The pensions industry lobby’s central Government hard for more pensions. Every change of Government means we get further changes to pensions, more legislation, different treatment, some minor alteration.
The industry loves all of this because it mystifies pensions, makes them more complex in the eyes of you – the consumer. In fact an entire industry lives off the back of you not understanding what is going on, not having the 10,000 hours to become proficient in understanding your own money, your own pension.
And then there is the option of a personal pension, defined benefit, defined contribution, Stakeholder, Auto Enrolment, drawdown, Sipp. The list it seems is endless and not all of them apply to you.
With that in mind we have a situation with pensions, the thing that is designed to support you in the longest holiday of your life, but the thing that seems more out of sync than ever.
The tax breaks offered from pensions are not what they seem, Gordon Brown and his tax raid on pensions a few years back seemed to be the last straw, if you are a basic rate taxpayer then pensions are tax neutral at best.
See, you do get tax relief on your contributions – but your final pension is taxed when you draw on it. It’s likely that your final pension pot will be larger at the end than when you started it – meaning the amount of tax taken from your pension will be more than the Government gave you tax relief. You didn’t read that in the sales blurb did you?
It’s also likely that as a higher rate taxpayer now and benefiting from higher rate tax relief on your pension contribution you will be taxed at a lower rate when you draw on your pension. So, pensions seem to make a bit more sense for you.
If you don’t pay into a pension it’s likely you will also miss out on your employer’s contribution and or if you are lucky enough to work for a Government department you may have a final salary pension scheme – which is very valuable.
Before you rush to invest in a pension and before you consider your options there are a few things to bear in mind.
Any tax relief offered by pensions will either be lost in charges, pensions are not managed for free or clawed back as taxation when you finally draw on your pension. Of course, that doesn’t mean you can invest for free (not anywhere) but it does mean that you’ll lose the flexibility to move your money – pensions can’t be moved like a current account. And the provider levies charges from now until then – whenever then is.
You can invest tax free buy using your Individual Savings Account (ISA) allowance every year (£20,000 as I write) and your Capital Gains Tax allowance is £12,000 (19/20) which means you can invest £100,000 and get 12% growth on that investment virtually tax free add the ISA allowance and £120k tax free is the final sum available to you. Of course, it could be more.
When comparing pension savings, you need to consider the following.
Cash paid into a pension is held until retirement. From age 55 currently. You have no access to it; you can decide where to invest but you can’t get access to it. Charges will be deducted every month on most funds.
So let’s compare that with the options.
You have the option of reducing the debt of your Student Loan, current interest rates on these could be as high as 5.4% (Feb 2020) for those of you classed as higher earners. Average pension fund returns (6% before product charges meaning you’ll need to get at least 4.4% return on your pension fund at a 1% charge to be better off).
Note. 1% charge. Be lucky if you have one this low. Also 4.4% return, below average – but then so are half of the UK’s pensions funds.
Perhaps, if you have credit card or personal loan debt you could reduce this instead of paying further into a pension. Average Credit Card interest in the UK is around 20% pa. Personal loans around 8%. Both are substantially higher than the 6% long term average (before charges) pension fund performance. A sure win for reducing debt.
You could also reduce your mortgage to nil or save a deposit for a house (renting long term is more expensive than home ownership) if you are in business then putting your ‘pension contributions’ into stock for sale, means you could be getting a 20% return this week instead of a return inside your pension fund. Both of which are likely to prove better than pensions.
Bottom line here is you have options, pensions are not the panacea, the one thing you should consider. There are lots of options. One is inflexible, constantly being fiddled with by Governments. The others, fully in your control and that makes financial sense.
I’ll leave that with you.
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