Key Post Should someone paying tax at 20% contribute to a pension

[Brendan Burgess]

It is a good idea to start young and make small contributions into their pension.
Maybe 1000 per year.
They should get into the habit young to see their pension fund grow over time.
This will incentivise them to build up a decent pension fund.
If your person started at age 20 they would have 45 years of investment growth to age 65.

This is a common fallacy promulgated by the pensions industry.

It is a good idea to start saving when you are young. But you should not save within a pension fund until you have bought your first home, except where you are contributing to match an employer's contribution.

If you start saving at age 20 and buy a house you will also have 45 years of investment growth to age 65.

 

[Brendan Burgess]

The benefit of making small contributions at a young age is that they have a very long time to grow, so the overall growth is probably going to be a lot higher than contributions you make later in life.

Again, the industry propaganda.

The same applies to buying a home and paying down your mortgage.

Just to be clear - I am a huge fan of pensions, and I am not arguing that you should not contribute. I am arguing that, in most cases, you should wait until you are paying 40% tax.

 

[Brendan Burgess]

However the long term growth that results from starting saving at a younger age is well worth the loss in tax reliefs.

I don't want to sound boring, but you get that when buying a house or paying down a mortgage as well.

Brendan

 

[S class]

It is a good idea to start saving when you are young. But you should not save within a pension fund until you have bought your first home, except where you are contributing to match an employer's contribution.

Home ownership will never be attainable for very many young Irish people. By following your advice some of these people may end up homeless in their retirement.

 

[Brendan Burgess]

Home ownership will never be attainable for very many young Irish people.

An interesting point. And it seems unattainable to many people in their 20s.

But I think that will change. So I don't think people should write it off.

I would still prioritise saving to buy a home.

Brendan

 

[Clamball]

So in summary, if your employer matches or makes a contribution to a pension scheme then you should contribute no matter what tax relief you get.

Otherwise focus on saving for a house over making pension contributions. You may not achieve your home purchase if you prioritise pension savings when young.

Once you purchase a home then make contributions especially at 40% tax relief.

 

[Gordon Gekko]

My own view is that it’s important to do more than one thing at the same time, e.g. save for a house, contribute to a pension, etc. My Dad advised me to contribute the maximum to my pension as soon as I started working because it would create a good habit and I’d never notice the money going-out, because I never had it in the first place. I was contributing at the 20% rate. I don’t think I’ve ever felt the ‘pain’ of making a pension contribution because it’s always been at source and pre-planned.

 

[TRS30]

My own view is that it’s important to do more than one thing at the same time, e.g. save for a house, contribute to a pension, etc. My Dad advised me to contribute the maximum to my pension as soon as I started working because it would create a good habit and I’d never notice the money going-out, because I never had it in the first place. I was contributing at the 20% rate. I don’t think I’ve ever felt the ‘pain’ of making a pension contribution because it’s always been at source and pre-planned.

The same. The best bit of financial advise my Dad every gave me (probably the only one I ever listened to!).

 

[Brendan Burgess]

it’s important to do more than one thing at the same time, e.g. save for a house, contribute to a pension, etc.

If you can afford to do both, no problem.

But these are different times and it's difficult to get on the housing ladder for most people. So they should maximise their chances. The more they put in their pension fund, the longer it will take them to get on the housing ladder.

Brendan

 

[Gordon Gekko]

If you can afford to do both, no problem.

But these are different times and it's difficult to get on the housing ladder for most people. So they should maximise their chances. The more they put in their pension fund, the longer it will take them to get on the housing ladder.

Brendan

I think everyone’s probably agreeing with each other actually, more or less.

If not matching my employer’s contribution and losing it was the difference between buying a home, and not, I’d do it.

But I do think that affordability rules mean that there’s very few people who can’t do both. By their very nature, the rules necessitate surplus cash.

 

[Iamyourfriend]

If you are never going to be paying 40% tax because you are in your 50s and you have reached peak earnings, then getting tax relief at 20% is worth it.

This is my mother's position. If she was to pay the full 40% of her wage as pension contribution, some of that contribution would be money otherwise taxed at 20%. But is she going to be effectively paying 20% tax when she gets the money back from the pension on retirement? That's her rationale for not taking advantage of the full relief.

 

[Brendan Burgess]

She will get 25% of her fund back tax free.
So her effective tax rate will be 15%. ( 100% -25%) @20%

some of that contribution would be money otherwise taxed at 20%

But I think she should only contribute to the extent that she gets 20% tax relief.

I think that this is how the calculations work out:

So presumably she has €40,000 @ 20%
With tax credits of €3,400

So effectively the first €17,000 is taxed at 0%.

If she is earning €30,000 and contributes 40% or €12,000 , she will be getting tax relief at 20% on all of it.

If she is earning €20,000
€20,000 @40% = €8,000
Taxable €12,000 @20% = €2,400

So she is wasting it.
She should contribute only €3,000.

Brendan

 

[Brendan Burgess]

I have seen others argue that because the fund grows tax-free, she should contribute even if she gets no tax relief on the contributions.

That calculation might be correct, but I really don't think that one should plan one's long-term finances assuming no changes to the tax-treatment.

Brendan

 

[johnwilliams]

at the start of this thread there is numerous references to "use it or lose it" ,can you explain that to me please ,never understood pensions

 

[Sarenco]

at the start of this thread there is numerous references to "use it or lose it" ,can you explain that to me please ,never understood pensions

It basically means you can’t retrospectively claim “unused” relief from previous years.

So, to avail of pension relief for 2023, you have to make a pension contribution by the tax filing deadline for 2023.

 

[Itchy]

This is my mother's position. If she was to pay the full 40% of her wage as pension contribution, some of that contribution would be money otherwise taxed at 20%. But is she going to be effectively paying 20% tax when she gets the money back from the pension on retirement? That's her rationale for not taking advantage of the full relief.

If she doesn't contribute to the pension, what is she going to with the money? It seems the full 40% of her wage are investible assets and her value judgment is that the pension is not the best vehicle?

 

[Lisboa]

Home ownership will never be attainable for very many young Irish people.

An interesting point. And it seems unattainable to many people in their 20s.

But I think that will change. So I don't think people should write it off.

I would still prioritise saving to buy a home.

Brendan

How do you foresee that changing?

A merry Christmas to you and yours.

 

[Gorteen]

This topic is of interest to my daughters situation at the moment. She is now 2 years with her employer and can now avail of the "Defined Contribution Pension Plan". She asked my advice but my full working life experience is within public service pension schemes, so it's all a bit puzzling to me.

It seems if she contributes a minimum of 4% of her salary (40,000 p.a.) her employer will match this contribution up to a maximum of 6%. The employer has given an 'assumed contribution' from my daughter of €100 per month.

She is currently single, aged 25, doesn't have (or need) a mortgage. In terms of money management, she is (thankfully) a sensible spender and saver and is happy to start planning for her pension right now. €100 per month sounds low to me and I wondered if €150 might be more realistic?

Does anyone have nay advice for me and/or her?

 

[Kev1964]

This topic is of interest to my daughters situation at the moment. She is now 2 years with her employer and can now avail of the "Defined Contribution Pension Plan". She asked my advice but my full working life experience is within public service pension schemes, so it's all a bit puzzling to me.

It seems if she contributes a minimum of 4% of her salary (40,000 p.a.) her employer will match this contribution up to a maximum of 6%. The employer has given an 'assumed contribution' from my daughter of €100 per month.

She is currently single, aged 25, doesn't have (or need) a mortgage. In terms of money management, she is (thankfully) a sensible spender and saver and is happy to start planning for her pension right now. €100 per month sounds low to me and I wondered if €150 might be more realistic?

Does anyone have nay advice for me and/or her?

If you don’t mind me saying this is big question and might merit a new topic. Your daughter is being offered a defined contribution (DC) pension scheme which these days is the most common type for new employees. Your public service experience is likely based on your salary and service and is probably a defined benefit (DB) scheme. DC and DB schemes are totally different from each other and there are better informed people on here who might more succinctly explain them than me.

I will say that a DC scheme is fundamentally just like a savings plan or bank account with added benefits and which is designed to give you an income when you retire. Your daughter should start early and invest as much as she can afford while taking advantage of tax relief and employer contributions. No one can now say how much is “realistic”. Her retirement is too far away. Her focus now should be to maximise contributions from all sources. At age under 30 the most she can pay while maximising tax relief is €500 per month (15%) of her salary. The net cost to her will be €400 after tax relief. Her employer will top this up by €200 per month. After a few years investing she will see her “pot” grow exponentially with contributions and (hopefully) tax free growth which is a powerful encouragement to keep going. When she gets older and when she starts paying 40% income tax the “deal” above gets even better. Once you pick a contribution amount you are not then tied in. The amount can be changed as circumstances change.

If €500 is too much then consider a minimum of €200 per month. This will be matched by her employer. Net cost to her is €160 per month while €400 is being invested each month.

Many 25 year olds are not thinking about pensions so she is lucky to have you help her with this.

 

[Gorteen]

If you don’t mind me saying this is big question and might merit a new topic. Your daughter is being offered a defined contribution (DC) pension scheme which these days is the most common type for new employees. Your public service experience is likely based on your salary and service and is probably a defined benefit (DB) scheme. DC and DB schemes are totally different from each other and there are better informed people on here who might more succinctly explain them than me.

I will say that a DC scheme is fundamentally just like a savings plan or bank account with added benefits and which is designed to give you an income when you retire. Your daughter should start early and invest as much as she can afford while taking advantage of tax relief and employer contributions. No one can now say how much is “realistic”. Her retirement is too far away. Her focus now should be to maximise contributions from all sources. At age under 30 the most she can pay while maximising tax relief is €500 per month (15%) of her salary. The net cost to her will be €400 after tax relief. Her employer will top this up by €200 per month. After a few years investing she will see her “pot” grow exponentially with contributions and (hopefully) tax free growth which is a powerful encouragement to keep going. When she gets older and when she starts paying 40% income tax the “deal” above gets even better. Once you pick a contribution amount you are not then tied in. The amount can be changed as circumstances change.

If €500 is too much then consider a minimum of €200 per month. This will be matched by her employer. Net cost to her is €160 per month while €400 is being invested each month.

Many 25 year olds are not thinking about pensions so she is lucky to have you help her with this.

Is the employer contribution capped at €200? I thought it might be more and related to whatever contribution she makes