Starting A Pension (To Avoid 40% Tax)

[Jason]

Hi all, my time to ask for some advice - this time on pensions.

I've just realised this tax year I'll be pushed into the 40% tax bracket, so I'm thinking about starting a pension to put anything above the 40% bracket into the pension. This tax year it will only be £790, so not too fussed but next tax year I will probably be pushed further into it (depending on tax thresholds etc, but I doubt they will be raised).

A few facts:

+ I'm 30,

+ my employer doesn't contribute,

+ I don't trust pensions

I have looked at stakeholder pensions, but their assumptions that it will grow 7% a year is just a pipe dream for this decade at least (well, my opinion) and therefore the 1% charge on the total capital is extortionate. I have thought about a sipp, but unless I'm putting in near 10k a year is it really worth it? Ideally I would just like to put it into a savings account within a pension, but I don't believe you can do that?

So, what do you all advise?

[19 year mortgage 8itch]

Tax thresholds are static till 2014 at least

Can't help on the pension front, mine is all company related.

[Mikhail Liebenstein]

Well my first comment will be can't you save anymore than that?

Seriously £790 for a year is nothing. After 30 years you'd only have added £23,700 and whilst you might get some growth, it is highly unlikely that you'll even get to £100k unless stupid inflation occurs and then a £100k pension pot will buy nothing.

You should really be saving 15% of you gross income , which I am guessing should mean you saving about £5610.

[Jason]

I think you miss-understand, I only want to avoid paying the 40% tax hence £790 is the amount where I pay 40% for this tax year. Next tax year it will probably be £2-3k (maybe?!?).

I see reducing my mortgage far more important that a pension at this stage in my life. So, this isn't really a question about whether I should financially prepare for the future, but how to by being the most tax efficient.

[Harry Sacks]

I think you miss-understand, I only want to avoid paying the 40% tax hence £790 is the amount where I pay 40% for this tax year. Next tax year it will probably be £2-3k (maybe?!?).

I see reducing my mortgage far more important that a pension at this stage in my life. So, this isn't really a question about whether I should financially prepare for the future, but how to by being the most tax efficient.

This is just my experience - I was paying 15% (the max) of my pre-tax earnings into my pension fund. It's a fund I manage myself, a SIPP. It works like a trading account, you just pay the brokerage fee, £10/trade. So I'm responsible for where the money goes and have no one to blame other than me if it goes tits up.

[Harry Sacks]

I think you miss-understand, I only want to avoid paying the 40% tax hence £790 is the amount where I pay 40% for this tax year. Next tax year it will probably be £2-3k (maybe?!?).

I see reducing my mortgage far more important that a pension at this stage in my life. So, this isn't really a question about whether I should financially prepare for the future, but how to by being the most tax efficient.

Err...you only pay the 40% on the bit over the threshold , not the total amount.

[scottbeard]

I've just realised this tax year I'll be pushed into the 40% tax bracket, so I'm thinking about starting a pension to put anything above the 40% bracket into the pension.

...

I have looked at stakeholder pensions, but their assumptions that it will grow 7% a year is just a pipe dream for this decade at least (well, my opinion) and therefore the 1% charge on the total capital is extortionate. I have thought about a sipp, but unless I'm putting in near 10k a year is it really worth it? Ideally I would just like to put it into a savings account within a pension, but I don't believe you can do that?

So, what do you all advise?

Sounds sensible tax avoidance to me. I'm looking into doing something similar for similar reasons.

If you really want to, you could invest in a cash fund within a normal personal pension, which is quite like a "savings account within a pension". However, inflation and charges will eat into that over time. Make sure you consider more inflation-proof investments as well.

You may also be able to get a lower charge than 1%pa if you shop around. Although it takes a lot of years of even 1%pa before it threatens to negate the tax benefits.

The 7%pa is just a red herring - it's a statutory illustration assumption and was set years ago when 7%pa was more reasonable.

Good luck!

(PS - I think a lot of mistrust of pensions comes from misunderstanding, so you're doing the right thing digging for information. However, their main benefit is tax relief and employer contributions, and so pensions may not be right for 20% tax payers whose employer doesn't pay in.)

Edited September 26, 2011 by scottbeard

[FIGGY]

Err...you only pay the 40% on the bit over the threshold , not the total amount.

Yep but if you have large savings then it can cause other problems with taxation at the higher rate (not sure if this is there reason in this case though)

[South Lorne]

...Sounds sensible tax avoidance to me.....

...think you mean tax efficiency....

[LJAR]

7% per annum is the long term (c.200 years and counting) real return on the stock market in the USA.

My advice would be:

Put all the money you can into a SIPP and buy a bit of a FTSE or S&P 500 tracker from vanguard every month.

reinvest your dividends and forget about it until you are 60 or so.

Long term (over 20 years) nothing has so far beaten stocks with reinvested dividends. They are also the statistically best hedge against inflation.

[scottbeard]

...think you mean tax efficiency....

I'm pretty sure I mean tax avoidance

Tax avoidance = avoiding tax by legitimate means

(contrast: Tax evasion = avoiding tax by illegitimate means)

http://en.wikipedia.org/wiki/Tax_avoidance

[South Lorne]

I'm pretty sure I mean tax avoidance

Tax avoidance = avoiding tax by legitimate means

(contrast: Tax evasion = avoiding tax by illegitimate means)

http://en.wikipedia.org/wiki/Tax_avoidance

... efficiency makes the glass half full....

Edited September 26, 2011 by South Lorne

[MongerOfDoom]

Hi all, my time to ask for some advice - this time on pensions.

I've just realised this tax year I'll be pushed into the 40% tax bracket, so I'm thinking about starting a pension to put anything above the 40% bracket into the pension. This tax year it will only be £790, so not too fussed but next tax year I will probably be pushed further into it (depending on tax thresholds etc, but I doubt they will be raised).

So, what do you all advise?

It's not worth the bother. The absolutely most you can save is 40% of £790, so about £300. However, you will pay a large part of that in fees (a SIPP is certainly a complete non-starter), and there will be tax to pay after you retire. This will likely be substantially over 40% unless your earnings dramatically increase or the minimum income guarantee disappears.

BTW, you should not assume that pensions cannot be confiscated by the government. You might think this country won't become another Zimbabwe, but another Hungary sounds a little less impossible. Of course, the occasional minor raid is rather far from being unprecedented thanks to comrade Brown. Then again, a pension is a good thing to have if you expect to be made bankrupt or face means-testing (AFAIK).

I would suggest you get a few days of unpaid leave if you have a use for it (though your marginal tax will reduce by fewer than 10%, again AFAIK).

[porca misèria]

It's not worth the bother.

That's for him to decide. There might be a point of principle at stake. I started my SIPP to avoid the "40%" tax, and its value today is more than twice my total contributions.

The absolutely most you can save is 40% of £790, so about £300.

I think we can all do the arithmetic.

However, you will pay a large part of that in fees (a SIPP is certainly a complete non-starter),

A large part of that? A competitive SIPP has charges starting at £0.00, depending on what you hold in the SIPP.

and there will be tax to pay after you retire.

Likely, yes. Though if the contributions stayed that low the pension would be well below the tax threshold (bearing in mind, pensioners get much more generous tax thresholds than working people). And at age 30 he'll be past the worst of the pension squeeze.

This will likely be substantially over 40% unless your earnings dramatically increase or the minimum income guarantee disappears.

To reach 40% would imply a very substantial pension. At today's rates, a seven-figure pension pot.

BTW, you should not assume that pensions cannot be confiscated by the government. You might think this country won't become another Zimbabwe, but another Hungary sounds a little less impossible. Of course, the occasional minor raid is rather far from being unprecedented thanks to comrade Brown. Then again, a pension is a good thing to have if you expect to be made bankrupt or face means-testing (AFAIK).

That's been happening a lot recently: printing money and inflating away the value of assets - including pensions. Before that we had the much bigger raid, with a decade of diverting money away from the productive economy and into housing. I don't expect a UK government to do anything more unsubtle with private pension pots (stakeholders or SIPPs).

I would suggest you get a few days of unpaid leave if you have a use for it (though your marginal tax will reduce by fewer than 10%, again AFAIK).

A perfectly valid option, but not relevant to the question.

[Frank Hovis]

Opened a SIPP last year to avoid (a legitimate term, unlike evasion) the 40% tax band. Used to do it with VCTs but 30% isn't so attractive. Have a final salary as well but for me it's about avoiding tax, lost money I will never see the benefit of. May lump more in this year, even down into basic rate because I can't see a good home for cash and have £20k coming out of a 4.2% bond next month with nowhere to go.

I agree with the comments that it's not really worth it for £790 this year! £3k next year becomes worth doing.

[Giordano Bruno]

Hi all, my time to ask for some advice - this time on pensions.

I've just realised this tax year I'll be pushed into the 40% tax bracket, so I'm thinking about starting a pension to put anything above the 40% bracket into the pension. This tax year it will only be £790, so not too fussed but next tax year I will probably be pushed further into it (depending on tax thresholds etc, but I doubt they will be raised).

A few facts:

+ I'm 30,

+ my employer doesn't contribute,

+ I don't trust pensions

I have looked at stakeholder pensions, but their assumptions that it will grow 7% a year is just a pipe dream for this decade at least (well, my opinion) and therefore the 1% charge on the total capital is extortionate. I have thought about a sipp, but unless I'm putting in near 10k a year is it really worth it? Ideally I would just like to put it into a savings account within a pension, but I don't believe you can do that?

So, what do you all advise?

Me no expert but I would have thought the tax relief would make it worth it. Also I think it better to prepare for the future in an inefficient way than not to do so at all. The future has a sneaky way of creeping up on you. I heard something about plans to require all companies to contribute into pension funds so that might come in. I would recommend starting to contribute.

I'm lucky in that my company contributes up to 10% of salary to match ones own contributions. I left it too late, I'm 64 now, but I'm trying to make up for lost time. I contribute 25% and I hope to work to 70 at least. Postponing the state pension adds 10.4% to it for every year of postponement, i.e. 1% every 5 weeks.

[QP1]

Just to put a counter argument…

I would rather have the money in my control (albeit 40% less of it after tax) than locked away in a pension. The future may have a tendency to come up fast but is also has a tendency to be unexpected.

I am no expert but AFAIK if you put the money into a pension:

• You cannot touch any of it until 55 (although that can change, it was 50 when I started a pension so best not to make any plans)

• At 55 you can only get 25% of it back

• The remaining 75% has to be used to purchase an annuity

• You only have a small window of time to purchase your annuity and if rates are bad at that time, tough!

• The income from your annuity is subject to tax (so you are only deferring your tax and hoping that the bill will be less when you are drawing your pension – yes, this may be likely but who knows what may happen with tax rates decades into the future?)

If a great business/investment opportunity comes along you can’t get your money out to take advantage of it.

If you get sick you can’t pull the money out to pay for treatment or care (except for a small number of terminal diseases) or make your final days more comfortable.

If a family member gets sick you can’t pull the money out to pay for treatment or care.

If you go through a hard patch financially you can’t pull the money out to help keep you in your home, keep your business afloat, keep your kid in school or whatever.

This is before you get into questions of what are you going to invest your pension in and whether it will actually give you any kind of return...

The London Business School/ABN Amro analysis shows that, in the 20th century, there has not been a 20-year period in which US shares have shown a negative return, when dividends are included. This is not true for the UK.

Professor Dimson said: "Equities are not just risky in the short term, they are risky over the long term, too. Twenty years is not a magic number. You have to hold for a very long time to be confident that equities will outperform."

See here for more:

http://www.independent.co.uk/news/business/news/ftse-100-index-unlikely-to-see-6900-level-again-for-15-years-596778.html

[Georgia O'Keeffe]

Just to put a counter argument…

I would rather have the money in my control (albeit 40% less of it after tax) than locked away in a pension. The future may have a tendency to come up fast but is also has a tendency to be unexpected.

I am no expert but AFAIK if you put the money into a pension:

• You cannot touch any of it until 55 (although that can change, it was 50 when I started a pension so best not to make any plans)

• At 55 you can only get 25% of it back

• The remaining 75% has to be used to purchase an annuity

• You only have a small window of time to purchase your annuity and if rates are bad at that time, tough!

• The income from your annuity is subject to tax (so you are only deferring your tax and hoping that the bill will be less when you are drawing your pension – yes, this may be likely but who knows what may happen with tax rates decades into the future?)

If a great business/investment opportunity comes along you can’t get your money out to take advantage of it.

If you get sick you can’t pull the money out to pay for treatment or care (except for a small number of terminal diseases) or make your final days more comfortable.

If a family member gets sick you can’t pull the money out to pay for treatment or care.

If you go through a hard patch financially you can’t pull the money out to help keep you in your home, keep your business afloat, keep your kid in school or whatever.

This is before you get into questions of what are you going to invest your pension in and whether it will actually give you any kind of return...

See here for more:

http://www.independent.co.uk/news/business/news/ftse-100-index-unlikely-to-see-6900-level-again-for-15-years-596778.html

Of course the upside to a pension is the govt mandated tax benefit (although it is opffset on withdrawal it doesnt change the reality that there is a tax benefit), by giving that tax benefit it opens them up to risk on the other side of the equation. In a time of extreme stress, default whatever is it perceivable that Private pensions could be nationalised. However extreme if this is truly a depression it is feasible.

You have to try to think forward to what scenario it could happen under which is difficult as it is difficult to perceive such financial and Govt stress as its not happened for generations. As an example there are many posters on here always bitching about Public sector pensions and the unfairness of it.

If you reverse that and envisage an effective default of some sort, major crash then alot of people will lose everything (most wont have a pension of any sort). At that point it is not hard to imagine relatively succesful private sector pensions may carry the same popular disdain as public pensions currently do on here. At that point given the tax advantage they have been bestowed it may be politically sound to tax/ nationalise them if it is in the majority interest to do so (and the tax advantage bestowed gives some moral authority for it) and it doesnt need to breach contract, all that needs to happen is for them to be taxed at 99% if not held in Gilts.

Pensions like anything carry a risk that few think about because the risk only exists at the margins, but it is still there

Edited September 27, 2011 by Tamara De Lempicka

[VeryMeanReversion]

Hi all, my time to ask for some advice - this time on pensions.

So, what do you all advise?

Sensible to put everything in the 40% band into a pension if you don't need the money at the moment.

Increase your effective tax relief by getting your employer to do salary sacrifice (look it up).

=> you or your employer do not pay NI on the money in the 40% band if done this way. Many employers (including mine) give you their NI contributions since it doesn't cost them anything

=> your effective tax relief can exceed 50%

If you have children, now or in the future then you will want to stay out of the 40% band and pension is a sensible only way to do it (reducing hours or giving it away to charity are alternatives). This means you keep the child benefit (say £1000+ tax-free for two).

Your marginal tax rate can far exceed 100% if you allow for NI and child benefit when you are just into the 40% band.

Low charges on pension funds are important, low-cost SIPP is sensible. I pay 0.6% on average.

[Bootsox]

Hi all, my time to ask for some advice - this time on pensions..... snip

You remind me of the same question I was asking myself when I was your age (about 20 years ago).

How to wriggle out of the 40% tax bracket?

Not a lot of scope for PAYE (there was even less then), so I went down the Additional Voluntary Contributions route. Over the years, investment wise, I am reasonably in the black but probably only by virtue of the 40% tax saving (Equitable life debacle, got out early doors - phew!).

AVCs paid through my employer so charges reasonably low (circa 0.66 %) for a managed fund.

I have got a decent final salary pension to look forward to so my reasons for AVC contributions, like yours, were purely tax evasion/avoidance/efficiency.

Just a general note, have you any other provisions for your old age (e.g. do you expect to inherit)?

Otherwise, with the lousy pension provision being made by your employer, you are still young enough to consider getting out.

Edited September 27, 2011 by Bootsox

[Neverland]

This is just my experience - I was paying 15% (the max) of my pre-tax earnings into my pension fund. It's a fund I manage myself, a SIPP. It works like a trading account, you just pay the brokerage fee, £10/trade. So I'm responsible for where the money goes and have no one to blame other than me if it goes tits up.

+1

This site has a charging comparison for 14 SIPPs, pick the cheapest which suits you

http://www.investmentsense.co.uk/sipp-zone/sipps/

If you pick a SIPP with low charges it works very well with a full tax rebate

Using a run-of-the-mill SIPP or work pension scheme, almost all of the tax break gets eaten up in charges

[QP1]

Pensions like anything carry a risk that few think about because the risk only exists at the margins, but it is still there

Indeed - I know people who lost on Equitable (don't know how much but they certainly weren't happy!). I have a family member who paid for nearly 30 years into a company pension scheme only for the company to go bust (not sure the scale of the hit he will take but it will be substantial) - the company was a multi-national, market-leader over 100 years old - he couldn't conceive of the company suddenly going under until it happened.

For me the tax upside (which may not be as great as people think - depending on tax rates/thresholds when the pension is drawn) just doesn't outweigh the downsides and risks, most notably that of not having access to the money in 'emergencies'. I paid 'money I really didn't need' into a pension for 12 years then suddenly found myself in very different circumstances where access to that money would have made a tremendous difference. My life has now changed again - I have left the UK and will be setting up a company overseas - once again access to that money could help me massively but I cannot touch it. I do not plan on returning to the UK so now I will have the added uncertainty of exchange rate fluctations and who knows what hassles trying to draw the pension from overseas when the time comes.

Due to the recent stock market slide, the pension itself is now worth less than I paid into it.

All I'm saying is that people need to think carefully about the drawbacks instead of getting a pension just because of the prevailing wisdom that says "that's how you make provision for your old age". A pension is not the right choice for everyone.

[porca misèria]

Opened a SIPP last year to avoid (a legitimate term, unlike evasion) the 40% tax band. Used to do it with VCTs but 30% isn't so attractive. Have a final salary as well but for me it's about avoiding tax, lost money I will never see the benefit of. May lump more in this year, even down into basic rate because I can't see a good home for cash and have £20k coming out of a 4.2% bond next month with nowhere to go.

I agree with the comments that it's not really worth it for £790 this year! £3k next year becomes worth doing.

The 35% for VCTs is more than the 40% for a pension, 'cos there's no deferred tax to pay later.

/me has both SIPP and VCTs. The latter are good for basic-rate money too!

[Neverland]

The 35% for VCTs is more than the 40% for a pension, 'cos there's no deferred tax to pay later.

/me has both SIPP and VCTs. The latter are good for basic-rate money too!

Many VCTs invest in unproven companies started by dodgy fringe businessmen...

...pubs...solar panels...nursing homes...music festival...films...

...all sorts of crap

You can put most sorts of mainstream investments in a pension

[porca misèria]

Just to put a counter argument…

I would rather have the money in my control (albeit 40% less of it after tax) than locked away in a pension. The future may have a tendency to come up fast but is also has a tendency to be unexpected.

A valid concern, especially for those with a long time to go to 55.

• You cannot touch any of it until 55 (although that can change, it was 50 when I started a pension so best not to make any plans)

• At 55 you can only get 25% of it back

• The remaining 75% has to be used to purchase an annuity

• You only have a small window of time to purchase your annuity and if rates are bad at that time, tough!

No. The requirement to buy an annuity has been dropped. And even before that, there was a long window (never less than 20 years) in which to buy it.

Not that 20 years will help those born just the wrong side of the Birthday of Doom (April 6th 1960) who are unlikely ever to see decent annuity rates. But for today's 30-year-olds there's a much better story.

• The income from your annuity is subject to tax (so you are only deferring your tax and hoping that the bill will be less when you are drawing your pension – yes, this may be likely but who knows what may happen with tax rates decades into the future?)

That's why the OP is doing exactly the right thing by putting 40% money in. Less tax is due on the way out.

If a great business/investment opportunity comes along you can’t get your money out to take advantage of it.

Not entirely true, but it can raise the barrier if you have to structure your investment to ensure it qualifies for a pension.

If you get sick you can’t pull the money out to pay for treatment or care (except for a small number of terminal diseases) or make your final days more comfortable.

Are you sure? I thought there was quite a lot of flexibility for those whose medical conditions merit it.

If you go through a hard patch financially you can’t pull the money out to help keep you in your home, keep your business afloat, keep your kid in school or whatever.

On the contrary, a pension is a Very Good place to have your savings. It means you qualify for means-tested benefits!