# Contributing a large proportion of salary to pension when you're young!!!



## ronaldo (16 Nov 2006)

Okay, let's say your someone around the age of 25. You are earning €2,000 per month after tax. You already own your own house and are debt-free (apart from your mortgage). Your house is worth €350,000 and you have a €200,000 mortgage on it.

What proportion of your salary would you consider diverting to a pension? Would you consider switching your mortgage to interest only and contributing a large proportion of your salary to a pension. I have read that you should get your mortgage down to a comfortable level first. Obviously, a repayment mortgage on the above amount wouldn't be considered as comfortable but, at a LTV of 57%, you wouldn't really need a repayment mortgage as you already have adequate equity in your home. 

At current NIB rates of 3.85% + an additional 0.25% to allow for the potential December increase, your mortgage would cost you €8,300 on an interest only basis. Detuct TRS from this and it would really cost you €7,792 - 32.5% of your net pay. I've read from various sources that a comfortable mortgage payment would take up proportions ranging from 20% - 35% of take-home pay. What is your opinion on this?

Which of the following would you consider to be the best approach in the above scenario:

Continue your mortgage on a repayment basis whilst paying off lump sums as regularly as possible until your mortgage is:
50% of the value of your home,
Repayments are 25% of take-home pay (mortgage of €150,000),

Switch to interest only now and pay as much as possible into your pension.
If you would go for option *1.a* or *1.b*, would you have small pension contributions on the side or would you focus solely on your mortgage.
The reason I am asking is that I've read an article (see link at bottom) that highlights how, if someone starts saving in a pension at 20 years old and saves €100 per month for 10 years and then stops competely, they will have more at age 60 than someone who started at 30 years old and saved €100 per month for 30 years.

[broken link removed]

This means that, the person in the scenario above were to save 15% of their pay into a pension, in addition to paying the 32.5% of their pay to a mortgage, they would be left with 52.5% of their net pay - €1050 per month. 

It seems to be a reasonable strategy since your pension investments should increase above the rate of inflation and your mortgage value will be ate away with inflation.


----------



## Brendan Burgess (16 Nov 2006)

You should only make a contribution if it gets tax relief at 42%. 

You are fairly comfortable with the mortgage from the sound of it, so switching to interest only is probably a good idea.

This assumes a fairly steady job and salary. If you were in a job where there was a prospect of redundancy or a lower salary later, you should reduce your mortgage further. 

Brendan


----------



## F. Kruger (17 Nov 2006)

You could always meet yourself halfway and do a bit of both 'options'.


----------



## money man (20 Nov 2006)

Brendan, Is it not carless advice to tell someone on a salary of 30k not to pay into a pension? I can see why you may say that you should not pay into a pension unless you get 48% relief but i still think its a bit careless. I would imagine someone with a salary below that level would need a pension upon retirement also if not worse than those paying higher tax rate?


----------



## oysterman (20 Nov 2006)

money man said:


> Brendan, Is it not carless advice to tell someone on a salary of 30k not to pay into a pension?


The advice is sound on the assumption that the taxpayer is likely to move up into the higher rate bracket in the future. That is the time to make pension contributions, not when paying tax at the lower rate.

What about the person who will _never_ get to be a marginal rate payer? In that case they still shouldn't be making contributions not matched by their employer until they have purchased a house and got their repayments under some sort of control. The greatest bonus in retirement - of far greater benefit than pensions to most of us - is owning your own house. With the property bubble (?) in this country all too many lower rate payers have given up on  purchasing a house at the moment. That's fine for the person mentioned above whose income is likely to rise in the future (who should buy a house then take out a pension in that order) but everybody needs to be realistic about his/her future - if your income is not likely to rise much in real terms you need to plan now to ensure that, come retirement, you will (at least almost) own your own house. And once that's sorted it is time for that person to take out a pension - even if they are paying tax at the lower rate.

But the lack of marginal rate tax relief is a huge disincentive for many to starting a pension. It is a shame that, despite all the revenue cascading into the government, we don't have a Minister for Finance (or at least a few influential ministers in other departments) with the flair to do something about equalising the pensions incentive for both lower and higher earners.


----------



## Guest126 (20 Nov 2006)

I suppose you could equalise it by standardising the rate of tax everyone pays?

Oh maybe that is not what you meant!


----------



## oysterman (20 Nov 2006)

CapitalCCC said:


> I suppose you could equalise it by standardising the rate of tax everyone pays?
> 
> Oh maybe that is not what you meant!


It is one way but I think that income tax should be progressive, that people on higher wages should pay a greater proportion of their income in tax.

Our system of incentivising people to contribute to personal pensions is, however, regressive i.e. higher paid individuals receive tax relief at a higher %age rate than the lower paid.

I can't see the public policy reason for this except the cost implications. Clearly, granting notional higher rate relief to to lower rate payers would have a considerable cost implication.

It can, however, be done on a cost neutral basis - by restricting the amount of tax effectively rebated to any individual across his/her lifetime. Obviously I don't know the figures but it would be a relatively straightforward exercise for somebody in the Dep. of Finance. [In any event, the social benefit from higher levels of pension provision among the lower paid would justify some additional cost to the state so the restriction might not be as significant as in the cost neutral model.]

There would be howls of protest from the wealthy. Let them moan - the pensions system has been yet another open door for tax avoidance for decades. I fail to see why anybody needs a pension pot of €5million in retirement - of course they don't, they're using it as a tax avoidance/postponement vehicle.


----------



## Guest126 (20 Nov 2006)

The only reason that the pension system is "regressive" though - is because the income tax system is "progressive"...the reason the higher tax payers get more relief is because they pay more tax, a lower taxed worker does not have to pay the higher tax (that is to their advantage) so why should they get the higher relief?


----------



## oysterman (20 Nov 2006)

CapitalCCC said:


> The only reason that the pension system is "regressive" though - is because the income tax system is "progressive"...the reason the higher tax payers get more relief is because they pay more tax, a lower taxed worker does not have to pay the higher tax (that is to their advantage) so why should they get the higher relief?


That is the essence of the problem. We incentivise people to provide pensions for themselves by giving them money to do so. The mechanism we choose is tax relief. There is no reason that it has to be so. The state could allow people to contribute an annual or lifetime limit (I'd have both to encourage consistent saving) into a pension and then the state could top that up with a contribution (notionally equivalent to higher rate tax relief).

The first advantage is that you can preserve the progressive nature of the tax system without having the flip-side of our current regressive tax relief on pension contributions system.

And, very importantly, my proposal is identical to the feature of the SSIA system that conventional wisdom says made it so appeaing - that the state's contribution to your savings (in this case pension) pot is transparent.


----------



## Brendan Burgess (20 Nov 2006)

> Brendan, Is it not carless advice to tell someone on a salary of 30k not to pay into a pension?



Oysterman defended me very well, but just to add one point. Someone on a salary of €30k put put their savings into an ordinary unit linked fund until their salary hits the 42% rate. At that stage, they could switch it from the fund into a pension scheme and get a further 22% added.

Brendan


----------



## allendog (21 Nov 2006)

It's about time the debate turns to the inequitable tax reliefs for pension contributions made by the lower-paid taxpayers.   It's sickening to notice that this category would cough up E80 for each E100 of the pension contributions, while the wealthy (whether it be nil(! - thanks to tax avoidance schemes) or 42%) need only contribute up to E48 for each E100.  How come the Minister for Finance, Minister for Social Affairs and the Pension Board be so blind to this inequity - if they're anxious to encourage some of the taxpayers to fund their own pensions?
  This inequity is also repeated in the tax reliefs for medical expenses.
allendog


----------



## F. Kruger (22 Nov 2006)

I would guess that the current Pension Incentive may be a dry run by Brian Cowan to alter the landscape on how pension reliefs are allocated.

They badly need to roll back the clock and revisit the whole area, instead of adding bits in here and there which end up confusing everyone.


----------

