Is a Pension really worth it?

[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.

[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%).

[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%).

[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.

[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.

[jerseyjoe]

Thanks

Thanks everyone for your advice. Has given me food for thought and will sit down with spreadsheets to try and see which course of action suits me best. The expanding of the property portfolio jumps out at me but will do my research first.

[Craig at Nixon Williams]

If you currently pay tax at basic rate, but expect to pay tax at the higher rate in retirement then you are correct in saying that the tax benefit of the pension will be diminished or even eliminated.

Are you certain that your income in retirement will fall into the higher rate? You have listed ISA investments as something that will contribute to your taxable income in retirement, however dividends that you receive from ISA investments will not be subject to income tax, likewise you will not pay CGT on any gains realised from ISA investments.

If you leave the cash in the company until such a time as you cease contracting, you could extract it as a Capital Gain and claim Entrepreneurs Relief (assuming that you qualify) which would mean that you would only pay 10% on the gain. Of course, this assumes that today’s rules are still in place at the point that you finish contracting.

[ASB]

If the companymakes contributions it will get CT relief. But as you acknowledge it will be at the Cos marginal tax rate. This may utrn out inefficient if you are a higher rate taxpayer in retirement.

Do you intend to spend all the dosj or hand some of it on to kid etc ? In the latter case it might be worth considering whether to move the properties into trust and accumulate the rental for the purposes of the trust. This may enable only basic rate to be suffered on the rental if it is, for example, passed on to your children (if any).

A further consideration might be to make personal contbiutions from income which has taken you into the 40% band. This way you will get more tax releif on the amounts going in, but you have to claim it through your tax return. Of course it has to be pensionable income.

I am not sure if the rental income counts though. Obviously paying salary would be ineffictive due to the ni elements.

What I was thinking was take 40k of dividends. Get to pay an extra 10%; but you now have 40+k of higher rate income. Stuff that - if the retals count for relevant income - into the pension. Instant 25% relief and balance (hopefully) reclaimed through your tax return. So the 40k of dividend becomes 30k but you end up with the "right" gross amount in the pension offsetting the 10k hrt paid.

If this is achievable then you should not be in a worse position with taxation come retirement, i.e. you suffer 40% on it, but got 40% relief.

Barring a few odd circumstances pensions are all about tax deferrement really.

Can this work ?? Not sure, I haven't been in that position. I've always had different appropriate income.

[AsISeeIt]

Keep in mind the dangers of being married or having kids in the UK in your future plans. If it goes DD up, your pension, any equity in your BTL and for that matter all of your savings (as you have to provide 12 months of bank statements for every account you have in the world) will be simply seen as one big bank account for:

1. UK lawyers to tell you what you want to hear, and proceed to clean you out, whilst the process rumbles on
2. The wonderful UK Family Court District Judge will want to find against you no matter what, who wants to make judgement against you....
3. Your ex-wife or the mother of your child (even if you only met her one night at the pub), no matter how unreasonable their demands are.

"If you have it, someone will want to take it." You simply cannot rely on these assets being there for you if your in England or Wales and don't see yourself as child-free or single until you retire.

[northernladuk]

It's just another tool for planning your finances in to retirement. It has some advantages in being tax efficient for LTD co owners but IMO it should be just another option so you don't have all your eggs in one basket. Mine has performed really well over the last 5 years returning more than I could get in any other savings option plus the tax saved.

A good IFA should really be able to tell you the best thing to do taking in to account all your other savings/income.

[ChimpMaster]

£50k retained profit is not a huge amount, so don't let that worry you - just keep building up the warchest so that you are well prepared for any down time. When you change career or go permie or retire, look at the options available at that time to extract the retained profits.

On the BTL investment side, £34k rental income is awesome (£1,400 PCM for each house), which means that the properties are probably worth over £300k each now. That's £600k you have sitting there. To reduce your taxable income there, re-mortgage to release equity, and look to either expand your portfolio or invest the funds elsewhere.

You have a superb base from where to launch. There is so much you can do.

Oh and on the pensions side, I personally don't see the point of putting money away for the long term when there is so little growth/income potential, especially when you see no benefits in the near/medium term (which you do with your BTLs). I did have a pension scheme when I was permie but only because the employer matched my contribution. The problem with a pension was that it died when you died, though that might have changed now. SIPPS could be an interesting option for you otherwise, but again I haven't taken any interest and so can't advise on the technicalities.

[SimonMac]

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. .

What makes you think it will be 40% later? Firstly we have no certainty what the rate will be in X number of years, also I have a SIPP which I am planning to use income drawdown so I have the flexibility to alter my income based on my finances at the time. Suppose you will also need to consider who is the pension for, if its just you or do you want some guarantee over spousal income etc?

[jerseyjoe]

Answer the following two questions:

Do you want to retire?
Yes


Do you expect to live on just the governments £72 a week?
No, I would expect to live off my other investments such as my ISAs and BTLs (which are owned outright)

Its best to divest so not all your eggs are in one place, if you can take money out of the company still pay down any debt, are your BTL's mortgaged? After that stick it in your ISA's (the limit has gone up recently so have you maxed it out), after that stick it in a pension

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. .

[SimonMac]

Answer the following two questions:

Do you want to retire?

Do you expect to live on just the governments £72 a week?

Its best to divest so not all your eggs are in one place, if you can take money out of the company still pay down any debt, are your BTL's mortgaged? After that stick it in your ISA's (the limit has gone up recently so have you maxed it out), after that stick it in a pension

[jerseyjoe]

Hi All

On the advice of my accountant I pay myself a salary that hits the personal allowance limit in order to maximise my tax benefits. However I also own a couple of BTL properties (no mortgages) which bring in rental income of about £34,000 per annum. Therefore when combined with my salary it takes me very close (about £2000 short) of the higher income threshold of £41,865.

The situation is that my earnings have gone up tremendously recently and by the end of the year I stand to have retained profits of about £50,000 in my limited company from this year alone. If I were to take more than £2000 of this as dividends it would trigger the 25% tax rate. To avoid this, I was considering starting a pension and paying in the annual maximum of £40,000.

However, taking out pension will have some pitfalls for me. The biggest one is that although I am currently a basic rate tax payer (thanks to my salary structure), due to the other investments I currently have (BTLs, ISAs etc), it is highly likely that in retirement my income will be close to the higher tax threshold, in which case drawing my pension (after taking the 25% lump sum) would probably push me over the threshold and I will therefore be paying 40% on my pension income.

I know many people talk about how tax beneficial it is to have a pension but this would seem to apply more to those who are currently high rate tax payers but will be basic rate payers in retirement. In my situation I'm not so sure there is much of a tax benefit.

Therefore is it better for me to take the 25% tax hit against dividends now or to take the probable 40% hit on my pension income in 15 years time? I know 15 years is a long time and anything could happen but I need to decide now as the opportunity to take the dividends is relevant to the present time.

Thanks in advance