Pension and tax relief - dumb question!

[Mouse]

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

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

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

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

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

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

[noTAGlove]

Don’t forget massive NI saving from salary sacrifice.

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

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

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

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

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

[Halitosis]

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

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

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

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

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

[David_D]

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

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

[Mouse]

Thanks for the above.

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

[M1011]

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

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

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

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

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

Basically pensions are excellent.

[Mouse]

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

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

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

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

Basically pensions are excellent.

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

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

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

[xxnick1975]

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

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[MartynJC (UK)]

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

[ryanb741]

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

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

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

[beechcustom]

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

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

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

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

[noTAGlove]

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

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

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

Leave high risk strategies to younger people.

[MartynJC (UK)]

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

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

Leave high risk strategies to younger people.

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

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

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

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

[westberks]

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

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

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

[beechcustom]

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

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

Leave high risk strategies to younger people.

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

[beechcustom]

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

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

[M1011]

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

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

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

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

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

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

[ryanb741]

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

I'm sure I read earlier you have 15 years to go before retirement? IMHO then what you've done seems extremely conservative in approach and statistically likely to mean your pension underperforms massively vs an index tracker. You're likely to get no more than 4% growth per year with your approach which compounded over 15 years would mean a massive underperformance vs a tracker getting 7 or 8%.

Perhaps chat with an IFA regarding your options.

[noTAGlove]

I'm sure I read earlier you have 15 years to go before retirement? IMHO then what you've done seems extremely conservative in approach and statistically likely to mean your pension underperforms massively vs an index tracker. You're likely to get no more than 4% growth per year with your approach which compounded over 15 years would mean a massive underperformance vs a tracker getting 7 or 8%.

Perhaps chat with an IFA regarding your options.

How did your high risk bets go?

[ryanb741]

How did your high risk bets go?

My portfolio is doing really well. Better now that it is in a combo of index funds and a Shariah fund

[Halitosis]

I'm sure I read earlier you have 15 years to go before retirement? IMHO then what you've done seems extremely conservative in approach and statistically *likely* to mean your pension underperforms massively vs an index tracker. You're *likely* to get no more than 4% growth per year with your approach which compounded over 15 years would mean a massive underperformance vs a tracker getting 7 or 8%.

A little over assertive given nobody has a clue where any markets will go in the future?

[ryanb741]

A little over assertive given nobody has a clue where any markets will go in the future?

The guy's got a 15 year window. If markets are down over 15 years then he's got a whole bunch of wider problems over and above what his pension pot is!

Data shows though statistically a 8% annual return from the S&P500 and this is over 100+ years' data.

Anyway best talk to an IFA of course but just my tuppence worth.

[noTAGlove]

The guy's got a 15 year window. If markets are down over 15 years then he's got a whole bunch of wider problems over and above what his pension pot is!

Data shows though statistically a 8% annual return from the S&P500 and this is over 100+ years' data.

Anyway best talk to an IFA of course but just my tuppence worth.

The common rule of asset allocation by age is that you should hold a percentage of stocks that is equal to 100 minus your age.

Not sure what crystal ball an IFA is supposed to have.

[noTAGlove]

Data shows though statistically a 8% annual return from the S&P500 and this is over 100+ years' data.

S&P 500 1st September 2000 = 1520

S&P 500 1st February 2013 = 1513

Sometimes a decade to fifteen years is not long enough.

[ryanb741]

S&P 500 1st September 2000 = 1520

S&P 500 1st February 2013 = 1513

Sometimes a decade to fifteen years is not long enough.

OK fair enough, having a Global Index tracker diversifies that risk even more. But everyone has their own tolerance for risk of course. I'd imagine as interest rates go down markets will go up but I

A. Could be wrong

B. Frequently have been so

I have a similar time to retire (14 years in my case to be 59/60) although I do like working so may continue to do so remotely, pending a Euromillions jackpot win of course.

I'd always leave my pension in an index tracker though even after retirement although I do plan to have 10 years living expenses in cash funds on top.

[noTAGlove]

I think folks attitude has changed given what happened between 2010-2024, expecting continued high single digit/double digit returns will always be the case.

Given typical reversion to the mean, trees usually don’t grow to the sky. But, hey what do I know and the party may well continue for a long time yet.

[Mouse]

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

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

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

Point 1 is fine. I see the benefit definitely. I didn't respond to it because I agree with what you've said.

I think the days of steady, reliable, share fund growth, whether it be for savings or pension, are gone. The world is a much more volatile place these days.

[noTAGlove]

I'd imagine as interest rates go down markets will go up

But who said interest rates are going down?

If you are going to quote long term returns from the stock market, then equally be aware that interest rates over the same term averaged over the current BoE base rate of 5.25%.

1% interest rates for a decade-plus was an anomaly.

Low interest rates have been a disaster for the young and concentrated wealth purely into the asset rich. I hope we never see interest rates that low again.



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[Passenger]

But who said interest rates are going down?

If you are going to quote long term returns from the stock market, then equally be aware that interest rates over the same term averaged over the current BoE base rate of 5.25%.

1% interest rates for a decade-plus was an anomaly.

Low interest rates have been a disaster for the young and concentrated wealth purely into the asset rich. I hope we never see interest rates that low again.



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You´re right to say it was an anomaly, a disaster for savers too. I´m also hoping we don´t see it again, leastways not in the short term.

[beechcustom]

I'm sure I read earlier you have 15 years to go before retirement? IMHO then what you've done seems extremely conservative in approach and statistically likely to mean your pension underperforms massively vs an index tracker. You're likely to get no more than 4% growth per year with your approach which compounded over 15 years would mean a massive underperformance vs a tracker getting 7 or 8%.

Perhaps chat with an IFA regarding your options.

I don't mean to hog / derail the thread but I'm very grateful for the input. I'm just getting started so to get the ball rolling I moved half the pot to the risk level 4 fund. It has a 0.2% fee (the default level 2 fund fee is 0.5%).

It might not be a massive move but at least I did something! I'm going to do some research and I may well move the funds allocate to the default (currently 50%) to another fund or funds. Will take a look at your tracker advice. I am adding between £1k and £2k to the pot per month. Not going to go crazy just yet as I need build my knowledge up.

[M1011]

Also worth mentioning that 10-years to retirement doesn’t mean 10-years left of your pension growing (unless you go for an annuity route I guess). The money in your pension will keep on growing (hopefully) long after you begin drawing down in retirement.

[Ruggertech]

The money in your pension will keep on growing (hopefully) long after you begin drawing down in retirement.

Indeed, I pay nothing into this fund anymore and have drawndown £800 every month for the last 29 months. That's £23,200 taken out and the total is still roughly what it was originally.

[noTAGlove]

It might not be a massive move but at least I did something!

Well done for having a go. The vast majority, including myself, can never get past inertia.


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[craig1912]

Also worth mentioning that 10-years to retirement doesn’t mean 10-years left of your pension growing (unless you go for an annuity route I guess). The money in your pension will keep on growing (hopefully) long after you begin drawing down in retirement.

Very good point- yep the fund needs to keep on growing- pleased at my recent annual review I had drawn less than the growth by a fair margin- using Structured products for roughly seven years ahead so don’t need to think about the shorter term. Medium to long term a bit more adventurous.
State pension kicks in in three years so income from pension will drop by £11000ish.

[Mouse]

Indeed, I pay nothing into this fund anymore and have drawndown £800 every month for the last 29 months. That's £23,200 taken out and the total is still roughly what it was originally.

So in the past six months, the 'static' fund has grown by £3650. And yet in those six months you've withdrawn £4800. Have I got that right?

What is the fund invested in - a Royal Mint printing press :/

[Ruggertech]

So in the past six months, the 'static' fund has grown by £3650. And yet in those six months you've withdrawn £4800. Have I got that right?

What is the fund invested in - a Royal Mint printing press :/

You have got it right. It's with Aegeon pensions and I just answer their questions every so often regarding my attitude to risk and I let them do the rest. Pretty lacklustre from me but it works (so far).
I opened it by consolidating a motley set of small occupational pensions about eight years ago, it was £71k then. It grew steadily to about £90k then plummeted to about £57k with the advent of covid. It gradually made its way back up to about where it is now when I started drawing down 29 months ago. Normally it's hovered about the same total give or take a grand or two despite me taking out £800 a month, but as you can see the last six months it's gone a bit bonkers (in a good way).
I originally thought it would run out when I was about 62, at which point I would let another small pension kick in. But now, even if it doesn't grow a penny it will last until I'm 65 as long as it doesn't drop either.

[Mouse]

You have got it right. It's with Aegeon pensions and I just answer their questions every so often regarding my attitude to risk and I let them do the rest. Pretty lacklustre from me but it works (so far).
I opened it by consolidating a motley set of small occupational pensions about eight years ago, it was £71k then. It grew steadily to about £90k then plummeted to about £57k with the advent of covid. It gradually made its way back up to about where it is now when I started drawing down 29 months ago. Normally it's hovered about the same total give or take a grand or two despite me taking out £800 a month, but as you can see the last six months it's gone a bit bonkers (in a good way).
I originally thought it would run out when I was about 62, at which point I would let another small pension kick in. But now, even if it doesn't grow a penny it will last until I'm 65 as long as it doesn't drop either.

Well all I can say is well done you. I am gobsmacked. You've basically had an overall gain, in six months, of £8450 with the 'modest' sum of £62K ish. I've not calculated the percentage but it's probably off the charts. Can't get my head around it tbh! I'd love to know how the fund is being invested by your provider - in fact I'm sure most would :)

<now googling Aegeon hehe>

[ryanb741]

I don't mean to hog / derail the thread but I'm very grateful for the input. I'm just getting started so to get the ball rolling I moved half the pot to the risk level 4 fund. It has a 0.2% fee (the default level 2 fund fee is 0.5%).

It might not be a massive move but at least I did something! I'm going to do some research and I may well move the funds allocate to the default (currently 50%) to another fund or funds. Will take a look at your tracker advice. I am adding between £1k and £2k to the pot per month. Not going to go crazy just yet as I need build my knowledge up.

Well done. Also a 0.2% fee is pretty good - that 0.3% difference with the standard fee will make a massive difference over 15 years.

For example for the sake of maths say you had £100k in there today and you added £10k a year. And say the average real return (after inflation and fees) was 7% a year. After 15 years you'd have £545k in today's money in there, after adding £150k to the £100k you already had (so £295k investment return in today's money). And that's with fees at 0.5%

If fees were 0.2% (so 0.3% lower), that doesn't seem a lot right? 0.3% is peanuts surely?

Well using the same scenario as above you'd have £557k in today's money after 15 years, so £12k more.

Plenty of nice watches available as a retirement gift to yourself with that extra £12k!

Now that 7% return per year after inflation and fees is a historical average with some years massively higher and some years massively lower so of course that's probably not how it will end up, although with a 15 year horizon I'd like to think you'd get close-ish at least having a diversified global portfolio.

What a lot of people do once they get to retirement age is change their portfolio to be more dividend stock focused (for the income) or less risky portfolios so they have more comfort that a market crash won't wipe them out (market crashes are fine when you keep investing as you now get to buy cheap stocks but once you're retired you are usually taking from the pot not adding to it).

[Ruggertech]

Well all I can say is well done you. I am gobsmacked. You've basically had an overall gain, in six months, of £8450 with the 'modest' sum of £62K ish. I've not calculated the percentage but it's probably off the charts. Can't get my head around it tbh! I'd love to know how the fund is being invested by your provider - in fact I'm sure most would :)

<now googling Aegeon hehe>

Pretty much blind luck on my behalf.

[Mouse]

Pretty much blind luck on my behalf.

I know who to tap up for a loan now anyhow

[Ruggertech]

I know who to tap up for a loan now anyhow

Lol, I charge a very competitive interest rate :)