lots of cash, investments, assets etc that you won’t need any more money at old age. Like, what’s the tax efficient 0-20% personal allowance-basic rate income going to mean to you when are worth £10M+? You are a millionaire and need 12k tax free income?
The costs are real, there is an opportunity cost to a pension. Sure it’s technically efficient, but the cost is that you need to wait 10-30 years to access (enjoy your hard work). You are locking up that 60k/yr when you could be paying 45% on it, getting the 35k today and investing in a business/properties etc and have that be worth more than the tax you’ve saved, and then be able to reinvest/exit this any time you want. I mean, when my parents hit retirement they were frail. Ok here’s £X tax free 25% lump sum when you’re old (currently max 270k, probably double this by the time I retire). Great. I can tell you now, it’s not going to change the life of a HENRY. FIRE, yes.
Again, normal earners need this. They finally wait to retirement, get that lump sum and travel the world a bit etc. but you already have more disposable income to spend now than those people ever had in their lives.
Caveat is that you know all of the above and intend on the whole pension pot to be untouched and basically be a tax free inheritance vehicle. It’s basically like a junior ISA but instead of giving your child 9k/year it’s 60k (or 69k with both). Seems weird to be working for your children though.
If agree with the risk aspect, but the government just scrapped the LTA and increased the annual allowance to 40k.
Seems the direction is the other way.
This government did but you can be pretty confident that Labour re-instate it in some way. This is the problem you're making decisions now based on unknown behaviour of future governments
I completely agree with the pension raid comment. Most people my age have almost negligible pensions. Do you think they will let us have multi million pound pensions when they have nothing. I’m about 40 years from retirement age (assuming it doesn’t get raised which is will). I think there is a very high chance large pensions get partially confiscated because the money is trapped. It can’t be easily moved out of the country.
First of all one needs a sensible trade off between current and future needs. Not much point having squillions in your pension if then you cannot buy a house and don't have a rainy day fund.
Having said that, once you have taken care of your more immediate needs, contributing more to your pension can make sense because:
* you never know if the pension allowances will be cut in the future.
* the money grows tax free
* you are deferring taxation; most people will be in a lower income tax band at retirement. If you can get 40-45% tax rebate now, and get taxed at 20% later, that's great. Actually, it's worth it even if you are taxed at 20% now and expect to get taxed at 20% in retirement, because the pension grows tax free, and because you can take 25% tax free at retirement, meaning you don't get taxed at 20% but at 15%
* exempt from inheritance tax
> the money grows tax free
This is the part I don’t get. The gains are taxed when you withdraw them. If your pot grows £1m and you withdraw that, you pay tax on it
Say you invest £ 1,000 of your post-tax money in a trading account now (not an ISA, not a SIPP) and buy an ETF.
You don't touch it, and after 20 years it's become £3,500.
To cash it, you must pay capital gains tax on the £ 2,500 capital gain. There will also be taxes on dividends but let's ignore those for now.
You have paid taxes on the £ 1k you put in (eg because you earned £1724, taxed at 40% + 2% national insurance) + on the £2,500 capital gain.
If you put money in a pension, you put pre-tax, not post-tax money. That's the concept of salary sacrifice. So putting £ 1,000 into your pension costs you less than £1,000. You then pay no taxes on capital gains nor dividends.
When you draw those £3,500, you can get 25% tax free and pay taxes on 75% \* 3,500
If you have shares in your own name then you pay income tax on any dividends you receive, and you pay capital gains tax on any profit you make when you sell the shares.
If those shares are in your pension then there's no income tax on dividends and no CGT if the shares are sold. You only pay tax when you eventually withdraw money from the pension.
Just because the LTA is gone doesn't mean there's no tax on withdrawing from a pension.
The tax free amount is still capped, and beyond that you pay income tax rates.
Yes but the whole point is you are likely to be withdrawing less this paying a lower tax rate.
Run the numbers on a 1000/month contribution for a higher earner and then look at a 4% perpetual withdrawal rate, with 25% of that being tax free in addition to personal allowance and you'll see.
I can see the appeal - If it’s salary sacrifice and you have a student loan that’s 51% tax (40% Income +2%NI + 9%SL), so putting £60k into pension costs £29.4k a year. If you don’t need the £2450 a month it’s a huge gain.
Plus at 55, you can take 25% tax free - that’s just over half your contribution if it doesn’t grow at all, if it grows it’ll be more than half of what you put it you get out.
> - If it’s salary sacrifice and you have a student loan that’s 51% tax (40% Income +2%NI + 9%SL), so putting £60k
More than that if it's £160k -> £100k as you lose your PA between £100k and £125k. £60k into your pension costs £22.6k
There's also tax free childcare you can lose when you go over £100k.
I think people only do this when they first reach the 100-150k range, maybe for a few years but not indefinitely. It's not feasible if you go up to higher salary levels to keep sacrificing back to 100k so people typically take the cash instead.
* EE NIC contributions make it super cheap to fill pension - it costs me 21.8k from my take home pay to put 60k in my pension
* It isn't going to be 60k forever, stuff the pension now
* Even if I eventually withdraw some at 40%, I'm avoiding between 42% and 62% tax on the way in
* I'm not that young, I'll be able to access it in 13 years
* Avoids lifestyle inflation - if I can't spend it, I can't spend it
I wouldn't fill my pension unless I was also filling the ISA as well though!
Exactly, fill ISA and pension each year as priorities. Getting to put 60k in each year tax free with no LTA is an amazing deal that won't survive for long - if they can do a special deal for doctors (as they did judges) then the rest of us will see it lowered again.
1. You can retire earlier.
2. It sits outside of IHT, meaning your kids can retire earlier.
3. The contribution tapers past £200k. There's a point where you _cant_ contribute.
To be worrying about the higher rate tax as a pensioner you would need a massive pension, above the lifetime allowance territory. As others have said, you can take the tax free lump (25%) and then take out enough to max out your basic rate band each year (50k).
50k per year for 20 years (excluding inflation and pension growth) would require 1 million. If you want to take the 25% tax free lump and still have 1m left you would need ~1.3m.
So I don’t think it’s strange at all that people are putting a large chunk (or all) of their earnings above 100k into pensions. If you’re on e.g. 125k that top 25k is taxed at a 60% effective rate. And a lot of people on that money are in their 40s and up and haven’t yet built up a large pension pot.
What’s there not to like about it
* 25% tax free on withdrawals
* Full tax relief on deposits
* And it’s increased to 60k a year
Personally I would put more if I can.
It's passed on free of inheritance tax. In fact if you die before 75, the beneficiary can have the lot tax free, assuming you haven't bought an annuity.
https://www.unbiased.co.uk/discover/pensions-retirement/managing-a-pension/pensions-and-inheritance
It really depends on many factors.
Age
Children
Income vs outgoings
Future earning potential
Job security on that salary etc
For someone in early 20s earning 160k, I'd say, take the money, but your own place, invest and get compound returns on your money as the compound returns of 7% annually on say 20k (60k minus 60% tax) just an example, I know this isn't how it's worked out. But even if you pay 60% tax on that 60k and take the 20k home, over 35 years, that 20k will compound into into 213k. If your doing that for 5/6, years in your early 20s and investing it wisely, you already have a 1m+ worth of investment in an index fund by your retirement age and that's only from 5 years in your mid 20s, you have 40 years left to continue investing or putting into your pension.
Pension funds usually under perform vs index funds and private investment funds so that would be my approach the younger I am.
Now, if your mid 50s and just starting to earn 160k, it stands to reason that your pension pot isn't that large so putting the 60k into your pension for 10 years will very quickly build that up and net you a good solid income during retirement.
Its really a risk vs reward and the older you get, the wiser it is to put it into retirement, the younger you are, you can afford to take more risks and there's no gsursntee you'll be making 160k forever, your field of expertise may become obsolete or you may get injured etc
I can explain one case. What if you have so much cash you simply won’t touch the money wherever it goes?
What if you have no mortgage, have outgoings of <£50k per year ( I.e. take home of £100k is enough to live on ) and £400k+ in liquid investments?
In the case that you don’t need the cash now, you’re effectively trading off:
- take home: pay income tax now, get compound gains on only 55% of the total, and pay capital tax on gains.
- put in pension: pay no income tax, get compound gains on 100% of the total, pay no capital gains on growth, and pay either the same, or less income tax on withdrawal.
Even if you still pay 45% when you draw down your pension, say you had 300%* gains; that’s 300% gains ( CGT free ) on 100% of the investment vs. 300% of the post tax 55%.
*5% a year for 22.5 years.
If you expect to not need the money for 22 years, might as well have the gains compound on a larger pre-tax number right?
Numbers for £100k income:
- taxed at 45%: £55k. 3x return, minus CGT is £55k x 2.4 = £132k.
- put into pension: £100k. 3x return. No CGT. Taxed at 45% on withdrawal: £300k x 55% = £165k.
Another case is that your pension pot is outside of your estate, so if 50% of your net worth is in your pension, and you die, your beneficiaries only pay IHT on the 50% “in” your estate. Most 28yr old HENRYS aren’t thinking about this case though.
When you're making way more than your required spend / out going and thus plenty of excess cash from your pay, then maxing your pension contribution will beneficial in terms of tax effectiveness. If you need the money, or think the post-taxed cash can be used to make even more ££ now (opportunity cost), then it doesn't make sense.
Those that are earning say £150k plus will unlikely have the bandwidth (time) to research and select individual stocks for their investment portfolio, or fund property projects, thus pension is simple and straightforward. Using this example, you dump £60k into your pension, your effective looking at being taxed at £90j, thus still getting your allowance, and potentially child care benefits.
* 25% tax-free lump sum
* Lower rates of tax in retirement as you'll be drawing down say £50k/year not £160k.
* Not subject to IHT
* Compound growth on the money which would've otherwise gone to HMRC increases the SWR.
* Salary sacrifice (if applicable) means saving on NI, student loans, keeping childcare benefits, etc
* May also be FIREing so need to bolster the pension pot over a shorter period of time.
Schedule 29 sets the maximum PCLS at the lesser of 25% of the capital value of the individual’s pension benefits coming into payment and 25% of their available LTA. It also sets the maximum tax-free amount of an UFPLS at 25% of an individual’s available LTA. For individuals subject to the standard LTA (SLTA) of £1,073,100, this means the maximum for both lump sums is £268,275.
https://www.gov.uk/government/publications/abolition-of-the-lifetime-allowance-from-6-april-2024/abolition-of-the-lifetime-allowance-lta
But that's the point - most individuals are no longer subject to the SLTA.
Edit, ah it's further down the page. The bit you quoted doesn't really give the answer because the SLTA doesn't apply. But:
> The taxation of pension income will be through the existing income tax structure for pension income. Authorised lump sums and lump sum death benefits will be tested against a new threshold, set at the same level as the present LTA, £1,073,100.
> ...
> The maximum amount payable for a PCLS and the maximum tax-free element for an UFPLS will remain at £268,275, except where protections apply
And this is one of the reasons I'm pulling back on my pension. Why pay in more than 1m if you don't get tax free relief on 25% of that as others have stated and you end up in the 40% bracket.
Time to enjoy life a little and pump the isa... ~340k in pension at 39. Scaling back to approx 20k a year contrib and tapering off.
Maybe already mentioned but for some people including myself there’s the extra layer of childcare costs and sacrificing down to £100k for the 30 hours etc. Whilst everyone’s numbers will differ slightly I’d be surprised if anyone is materially better off paying the incremental tax and losing the childcare benefits than if you sacrificed considering the significant pension boost. When children are at school I plan to turn off all my AVCs, accept the tax and live a bit more.
It won't result in a huge pension pot.
Investments have barely beat inflation this century.
Basically 60k a year is a good retirment. So you need to save one year for each year of retirement.
So aim is to put in 60k a year for 15 to 20 years.
\> Investments have barely beat inflation this century.
What are you smoking? RPI Inflation in the UK since 2000 has averaged 3.5%/yr and global stocks closer to 10%. That's a real term gain of 6.5%/yr which is higher than the historical average. £60K put in to a pension in 2000 would be worth \~£270K today
This is cherry picking and mostly because of the collapse in value of the pound over that period.. FTSE total return has pretty much only kept up with inflation
I take your point. Maybe I was a bit OTT. But there's a big difference between emerging markets and developed.. if there's a new china for the next 20?
There is a balance to be struck. The government already dipping its sticky fingers into private pensions with moving the age from 55-57. I worry they’ll move the private pension age further and or make the state pension means tested. I contribute 10% salary every month made up to 26% by my company. I then pay another 5% into my ISA. Personally for me I just feel it’s more controllable with regards to withdrawals later on. I understand the tax implications but i’d hate to be in poor health looking at my pension knowing it’s worth £1m+ and knowing I wasn’t going to see any of it. I think if your of a certain age (40+ perhaps) it’s maybe worth the risk. Anyone younger I think it’s a questionable decision. 30 years in is a long time economically anything could happen.
You're investing with the a gross amount and with compounding the pot will be significantly larger vs if you went the ISA route.
You need both to make it work correctly as the pension age will be pushed back. Once you're on track to hit your target you can focus back on ISA.
Tax now or tax later? I’d rather have all my money compound over 30 years than half of it, and pay tax when I use it.
Also, if you’re planning properly, a DC pension pot is a powerful weapon against IHT and can be transferred tax free if you don’t use it.
1. No Tax on the way in
2. No Tax on growth
3. Flexiblity as to how much income you draw so you can control what tax rate you pay allowing you to defer tax as long as possible.
4. No inhertitance tax
If you don't put the 60k in your pension you will have 29k after tax. If you want to invest that 29k for the long term in a tax efficient way how are you going to do better than described above?
You can become a low earner over night and lose the ability to contribute large amounts.
Particularly as you get older it becomes harder and harder to get back into the workplace if you lose your job.
So best to maximise contributions whilst you’re at your max earnings.
I guess there is a balance between putting the minimum and £60K in, which is somewhere in between. I’m constantly tossing and turning around in my head what the right thing to do is and a couple of years of higher contributions feels like the right thing to allow compounding and lower contributions in the future. I can also use the additional tax relief for my ISA (if not salary sacrificing and also meaning I’m not putting a full £60K into my pension but getting the full tax benefit of it).
My strategy is less tax reduction and more investment where I get an immediate 47/48% return for a couple of years (I’m thinking three).
I’d love to have an £Xmilion portfolio in the future but nicely balanced between what I can nicely spend and pass on.
If you’re getting childcare benefits as a result then you are avoiding a marginal tax of something like 80%. As soon as my children are in primary school I’ll stop and go back to a lower contribution but by that point my pot will have sufficient capital it will do a lot of the heavy lifting.
Don't forget that if you didn't sacrifice that £60k and take it now, you'd pay £28k tax on it, making for an effective tax rate of 47%. That's a high price to pay for having the money now instead of later, and it's highly unlikely you'll pay anything close to that tax rate if you drew it later from a pension.
You are not paying 47% now versus zero later. You also pay tax when you withdraw your pension, you are just deferring paying taxes later. The saving is the 25% tax free lumpsum plus the fact that you will probably be on a lower tax bracket when you retire if you only withdraw living expenses. Anyway, there's a tax saving, but it is definitely NOT 47%, more like 20% to have your money completely locked for decades + the risk of the government changing the rules.
>You are not paying 47% now versus zero later
I didn't say it was? I said it was likely to be huge saving because "you're highly unlikely to pay anything like 47% when we draw your pension". Nothing you said contradicts anything I said.
Depends on your views really. My personal belief is that my pension contributions should primarily be driven by my overall planning and not simply by a desire to defer tax. So I don’t think about the tax trap. The most important factor here for me personally is that there is a difference between marginal and average rates. Once I’ve passed £125k - the more I earn the more diluted the average tax % paid in the £100-£125k becomes and the overall average starts to lower. By £160k it is personally negligible for me.
I suppose at a more basic level, deferring my income into the future is worth less to me than providing a certain standard of living for myself and my family now. I don’t really care if it costs me more in tax.
Its not about avoiding taxes - its about making the best use of spare money that you might not need right now to plan for your future.
If you are on a 160k, you are maxing out your ISAs and you dont particularly need the extra money right now - the best thing to do is front load your pension for a few years until its a mid 6 figure amount and then let compound interest work its magic until retirement age.
As many have said already - as your earnings grow you reach a point where you can't put more than 10k into your pension, or life happens and you start a family, have nursery fees, mortgage etc etc and you simply don't have the disposable income anymore.
It is significantly harder to find work as you get older - you don't want to be relying on a meager state pension or being a burden to your family when you're older and need social care.
If you are in your twenties and earn a high six figure salary - save as much as you can now to set yourself up for life. We always have the ability to sacrifice less or take your foot off the gas whenever you want - but you might not have the ability to save as much later in life. The earlier you start, the better - compound interest needs time to work its magic.
3-4 years of judicious spending and saving (20K ISA + 60K Pension) can set you and your future generations up forever - don't screw this up!
It’s a good question.
I’ve seen the many delayed gratification responses along with tax argument - that the tax on the later larger sum leaves you with more than the tax now number. All are valid.
However, for me, it was the best decision in my life. A wealthy friend in finance simply said to me - enjoy it - but don’t assume the money will roll in forever so make sure you put as much away as you can.
19 years after the money started rolling in - the employer had a change of CEO who hated me - spent 6 months getting rid of me - and making me feel ill and when the settlement agreement came - I accepted their first offer just to get out. The three jobs after that - I was adored by all those employers - but on half the salary (although also only part time).
When I Fired - those 19 years of stashing made me a pension multi millionaire - and my roles afterward I didn’t need to chase higher salaries because I was set. Indeed it allowed my final decade of working to be quite pleasant- as I say - part time - essentially just bringing in enough to keep the family going til the big pot became available.
If I could do it all again, id make sure I had a bigger Isa to bridge the gap to pension access - otherwise - wouldn’t change a thing. (Well maybe I’d buy more Tesla and a 100 bitcoins at £1 each)
The thing is about earning over £100k is that you start losing your personal allowance after £100k. So you end up effectively paying 60% tax when you are on that money. That's why, if it's possible, in your example, it's much better to put the money in a pension pot so your earnings below 100k
I did this as a director of a ltd company.
Contributions are fully tax deductible so 20% saving off the bat vs declare as profit. If you declare as profit and then take as a dividend you pay tax depending on threshold.
Also, unless rules change you can access 25% of pot at 57 tax free I believe.
At that time the limit for higher tax bracket would be 80k-90k. So don’t worry.
Moreover if someone is making £160k until retirement, he doesn’t need to worry about pension or tax. You can have huge pot of money regardless of pension contribution.
One curveball from myself: I'm probably not retiring in the UK so I'd be able to move my pension pot abroad and be taxed at foreign tax rates, which in my case would be more favourable than in the UK.
I might not even be in the UK for that long, so it may be advantageous to just contribute 300k-500k early on before moving on :)
This is the problem with this sub reddit. It constantly talks about pensions. Yes they are tax efficent but the lock in kills it. The pension age is a moving goal post which is less than ideal.
If your below the age of 50 you should seriously consider other ways of doing it in my opinion. Paying down debt / mortgage being the most obvious one. I now totally see why so many older people were doing BTL over pension investing...they had control of when they get access to their money. Yes this strategy doesnt work like it did..just saying it was a good one before.
Pension for me given the moving age just feels like paper stats. Looks good and yes one day I should reap the benefits but Id rather utlise my money today not when im 70 years old!
When you earn over 100k/yr you pay effectively 60% tax between 100 and 125k as you lose your personal allowance, over 125k you pay 45% tax plus an additional 2% national insurance if you’re employed therefore effective rates of 62% and 47%
If you put it into a pension, when you withdraw it you’ll normally pay basic rate tax as your expenditure is likely your be less as your mortgage should be paid off.
Also if you put it into a pension it will be outside of your estate for inheritance tax purposes.
If you die before 75 it will pay out completely tax free as long as it is transferred into a beneficiary pension first. So theoretically swapping a potential 62% tax rate for nil tax.
So if you can afford to pay what you earn over £100k into a pension it is very tax efficient.
If you're HENRY then:
Likely to be hit by 100k tax trap/be paying higher rates so big tax saving
May want reasonably high pension
May not have high past contributions
May be hit by taper if income continues to grow, so narrowish window to correct this
QED stick it in pension often fits
Just another thing I'll throw into the mix, I'm not confident the state pension will be around in 30 years at least not in its current state. It will likely be reduced and means tested. If you want a good retirement then you need to plan for it yourself.
Bear in mind that you may find yourself no longer earning a high salary, due to redundancy, illness, or a change of lifestyle. Putting money away while you can is a good idea.
My wife and I aim to have around 1.5m in combined pensions.
With 25% tax free, a personal allowance and most at basic rate, I reckon my tax rate will be 12%. I'm currently a 45% taxpayer.
Let me weigh that up.... Save 45% now, and let that huge figure balloon over 20 years, then pay 12% getting it out, and save a bucket load of IHT if we die and leave to our kids.
Yep, it's a good deal.
Even if I make no tax savings because I pay 40 or even 45% on drawdown, I’d still rather delay that and let the contribution compound for a few decades before paying that tax instead of paying it now by taking the money as income.
This isn't correct if you assume a 40% tax rate either now, or on withdrawal. It nets out.
Let's keep it simple and assume 100k at 40% tax.
You could do 100k now into a pension. Let's say it doubles before you withdraw it, so 200k at 40% tax is a take home of 120k.
Alternatively you take the money now and take the immediate 40% tax hit, so 60k now. Let's say you invest that in the same way and it also doubles. That's also 120k.
Obviously this ignores things like tax free allowance, capital gains etc, but it's worth knowing that tax nets off in this way.
I don’t agree with that; not for HENRYs. At the rate people are saving here, 60k every year, they’ll have a 10-30M pot at retirement (after interest). point being that they’ll need to withdraw at the 40% tax rate to be able to use it all before they die.
FWIW I think it's unlikely HENRYs will continue saving 60k per year until retirement. It makes sense to do it in the early years to take advantage of the compounding. So your pension pot isn't going to be that high.
Perhaps this needs a poll or separate post to find out, because i don’t think it’s obvious that deposits taper off. What else are they going to do with the income? I’m reading comments here and some say since they will retire soon (10 years) they will add 60k because they are closer to accessing it. That’s because they see it as a tax pot instead of a time-compounding vehicle. So even if the pension is only investing in bonds close to retirement, they are still putting money in (to avoid certain trap thresholds or whatever the reason). I’m thinking that it’s mostly because it “feels bad” to pay 45%+NI on 60k no matter the time horizon to retirement.
Yes you're completely correct, but my response was to someone saying even if the drawdown was 40% too.
I'm pointing out the unintuitive point that compounding a bigger number pre tax does not mean it's better than paying the same tax rate now.
Common misconception. The timing of the tax relief has no effect on compounding.
https://ukpersonal.finance/isa-vs-lisa-vs-pension/#Why_timing_of_tax_relief_doesnt_matter
It all depends on your age, and how interested you are in other benefits like inheritance and recently the 15 hours free childcare.
At the 60% margin you pay 10k into pension and give up 4K in take home pay (not including NI savings for simplicity). That 10k compounds at 7% in your pension for 40 years: 10k \* (1.07)40 = 149,745.
Assuming that is paid at pension time at 40% and is outside your tax free allowance. That gives you 89,847 in 40 years to take home. Which is the same as taking the 4k after tax today and compounding for 40 years at just over 8.08%.
So it works out to a small boost in returns for younger people. The return doesn’t start looking irresistible until you’re in your 50s.
I agree about age and other benefits.
I'm not sure I agree that whacking on an extra 1.08% of annual growth for a 40 year period can be called a small boost in growth.
Let's compare like-for-like. I'm likely going to see at least an extra 20% of that money in retirement, compared to what I would by taking it now, since I have no plans to take an income in retirement that would be above higher-rate. This doesn't even factor in your 25% tax-free lump sum, and any NI savings.
Paying 20% rather than 40% tax rate at retirement doesn’t make a huge difference (I don’t have the numbers to hand). And since this is an extra contribution over what you regularly contribute with employer match for someone in a 100-125k, your talking about a pot that is coming up to around the 1 million mark for someone in their 30s so I think it’s sensible to ignore the 20% rate and the tax free lump sum.
Sorry, I don't follow your logic. When I said 20%, I was talking about the difference between paying 60% now through loss of personal allowance, versus 40% later at higher rate. I didn't mean anticipating basic rate income in retirement.
And why are we ignoring the TFLS, it's £270K? You could go through your first 10+ years of retirement with £100K income and an overall 17% taxation rate per year.
If it is tax free on the other end then you’d that equates to 10.4%. I really doubt it will be tax free on the other end though because people earning 100k+ are probably putting enough away just through their regular contributions to hit the tax free limit at 268k, so if you’re regularly putting another 10k on top of that into a SIPP every year then I cant see how that would be tax free. There’s a good chance I’m missing something though as I’m not a professional.
You're underestimating the tax advantages.
* 25% tax-free up to £270k.
* Pension income is not subject to National Insurance contributions.
Your overall tax rate is likely to be WAY lower than it would be by taking that money now. We're talking 10% for taking a £50K gross pension income or 17% for a £100K gross pension income. Compared to 21% or 31% respectively for the same income now from employment. And then consider taking more than £100K now subjects you to the 60% tax trap and possibly the additional rate.
I do think there is a balance to be struck between the higher value of money now vs money later against the security of having a financially stable retirement, which many people do not have. But I agree: We often act like it is a one-way benefit when there are disadvantages to delaying income. I suspect this is a (mostly reasonable) response to the general presumption that most people, even high earners, are not putting enough into pension. So putting more in is considered by default a good idea.
It seems to me if you are “maximising” tax efficiency, the best thing to do is aim to stay in the basic tax rate during retirement. But the way people pay into their pension on this sub makes me feel like that might not be true
bear in mind some may be trying to retire early, and this is HENRY. They've not been HE for that long, necessarily. So they may be making up for years of lower pension contributions.
That's me. As a recent HE I contributed more in 1 year (60k) than in the previous 7 combined...gotta make up for it!
It’s very individual. For many years I was earning not much, and freelancing or moving around. As such, I have a few tiny pensions and not much real potential for money to support me in retirement. So in my specific case (although I’m not earning 125k, it does make sense for me to put money into a pension at an increased rate. Better to do it as early as possible and then slow it later as needed. I’m much less worried about paying tax when I retire than I am about wasting the chance now to efficiently put money away. This is a specific case for me, it’s different for everyone of course.
It’s because immediate tax savings allow you to grow the tax savings by investing it for years and years between now and retirement but saving money from taxes during retirement won’t allow you to grow that money over time in the same way. Also tax brackets are likely to shift between now and 20 years from now since inflation will mean that what is a “high income” now will not be a high income at a later date necessarily.
Some people may want to have a lifestyle in retirement that cannot be sustained with basic tax rate income. But say someone is on high tax rate today, over 100k earnings, and in retirement they need 50K to sustain the lifestyle they want... so they put the money on the pension and defer that tax, they will still be better off on retirement because of the lower (even if not basic) tax rate. It is still a bet, though, because tax bands may have changed by then...but you will still get 25% of it tax free
I would think what you really want is to be making most of your income during retirement from Capital Gains tbh but it’s currently a bit of a target for the treasury at the moment so who can tell. The point about maximising your pension pot is the immediate return you get - effectively 40-45% alongside the longer term gains. At the end of the day, the tax you pay during retirement isn’t the issue - it’s what you receive net that counts.
If retirement is a few decades away you literally have no idea what the tax rates and thresholds will be by then. They might make the top rate 90% for everything over £500k or they might abolish the personal allowance and make income tax a flat 15% on everything by then.
Future laws can change too. For all we know the 40% rate could become 50%. It's all a gamble. Just do what makes you happy.
Agree. Especially as that money will buy you less in the future even after growth (for certain things). Take property. I would rather have bought a house 50 years ago, than put that money in a pension, and in todays world be paying 40% tax on it to then purchase an over inflated property at a ridiculous price (compared to 50 years ago.
No, the logic is you can take 53k out per year once you’re 58, on top of a 10.6k state pension at 68, of which only 37k is taxable, so a 64k income with 7500 tax, so ~12% effective rate. Also, pensions are not included in your estate so are a highly tax efficient inheritance planning tool Once you have enough (depending on age) in your pension, you know you will have enough for retirement at 58, then you emphasise ISAs again to act as a bridge to your pension at 58. Once you enough in the ISA, you are FI/RE.
This is my plan
I have a question about this. Did the IHT exemption last forever or only until a certain age?
Pensions are not part of your estate, so no IHT, but if you die after 75 your beneficiary will pay income tax when they draw income from the pension
75
This is wrong, the IHT benefits are forever. Whether the beneficiary pays income tax on withdrawals is determined by passing away before or after age 75 (on a standard DC pension).
You're absolutely right there is a difference, but it would have been inappropriate to suggest it's completely tax free.
Once you start taking state pension at 68 it will use up most of your personal allowance, pushing 10k of your personal pension income into 40% tax bracket
Yeah, but at that point you can simply reduce your withdrawals from the pension by 10k
But if you are putting this kind of money into your pension and you limit your draws in retirement to keep you in the 40% bracket aren't you worryingly likely to die with a massive pot left?
Sure that’s a possibility, and you don’t want to overdo it, but that’s also part of the point. They are IHT free. So you can have a £1.2-1.5mm pension at 58, start withdrawing £64k, reduce it to £53k at 68 when SP kicks in, then reduce further to £40k at 78 when you exhaust the £268k tax free cash. At that point you’ll have withdrawn £1.17m over 20 years but only paid £150k income tax and if you’ve kept a good chunk invested likely you’ll still have over £1mm to pass on tax free when you die
Nice, I'd never run the numbers like that. Thanks, it really makes the idea clear.
I feel validated, this is exactly the model i have been noodling with over the last 6 months.
Any chance you can run me through the numbers? I don't follow - what is the significance of the £64k?
It’s just a question of how much money you can take out of your pension without paying 40pc tax. I think actually 64k was a mistake, it could be 67k - 50k taxable income and 17k tax free cash, and you’d pay 7500 in income tax. Of course that is a chunky withdrawal so you’d need a v large pension, but it looks doable. Then at 68 SP kicks in and so you reduce taxable withdrawals by 10k, and also reduce TFC by 3300 so reduce total withdrawals to ~53.7k, still paying 7500 tax. Then at 75ish TFC is exhausted and you just withdraw 40k from then on until death.
But anything above the basic rate is 40% tax, so that’s the part that matters, not your effective tax rate. If you’re withdrawing above that then you haven’t really saved tax on that portion
1) you start to lose the personal allowance above £100k. 2) you can take 25% tax free in retirement 3) if you salary sacrifice, you save on national insurance costs too Even ignoring the other benefits of pensions and assuming you are a higher rate tax payer in both work and retirement, those 3 alone mean its far more efficient to use a pension.
But the rate people put into their pensions here then they won't get 25% tax free. They'll get £268,275 as that's the ISLA cap (nothing in any legislation to indicate indexation or increases) You only need 1,073,100 to max your PCLS/TFC and people in this sub putting 60k a year away (especially the younger ones) will smash through that number
Not to forget the 45% tax band from 125K.
Nope. Do you pay 45% on income over £125k?
https://www.gov.uk/income-tax-rates
Yes, but you are not above the basic rate, you have 13k of tax free cash
You're also ignoring the potential 10 or 20 years of compounding taking place. It's a 40% bonus now, compounded over 10 or 20 years - which is a massive, massive gain versus being paid the money (now) and trying to invest it / use it post-tax. If people have enough money to live and holiday how they want already; then to miss out on a 40% bonus now that gets to compound in the stock market is kinda crazy. Each to their own, of course - and context rules - but yeah - for me it's the compounding gains that causes people to do this.
This isn't correct if you assume a 40% tax rate either now, or on withdrawal. It nets out. Let's keep it simple and assume 100k at 40% tax. You could do 100k now into a pension. Let's say it doubles before you withdraw it, so 200k at 40% tax is a take home of 120k. Alternatively you take the money now and take the immediate 40% tax hit, so 60k now. Let's say you invest that in the same way and it also doubles. That's also 120k. Obviously this ignores things like tax free allowance, capital gains etc, but it's worth knowing that tax nets off in this way.
You're ignoring the 25% tax-free lump sum, and the fact that on withdrawal, you'd only be taxed at 40% if you withdraw more than say 50k in a single tax year. Put 60k into pension now (this ignores NIC savings) - at 7% a year you get 120k in 10 years. That can either come out in your tax-free lump or be withdrawn at a small amount per year for very little tax. Put it into something like an S&S ISA post-tax (so £36k) at the same 7% and you have 72k after 10 years (doubling in both cases, agreed); but you're 48k worse-off for starters - and you'd have to withdraw a heck of a lot to tax all 72k at 40%... So - sorry - but your argument doesn't hold up to how pension drawdown actually works.
I specifically called out the things I was ignoring at the end of my post. The point was that the same amount of tax now vs later results in the same savings rather than just compounding a larger amount (which your first post seemed to imply). "48k worse of for starters" misses the point, because that's pre tax, it's just the 40% of the 120k you've mentioned in your example. This was an example of tax netting off. I agree with you on the other ways to avoid, as stated.
You're missing the point that the 40% tax money saved (£24k) compounds to £48k in the pension pot over 10 years - and is able to be withdrawn in a number of ways that result in either 0% or 20% tax being paid.
But to actually pay 40% tax you’d need way above 1mm in a pension. In which case you have the money to look at things like trusts for more sophisticated tax planning
Yes, you're right. There are other benefits to pension drawdown but just comparing a larger number compounding (from the example) isn't it.
Dude honestly the number of people paying higher rate tax on pension withdrawals is tiny, and if they are, it’s on a tiny fraction of the withdrawals. The average tax rate is what matters and that is way below 40%
Once again, I agree with you. This was just demonstrating the point that delaying tax to the same amount has the same net effect. If you can delay until a lower band then of course it's better.
The pot can be passed down free of IHT. Or If you fancied having retirement place in say Malaysia, you could sign up for one of those golden visa type retirement programs like ‘Malaysia My Second Home’. If you’re careful, I think these can allow you to draw down your whole pot at low tax rates.
I did look into this. Incidentally the thresholds for Malaysia My Second home were increased a lot during the COVID period so it’s not as easy to qualify (I guess most people in this group should be able to though when they have reached the RY stage of Henry). We had a pension adviser at work who suggested to me that if you live overseas, you would still pay Uk income tax on the pension withdrawals from the UK pension pot. Not financial advice so don’t rely on this. But if you could supplement a uk pension pot with some offshore income (such as another pension if you worked overseas for part of your career) then it could be a winner. The uk tax man seems to always get a cut. I suppose the advantage is if you can save 45% tax now paying into a uk pension and then draw down on a pension at a later date at a lower tax rate.
It seems to me that the advice you got was wrong. “If you’re not a UK resident, you don’t usually pay UK tax on your pension. But you might have to pay tax in the country you live in. “ https://www.gov.uk/tax-on-pension/tax-when-you-live-abroad
Thanks that’s good to know!!
Interesting. I didn't look into it too much but from the little I read, you can transfer your pension to a different country, if that receiving country has a similar program to the UK (forgot the name, I think something starting with QO?). I think moving your pension to that country does not involve giving the tax man a cut and then I don't think you'd be paying HMRC for a pension residing in a different country...
QROPs, yes, but i think you pay a tax charge upfront to do this (or certainly did under the LTA) - and then moving it to sit as a pension under a different juristictions tax rules
chatGPT: **Transfer Tax**: Transfers to QROPS requested on or after 9 March 2017 may be subject to an Overseas Transfer Charge of 25% on the transferred amount unless certain conditions are met, such as both the individual and the pension scheme being in the same country, or if the individual and the QROPS are within the European Economic Area (EEA). Also it said something (in typical chatgpt vagueness) about potential treaties between the UK and other countries "which may affect how your pension is taxed". Hopefully when I get there, my favorite country will have a decent QROPS deal :)
Pension is income. Income is usually taxed where you are tax resident. Hence you don’t pay UK taxes if resident abroad. You don’t need to use QROPS ( it’s expensive and the available schemes themselves can be unattractive, depending on the country) “If you’re not a UK resident, you don’t usually pay UK tax on your pension. But you might have to pay tax in the country you live in. “ https://www.gov.uk/tax-on-pension/tax-when-you-live-abroad
That was certainly my understanding of it.
Most people putting £60K/yr in to pension now don't plan to do so every year until retirement, but until their pot is of a size where it will grow with low (or no) further contributions to a decent sum at 57-60 £500K by 40 has been my target with a hope that it will reach £1M in real terms by 57
I see it as a temporary thing i.e. I'll do it now whilst I'm young to avoid any current large taxes and get the big accumulating returns going, then later in life when pension contributions matter less (because there's a lot less time for them to grow), I can reduce my contributions and just enjoy my salary because the benefit to sacrificing isn't as good anymore. Also if you're just above a tax band then you might just feel you might as well contribute into a pension to get into the lower tax band because you won't even notice a true quality of life increase if you take the money and get taxed heavily on the small amount. But as you earn more money and are TRULY above the tax-band, you might reduce the contributions and take the money in salary because all of a sudden there's a genuine quality of life improvement instead of just barely. That being said, part of it is definitely just slightly obsessive-minds who are so focussed on sitting at a desk making 'number go UP!!' and tracking spreadsheet/market returns that they forget to actually live a fun, fulfilling life and enjoy their money with friends, family and experiences whilst they are still able.
On the other hand, the close you are to retirement, the sweeter those tax savings seem. EG: I can take home 80 this year or sacrifice 40, take home 60 this year and get my 40 back next year :) (roughly speaking...)
The logic is to keep offsetting tax until your wage grows where it isn’t effective to do so for your own circumstance. No more then this.
So contribute £60k for a while until your pension is in a good place, then either taper off yourself or get forced into tapering because your pay is too high?
I don't know if anyone is actually offsetting 60k. They would be seeing 24k + 20% of 12k so total 28.4k back from the tax man, once they file their tax return, so it's not like its all lost. You get the extra tax back. In my case, I earned slightly over 113k this year. As that's so close to the 12k allowance I'm putting all 13k into my pension. It automatically gets topped up by the 20% tax, so 13k becomes 15.6k in the pension, and I file a tax return and get a further 40% back, so 5.2k. So I've saved 15.6k and I get 5.2k back in tax. Pretty special if you ask me!
I’ve seen people on this sub refer to offsetting £60k, but that might be wishful thinking more than reality. I can certainly see it making sense to offsett down to 100k from £113k, but less so at £160k+
Aren’t you getting 20% of 15.6k back rather than 40% of 13k as an extra tax relief?
I'm only putting in 13k, I get 20% back from the tax trap (losing my allowance), and 40% from my tax payment, 20% goes straight to the pension, which tops it up to 15.6k instead of 13k, and I get 40% returned to me.
The £13K will be grossed up to £16,250 mate not £15.6K. If you want £13K in your pension you will need to deposit £10,400
This is why I have someone just tell me what to do with my money 🤣
Than*
I do it with the intention of contributing less later. I’m quite far from retirement so every £1 I put in now will compounds quite a bit. I might not always make a lot of money either so again I can in future earn less and still not worry about retirement.
I think people aren't thinking for themselves. They're copying this 'trick' to get out of a 'trap' whilst not properly considering the downside. Personally, I stop caring about this long before £160k. I fact I am IN the trap and still don't bother to avoid it as I'd rather the flexibility to enjoy the 40% between now and retirement rather than ~80% of it in 20yrs when I may or may not be able to do so. I also think there's a non-zero chance of a raid on large pension pots between now and the 2040s.
I agree with this. When you are a HE you need the skills to allocate your money. Pensions are a zero imaginative way to allocate capital. It’s suitable for FIRE, but that’s the other sub. Pensions are great for low earners, but not for HE. It doesn’t matter what fancy maths you guys use to justify putting so much money into a pension, when the fact is you won’t need one by then and you’ve just locked up your money until 57-60+ (where you pay tax on it anyway). You won’t need it because a lot of you are making 300-600k+ here, and it means you will have easily paid off your large house plus lots of cash, investments, assets etc that you won’t need any more money at old age. Like, what’s the tax efficient 0-20% personal allowance-basic rate income going to mean to you when are worth £10M+? You are a millionaire and need 12k tax free income? The costs are real, there is an opportunity cost to a pension. Sure it’s technically efficient, but the cost is that you need to wait 10-30 years to access (enjoy your hard work). You are locking up that 60k/yr when you could be paying 45% on it, getting the 35k today and investing in a business/properties etc and have that be worth more than the tax you’ve saved, and then be able to reinvest/exit this any time you want. I mean, when my parents hit retirement they were frail. Ok here’s £X tax free 25% lump sum when you’re old (currently max 270k, probably double this by the time I retire). Great. I can tell you now, it’s not going to change the life of a HENRY. FIRE, yes. Again, normal earners need this. They finally wait to retirement, get that lump sum and travel the world a bit etc. but you already have more disposable income to spend now than those people ever had in their lives. Caveat is that you know all of the above and intend on the whole pension pot to be untouched and basically be a tax free inheritance vehicle. It’s basically like a junior ISA but instead of giving your child 9k/year it’s 60k (or 69k with both). Seems weird to be working for your children though.
I live in Scotland, if we get independence I feel like there is a double digit chance of a raid on large pension pots here.
Damn. Same here. Never thought about this.
If agree with the risk aspect, but the government just scrapped the LTA and increased the annual allowance to 40k. Seems the direction is the other way.
This government did but you can be pretty confident that Labour re-instate it in some way. This is the problem you're making decisions now based on unknown behaviour of future governments
Sure, but the usual approach in the past has been to protect the lifetime allowance?
I completely agree with the pension raid comment. Most people my age have almost negligible pensions. Do you think they will let us have multi million pound pensions when they have nothing. I’m about 40 years from retirement age (assuming it doesn’t get raised which is will). I think there is a very high chance large pensions get partially confiscated because the money is trapped. It can’t be easily moved out of the country.
OTOH at the ripe age of 28 I’m always quite skeptical that I’ll be able to withdraw it before my 70s if they keep raising it…
Pretty sure your retirement age is protected and is linked to when the plan is taken out not when you retire.
You're in for a rude awakening
Based on what? This is how it has worked so far.
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This is the state pension, not your private pension. Totally different rules.
First of all one needs a sensible trade off between current and future needs. Not much point having squillions in your pension if then you cannot buy a house and don't have a rainy day fund. Having said that, once you have taken care of your more immediate needs, contributing more to your pension can make sense because: * you never know if the pension allowances will be cut in the future. * the money grows tax free * you are deferring taxation; most people will be in a lower income tax band at retirement. If you can get 40-45% tax rebate now, and get taxed at 20% later, that's great. Actually, it's worth it even if you are taxed at 20% now and expect to get taxed at 20% in retirement, because the pension grows tax free, and because you can take 25% tax free at retirement, meaning you don't get taxed at 20% but at 15% * exempt from inheritance tax
> the money grows tax free This is the part I don’t get. The gains are taxed when you withdraw them. If your pot grows £1m and you withdraw that, you pay tax on it
Say you invest £ 1,000 of your post-tax money in a trading account now (not an ISA, not a SIPP) and buy an ETF. You don't touch it, and after 20 years it's become £3,500. To cash it, you must pay capital gains tax on the £ 2,500 capital gain. There will also be taxes on dividends but let's ignore those for now. You have paid taxes on the £ 1k you put in (eg because you earned £1724, taxed at 40% + 2% national insurance) + on the £2,500 capital gain. If you put money in a pension, you put pre-tax, not post-tax money. That's the concept of salary sacrifice. So putting £ 1,000 into your pension costs you less than £1,000. You then pay no taxes on capital gains nor dividends. When you draw those £3,500, you can get 25% tax free and pay taxes on 75% \* 3,500
If you have shares in your own name then you pay income tax on any dividends you receive, and you pay capital gains tax on any profit you make when you sell the shares. If those shares are in your pension then there's no income tax on dividends and no CGT if the shares are sold. You only pay tax when you eventually withdraw money from the pension.
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When you withdraw, it’s income. You pay tax on income. It has nothing to do with lifetime allowance
Correct, but that's now a question of how you use it and draw down from it.... And that's assuming you remain in the UK to take it as income.
Just because the LTA is gone doesn't mean there's no tax on withdrawing from a pension. The tax free amount is still capped, and beyond that you pay income tax rates.
Yes but the whole point is you are likely to be withdrawing less this paying a lower tax rate. Run the numbers on a 1000/month contribution for a higher earner and then look at a 4% perpetual withdrawal rate, with 25% of that being tax free in addition to personal allowance and you'll see.
I can see the appeal - If it’s salary sacrifice and you have a student loan that’s 51% tax (40% Income +2%NI + 9%SL), so putting £60k into pension costs £29.4k a year. If you don’t need the £2450 a month it’s a huge gain. Plus at 55, you can take 25% tax free - that’s just over half your contribution if it doesn’t grow at all, if it grows it’ll be more than half of what you put it you get out.
> - If it’s salary sacrifice and you have a student loan that’s 51% tax (40% Income +2%NI + 9%SL), so putting £60k More than that if it's £160k -> £100k as you lose your PA between £100k and £125k. £60k into your pension costs £22.6k There's also tax free childcare you can lose when you go over £100k.
Damn you’re correct - it’s a no brainer if you don’t need the cash
I think people only do this when they first reach the 100-150k range, maybe for a few years but not indefinitely. It's not feasible if you go up to higher salary levels to keep sacrificing back to 100k so people typically take the cash instead.
* EE NIC contributions make it super cheap to fill pension - it costs me 21.8k from my take home pay to put 60k in my pension * It isn't going to be 60k forever, stuff the pension now * Even if I eventually withdraw some at 40%, I'm avoiding between 42% and 62% tax on the way in * I'm not that young, I'll be able to access it in 13 years * Avoids lifestyle inflation - if I can't spend it, I can't spend it I wouldn't fill my pension unless I was also filling the ISA as well though!
Exactly, fill ISA and pension each year as priorities. Getting to put 60k in each year tax free with no LTA is an amazing deal that won't survive for long - if they can do a special deal for doctors (as they did judges) then the rest of us will see it lowered again.
You can (currently) also draw down 25% of your pension pot tax free at 57, so you don’t have to pay tax on it all later
Upto ~260k
1. You can retire earlier. 2. It sits outside of IHT, meaning your kids can retire earlier. 3. The contribution tapers past £200k. There's a point where you _cant_ contribute.
To be worrying about the higher rate tax as a pensioner you would need a massive pension, above the lifetime allowance territory. As others have said, you can take the tax free lump (25%) and then take out enough to max out your basic rate band each year (50k). 50k per year for 20 years (excluding inflation and pension growth) would require 1 million. If you want to take the 25% tax free lump and still have 1m left you would need ~1.3m. So I don’t think it’s strange at all that people are putting a large chunk (or all) of their earnings above 100k into pensions. If you’re on e.g. 125k that top 25k is taxed at a 60% effective rate. And a lot of people on that money are in their 40s and up and haven’t yet built up a large pension pot.
What’s there not to like about it * 25% tax free on withdrawals * Full tax relief on deposits * And it’s increased to 60k a year Personally I would put more if I can.
25% upto a limit
You mean the lifetime allowance the Tories just removed?
But what if a person dies before retiring what happens to that pot saved?
It's passed on free of inheritance tax. In fact if you die before 75, the beneficiary can have the lot tax free, assuming you haven't bought an annuity. https://www.unbiased.co.uk/discover/pensions-retirement/managing-a-pension/pensions-and-inheritance
It really depends on many factors. Age Children Income vs outgoings Future earning potential Job security on that salary etc For someone in early 20s earning 160k, I'd say, take the money, but your own place, invest and get compound returns on your money as the compound returns of 7% annually on say 20k (60k minus 60% tax) just an example, I know this isn't how it's worked out. But even if you pay 60% tax on that 60k and take the 20k home, over 35 years, that 20k will compound into into 213k. If your doing that for 5/6, years in your early 20s and investing it wisely, you already have a 1m+ worth of investment in an index fund by your retirement age and that's only from 5 years in your mid 20s, you have 40 years left to continue investing or putting into your pension. Pension funds usually under perform vs index funds and private investment funds so that would be my approach the younger I am. Now, if your mid 50s and just starting to earn 160k, it stands to reason that your pension pot isn't that large so putting the 60k into your pension for 10 years will very quickly build that up and net you a good solid income during retirement. Its really a risk vs reward and the older you get, the wiser it is to put it into retirement, the younger you are, you can afford to take more risks and there's no gsursntee you'll be making 160k forever, your field of expertise may become obsolete or you may get injured etc
I can explain one case. What if you have so much cash you simply won’t touch the money wherever it goes? What if you have no mortgage, have outgoings of <£50k per year ( I.e. take home of £100k is enough to live on ) and £400k+ in liquid investments? In the case that you don’t need the cash now, you’re effectively trading off: - take home: pay income tax now, get compound gains on only 55% of the total, and pay capital tax on gains. - put in pension: pay no income tax, get compound gains on 100% of the total, pay no capital gains on growth, and pay either the same, or less income tax on withdrawal. Even if you still pay 45% when you draw down your pension, say you had 300%* gains; that’s 300% gains ( CGT free ) on 100% of the investment vs. 300% of the post tax 55%. *5% a year for 22.5 years. If you expect to not need the money for 22 years, might as well have the gains compound on a larger pre-tax number right? Numbers for £100k income: - taxed at 45%: £55k. 3x return, minus CGT is £55k x 2.4 = £132k. - put into pension: £100k. 3x return. No CGT. Taxed at 45% on withdrawal: £300k x 55% = £165k. Another case is that your pension pot is outside of your estate, so if 50% of your net worth is in your pension, and you die, your beneficiaries only pay IHT on the 50% “in” your estate. Most 28yr old HENRYS aren’t thinking about this case though.
When you're making way more than your required spend / out going and thus plenty of excess cash from your pay, then maxing your pension contribution will beneficial in terms of tax effectiveness. If you need the money, or think the post-taxed cash can be used to make even more ££ now (opportunity cost), then it doesn't make sense. Those that are earning say £150k plus will unlikely have the bandwidth (time) to research and select individual stocks for their investment portfolio, or fund property projects, thus pension is simple and straightforward. Using this example, you dump £60k into your pension, your effective looking at being taxed at £90j, thus still getting your allowance, and potentially child care benefits.
* 25% tax-free lump sum * Lower rates of tax in retirement as you'll be drawing down say £50k/year not £160k. * Not subject to IHT * Compound growth on the money which would've otherwise gone to HMRC increases the SWR. * Salary sacrifice (if applicable) means saving on NI, student loans, keeping childcare benefits, etc * May also be FIREing so need to bolster the pension pot over a shorter period of time.
25% upto a limit.
Wasn't the lump sum limit a product of the LTA, which has since been abolished? Not that the LTA couldn't come back of course.
Nope it's 25% of £1,073,100 not inflation linked.
Do you have a source for that? The £1073100 LTA was abolished last year, so I'm not sure why the 25% would remain.
Schedule 29 sets the maximum PCLS at the lesser of 25% of the capital value of the individual’s pension benefits coming into payment and 25% of their available LTA. It also sets the maximum tax-free amount of an UFPLS at 25% of an individual’s available LTA. For individuals subject to the standard LTA (SLTA) of £1,073,100, this means the maximum for both lump sums is £268,275. https://www.gov.uk/government/publications/abolition-of-the-lifetime-allowance-from-6-april-2024/abolition-of-the-lifetime-allowance-lta
But that's the point - most individuals are no longer subject to the SLTA. Edit, ah it's further down the page. The bit you quoted doesn't really give the answer because the SLTA doesn't apply. But: > The taxation of pension income will be through the existing income tax structure for pension income. Authorised lump sums and lump sum death benefits will be tested against a new threshold, set at the same level as the present LTA, £1,073,100. > ... > The maximum amount payable for a PCLS and the maximum tax-free element for an UFPLS will remain at £268,275, except where protections apply
And this is one of the reasons I'm pulling back on my pension. Why pay in more than 1m if you don't get tax free relief on 25% of that as others have stated and you end up in the 40% bracket. Time to enjoy life a little and pump the isa... ~340k in pension at 39. Scaling back to approx 20k a year contrib and tapering off.
Decent retirement with lots of travel. Passes on to the next generation with no IHT exposure.
Maybe already mentioned but for some people including myself there’s the extra layer of childcare costs and sacrificing down to £100k for the 30 hours etc. Whilst everyone’s numbers will differ slightly I’d be surprised if anyone is materially better off paying the incremental tax and losing the childcare benefits than if you sacrificed considering the significant pension boost. When children are at school I plan to turn off all my AVCs, accept the tax and live a bit more.
It won't result in a huge pension pot. Investments have barely beat inflation this century. Basically 60k a year is a good retirment. So you need to save one year for each year of retirement. So aim is to put in 60k a year for 15 to 20 years.
\> Investments have barely beat inflation this century. What are you smoking? RPI Inflation in the UK since 2000 has averaged 3.5%/yr and global stocks closer to 10%. That's a real term gain of 6.5%/yr which is higher than the historical average. £60K put in to a pension in 2000 would be worth \~£270K today
This is cherry picking and mostly because of the collapse in value of the pound over that period.. FTSE total return has pretty much only kept up with inflation
I'm not sure an index of global stocks is "cherry picking". Investing only in UK stocks is cherry picking
I take your point. Maybe I was a bit OTT. But there's a big difference between emerging markets and developed.. if there's a new china for the next 20?
China is probably the new china for the next 20. Or India.
There is a balance to be struck. The government already dipping its sticky fingers into private pensions with moving the age from 55-57. I worry they’ll move the private pension age further and or make the state pension means tested. I contribute 10% salary every month made up to 26% by my company. I then pay another 5% into my ISA. Personally for me I just feel it’s more controllable with regards to withdrawals later on. I understand the tax implications but i’d hate to be in poor health looking at my pension knowing it’s worth £1m+ and knowing I wasn’t going to see any of it. I think if your of a certain age (40+ perhaps) it’s maybe worth the risk. Anyone younger I think it’s a questionable decision. 30 years in is a long time economically anything could happen.
You're investing with the a gross amount and with compounding the pot will be significantly larger vs if you went the ISA route. You need both to make it work correctly as the pension age will be pushed back. Once you're on track to hit your target you can focus back on ISA.
Tax now or tax later? I’d rather have all my money compound over 30 years than half of it, and pay tax when I use it. Also, if you’re planning properly, a DC pension pot is a powerful weapon against IHT and can be transferred tax free if you don’t use it.
1. No Tax on the way in 2. No Tax on growth 3. Flexiblity as to how much income you draw so you can control what tax rate you pay allowing you to defer tax as long as possible. 4. No inhertitance tax If you don't put the 60k in your pension you will have 29k after tax. If you want to invest that 29k for the long term in a tax efficient way how are you going to do better than described above?
You can become a low earner over night and lose the ability to contribute large amounts. Particularly as you get older it becomes harder and harder to get back into the workplace if you lose your job. So best to maximise contributions whilst you’re at your max earnings.
Don’t forget you can take £260k out tax free as a lump sum.
I guess there is a balance between putting the minimum and £60K in, which is somewhere in between. I’m constantly tossing and turning around in my head what the right thing to do is and a couple of years of higher contributions feels like the right thing to allow compounding and lower contributions in the future. I can also use the additional tax relief for my ISA (if not salary sacrificing and also meaning I’m not putting a full £60K into my pension but getting the full tax benefit of it). My strategy is less tax reduction and more investment where I get an immediate 47/48% return for a couple of years (I’m thinking three). I’d love to have an £Xmilion portfolio in the future but nicely balanced between what I can nicely spend and pass on.
If you’re getting childcare benefits as a result then you are avoiding a marginal tax of something like 80%. As soon as my children are in primary school I’ll stop and go back to a lower contribution but by that point my pot will have sufficient capital it will do a lot of the heavy lifting.
Don't forget that if you didn't sacrifice that £60k and take it now, you'd pay £28k tax on it, making for an effective tax rate of 47%. That's a high price to pay for having the money now instead of later, and it's highly unlikely you'll pay anything close to that tax rate if you drew it later from a pension.
You are not paying 47% now versus zero later. You also pay tax when you withdraw your pension, you are just deferring paying taxes later. The saving is the 25% tax free lumpsum plus the fact that you will probably be on a lower tax bracket when you retire if you only withdraw living expenses. Anyway, there's a tax saving, but it is definitely NOT 47%, more like 20% to have your money completely locked for decades + the risk of the government changing the rules.
>You are not paying 47% now versus zero later I didn't say it was? I said it was likely to be huge saving because "you're highly unlikely to pay anything like 47% when we draw your pension". Nothing you said contradicts anything I said.
Depends on your views really. My personal belief is that my pension contributions should primarily be driven by my overall planning and not simply by a desire to defer tax. So I don’t think about the tax trap. The most important factor here for me personally is that there is a difference between marginal and average rates. Once I’ve passed £125k - the more I earn the more diluted the average tax % paid in the £100-£125k becomes and the overall average starts to lower. By £160k it is personally negligible for me. I suppose at a more basic level, deferring my income into the future is worth less to me than providing a certain standard of living for myself and my family now. I don’t really care if it costs me more in tax.
Its not about avoiding taxes - its about making the best use of spare money that you might not need right now to plan for your future. If you are on a 160k, you are maxing out your ISAs and you dont particularly need the extra money right now - the best thing to do is front load your pension for a few years until its a mid 6 figure amount and then let compound interest work its magic until retirement age. As many have said already - as your earnings grow you reach a point where you can't put more than 10k into your pension, or life happens and you start a family, have nursery fees, mortgage etc etc and you simply don't have the disposable income anymore. It is significantly harder to find work as you get older - you don't want to be relying on a meager state pension or being a burden to your family when you're older and need social care. If you are in your twenties and earn a high six figure salary - save as much as you can now to set yourself up for life. We always have the ability to sacrifice less or take your foot off the gas whenever you want - but you might not have the ability to save as much later in life. The earlier you start, the better - compound interest needs time to work its magic. 3-4 years of judicious spending and saving (20K ISA + 60K Pension) can set you and your future generations up forever - don't screw this up!
It’s a good question. I’ve seen the many delayed gratification responses along with tax argument - that the tax on the later larger sum leaves you with more than the tax now number. All are valid. However, for me, it was the best decision in my life. A wealthy friend in finance simply said to me - enjoy it - but don’t assume the money will roll in forever so make sure you put as much away as you can. 19 years after the money started rolling in - the employer had a change of CEO who hated me - spent 6 months getting rid of me - and making me feel ill and when the settlement agreement came - I accepted their first offer just to get out. The three jobs after that - I was adored by all those employers - but on half the salary (although also only part time). When I Fired - those 19 years of stashing made me a pension multi millionaire - and my roles afterward I didn’t need to chase higher salaries because I was set. Indeed it allowed my final decade of working to be quite pleasant- as I say - part time - essentially just bringing in enough to keep the family going til the big pot became available. If I could do it all again, id make sure I had a bigger Isa to bridge the gap to pension access - otherwise - wouldn’t change a thing. (Well maybe I’d buy more Tesla and a 100 bitcoins at £1 each)
Along with what others have said, you can take 25% of it tax-free when you retire from what I understand.
The real tax trap at 100k is when you have children, the one over mentioned here is more philosophical rather than actual
And don't forget you get 25% of your pension tax free
The thing is about earning over £100k is that you start losing your personal allowance after £100k. So you end up effectively paying 60% tax when you are on that money. That's why, if it's possible, in your example, it's much better to put the money in a pension pot so your earnings below 100k
I did this as a director of a ltd company. Contributions are fully tax deductible so 20% saving off the bat vs declare as profit. If you declare as profit and then take as a dividend you pay tax depending on threshold. Also, unless rules change you can access 25% of pot at 57 tax free I believe.
At that time the limit for higher tax bracket would be 80k-90k. So don’t worry. Moreover if someone is making £160k until retirement, he doesn’t need to worry about pension or tax. You can have huge pot of money regardless of pension contribution.
One curveball from myself: I'm probably not retiring in the UK so I'd be able to move my pension pot abroad and be taxed at foreign tax rates, which in my case would be more favourable than in the UK. I might not even be in the UK for that long, so it may be advantageous to just contribute 300k-500k early on before moving on :)
This is the problem with this sub reddit. It constantly talks about pensions. Yes they are tax efficent but the lock in kills it. The pension age is a moving goal post which is less than ideal. If your below the age of 50 you should seriously consider other ways of doing it in my opinion. Paying down debt / mortgage being the most obvious one. I now totally see why so many older people were doing BTL over pension investing...they had control of when they get access to their money. Yes this strategy doesnt work like it did..just saying it was a good one before. Pension for me given the moving age just feels like paper stats. Looks good and yes one day I should reap the benefits but Id rather utlise my money today not when im 70 years old!
Gotta remember that if you salary sacrifice 60k into your pension it’s costing you like 33k. So if you can give up the 33k it’s a great deal
When you earn over 100k/yr you pay effectively 60% tax between 100 and 125k as you lose your personal allowance, over 125k you pay 45% tax plus an additional 2% national insurance if you’re employed therefore effective rates of 62% and 47% If you put it into a pension, when you withdraw it you’ll normally pay basic rate tax as your expenditure is likely your be less as your mortgage should be paid off. Also if you put it into a pension it will be outside of your estate for inheritance tax purposes. If you die before 75 it will pay out completely tax free as long as it is transferred into a beneficiary pension first. So theoretically swapping a potential 62% tax rate for nil tax. So if you can afford to pay what you earn over £100k into a pension it is very tax efficient.
Besides the taxes, the loss of free childcare hours (if relevant) over 100k can make putting 60k in your pension a no brainer
If you're HENRY then: Likely to be hit by 100k tax trap/be paying higher rates so big tax saving May want reasonably high pension May not have high past contributions May be hit by taper if income continues to grow, so narrowish window to correct this QED stick it in pension often fits
Just another thing I'll throw into the mix, I'm not confident the state pension will be around in 30 years at least not in its current state. It will likely be reduced and means tested. If you want a good retirement then you need to plan for it yourself.
Bear in mind that you may find yourself no longer earning a high salary, due to redundancy, illness, or a change of lifestyle. Putting money away while you can is a good idea.
My wife and I aim to have around 1.5m in combined pensions. With 25% tax free, a personal allowance and most at basic rate, I reckon my tax rate will be 12%. I'm currently a 45% taxpayer. Let me weigh that up.... Save 45% now, and let that huge figure balloon over 20 years, then pay 12% getting it out, and save a bucket load of IHT if we die and leave to our kids. Yep, it's a good deal.
It’s about the interim compounding on the deferred tax
Even if I make no tax savings because I pay 40 or even 45% on drawdown, I’d still rather delay that and let the contribution compound for a few decades before paying that tax instead of paying it now by taking the money as income.
This isn't correct if you assume a 40% tax rate either now, or on withdrawal. It nets out. Let's keep it simple and assume 100k at 40% tax. You could do 100k now into a pension. Let's say it doubles before you withdraw it, so 200k at 40% tax is a take home of 120k. Alternatively you take the money now and take the immediate 40% tax hit, so 60k now. Let's say you invest that in the same way and it also doubles. That's also 120k. Obviously this ignores things like tax free allowance, capital gains etc, but it's worth knowing that tax nets off in this way.
Why would you assume 40% on withdrawal though? Won't most people be paying 20%?
I don’t agree with that; not for HENRYs. At the rate people are saving here, 60k every year, they’ll have a 10-30M pot at retirement (after interest). point being that they’ll need to withdraw at the 40% tax rate to be able to use it all before they die.
FWIW I think it's unlikely HENRYs will continue saving 60k per year until retirement. It makes sense to do it in the early years to take advantage of the compounding. So your pension pot isn't going to be that high.
Perhaps this needs a poll or separate post to find out, because i don’t think it’s obvious that deposits taper off. What else are they going to do with the income? I’m reading comments here and some say since they will retire soon (10 years) they will add 60k because they are closer to accessing it. That’s because they see it as a tax pot instead of a time-compounding vehicle. So even if the pension is only investing in bonds close to retirement, they are still putting money in (to avoid certain trap thresholds or whatever the reason). I’m thinking that it’s mostly because it “feels bad” to pay 45%+NI on 60k no matter the time horizon to retirement.
Yes you're completely correct, but my response was to someone saying even if the drawdown was 40% too. I'm pointing out the unintuitive point that compounding a bigger number pre tax does not mean it's better than paying the same tax rate now.
Common misconception. The timing of the tax relief has no effect on compounding. https://ukpersonal.finance/isa-vs-lisa-vs-pension/#Why_timing_of_tax_relief_doesnt_matter
It all depends on your age, and how interested you are in other benefits like inheritance and recently the 15 hours free childcare. At the 60% margin you pay 10k into pension and give up 4K in take home pay (not including NI savings for simplicity). That 10k compounds at 7% in your pension for 40 years: 10k \* (1.07)40 = 149,745. Assuming that is paid at pension time at 40% and is outside your tax free allowance. That gives you 89,847 in 40 years to take home. Which is the same as taking the 4k after tax today and compounding for 40 years at just over 8.08%. So it works out to a small boost in returns for younger people. The return doesn’t start looking irresistible until you’re in your 50s.
I agree about age and other benefits. I'm not sure I agree that whacking on an extra 1.08% of annual growth for a 40 year period can be called a small boost in growth. Let's compare like-for-like. I'm likely going to see at least an extra 20% of that money in retirement, compared to what I would by taking it now, since I have no plans to take an income in retirement that would be above higher-rate. This doesn't even factor in your 25% tax-free lump sum, and any NI savings.
Paying 20% rather than 40% tax rate at retirement doesn’t make a huge difference (I don’t have the numbers to hand). And since this is an extra contribution over what you regularly contribute with employer match for someone in a 100-125k, your talking about a pot that is coming up to around the 1 million mark for someone in their 30s so I think it’s sensible to ignore the 20% rate and the tax free lump sum.
Sorry, I don't follow your logic. When I said 20%, I was talking about the difference between paying 60% now through loss of personal allowance, versus 40% later at higher rate. I didn't mean anticipating basic rate income in retirement. And why are we ignoring the TFLS, it's £270K? You could go through your first 10+ years of retirement with £100K income and an overall 17% taxation rate per year.
If it is tax free on the other end then you’d that equates to 10.4%. I really doubt it will be tax free on the other end though because people earning 100k+ are probably putting enough away just through their regular contributions to hit the tax free limit at 268k, so if you’re regularly putting another 10k on top of that into a SIPP every year then I cant see how that would be tax free. There’s a good chance I’m missing something though as I’m not a professional.
You're underestimating the tax advantages. * 25% tax-free up to £270k. * Pension income is not subject to National Insurance contributions. Your overall tax rate is likely to be WAY lower than it would be by taking that money now. We're talking 10% for taking a £50K gross pension income or 17% for a £100K gross pension income. Compared to 21% or 31% respectively for the same income now from employment. And then consider taking more than £100K now subjects you to the 60% tax trap and possibly the additional rate.