Is a Pension really worth it?

[IR35 Avoider]

If I've followed this correctly, then it seem you have a choice of being a higher-rate taxpayer now (on dividends) or in the future (on pension funded by employer contributions.) Dividends would be taxed at 40% (of income into the company) and pension (at current rates) on average at 30%. (40% x 75% = 30%)

So tax would be minimised if you went the pension route, but the difference isn't large.

Here's a suggested algorithm.

1. Calculate how much after-tax income you will have in retirement from your current assets, including any inside a pension.
2. Pay yourself income for the current year until you reach that (after-tax) income level.
3. Pay the next chunk of company income into pension (which will increase your projected retirement income from your assets.) ("Chunk" might be roughly the proceeds of each monthly invoice.)
4. it not yet time to retire, go to 1.

[TheCyclingProgrammer]

I understand that but I guess what I'm trying to decide is what is makes more economical sense. If I withdraw dividends I will be investing them for the future (either within an ISA or via other tax free investments such as VCTs). What I am therefore trying to ascertain is whether a 25% hit now makes more sense than a 40% hit later. I currently have no debts so any spare cash I have goes towards investments. My ISA is maxed out. .

It's not a 25% hit now and 40% later. Ignoring the 25% lump sum and any future rate changes, the effective rate of taxation is equal.

Take dividend now and pay 25% personal tax, but dividend is taken from post tax profits so when accounting for 20% CT, the effective tax rate is 40%.

Pay into pension and it comes from pre tax profits, reducing your CT bill. You save the 20% now but pay 40% later. So effectively the same.

He biggest difference is that the effective tax on your pension is lower than 40% when you account for the tax free 25% lump sum.

OTOH, take the tax hit now and you know what the tax will be. Who knows what the tax rate could be when you reach pension age.

[Maslins]

What I am therefore trying to ascertain is whether a 25% hit now makes more sense than a 40% hit later.

I don't think it is a case of 25% now vs 40%. The 25% is the effective personal tax on income that's already suffered 20% corporation tax. If instead of taking that dividend you put it into a pension scheme (assuming it doesn't create an unrelievable loss for the pedants) you'll save not only the 25% personal tax, but also 20% corporation tax. Ends up being 40% anyway (as the 25% tax is on the 80% remaining after corporation tax).

If chances are you'll be a higher rate taxpayer now and also in retirement, won't make much difference. It's not as simple as 40% vs 40% though, a few other things to consider:
- you can typically get some of your pension pot as a tax free lump sum,
- gains on investments inside a pension typically aren't taxed. Whilst investments inside a personally owned ISA wouldn't be either, privately owned BTLs might suffer tax on gains,
- you presumably know you'll be a higher rate taxpayer now. The future is uncertain. Tax rates/thresholds could change significantly, or perhaps you might need to sell off one/both of the BTLs to fund something.

...but yes, I think your general logic is sound, the main reason pensions are popular is that typically people are higher rate taxpayers whilst working (and having kids to pay for/mortgages etc), in retirement, their income is often lower hence just suffering basic rate. They can afford for it to be (as kids left home and mortgage cleared). Obviously everyone's situation is a little different, but for many it'll be broadly as above.

One other option (I am biased in this respect as many regular forum readers will know) would be to neither put the money into a pension scheme or take it as dividends. Instead leave a pot of cash to build up in the company, then extract upon closure via an MVL, often meaning you get all that cash out at only 10% tax, even if amounts are into the hundreds of thousands (where dividends would likely attract even higher than 25%).

[jerseyjoe]

One other option (I am biased in this respect as many regular forum readers will know) would be to neither put the money into a pension scheme or take it as dividends. Instead leave a pot of cash to build up in the company, then extract upon closure via an MVL, often meaning you get all that cash out at only 10% tax, even if amounts are into the hundreds of thousands (where dividends would likely attract even higher than 25%).

Surely, leaving the money in the account would only be a good option if you plan on closing within the next 8 years. After 8 years, the 25% dividend tax saving will have been eaten away by inflation (assuming a rate of 3%).

[CloudWalker]

I have a feeling many pensions wont be worth the money you pay in. As with most pensions you have to live to 110 years old just to get back the money you paid in. And If you want to take a lump sum it will be very small, probably be better to put it in Housing.