Is a pension worth it if you're on the lower tax rate?

[galway_blow_in]

At 40, he definitely should not be contributing to a pension which attracts tax relief at only 20%.

It will be taxed on the way out. So it could well be taxed at 20% or more when he receives it.

The thing to do is to continue saving. If he earns income at the higher rate in the future, then he can contribute to a pension.

If he has a mortgage, he should pay it off.

If he is renting, he should look at buying a house.

Brendan

I'd question if relying on the state pension is a wise plan for anyone under forty five, it's unsustainably high at the moment so whether the tax saving is there or not, perhaps it's very necessary to invest in private retirement provision[/QUOTE]

 

[NoRegretsCoyote]

This has nothing at all to do with the question being asked as Creme Egg has already pointed out.

The OP asked about his entire investment strategy:

"I think I'll just keep saving - it's a guaranteed return, gives me more flexibility and is a hell of a lot less complicated."

Cash saving is a guaranteed negative return at the moment after DIRT and expected inflation! So I think the relative benefits of equities are highly relevant to his entire investment strategy.

Of course it all depends on his preferences for income in retirement, liquidity in the meantime, etc. There are plenty of scenarios where a pension makes sense for him and your blanket dismissal of the benefit of the tax relief is daft.

 

[Conan]

I'd question if relying on the state pension is a wise plan for anyone under forty five, it's unsustainably high at the moment so whether the tax saving is there or not, perhaps it's very necessary to invest in private retirement provision

[/QUOTE]
Agreed
But also worth bearing in mind that if tax relief is only 20% whilst working, it's probably unlikely that he will be on higher tax rate in retirement.
Also it is possible to take tax free lump sum of up to 150% of Salary out of the accumulated fund, even if that exhausts the Fund (under current legislation).

 

[cremeegg]

if experts such as yourselves can disagree so strongly over what should be a relatively straightforward question, how on earth is the layperson supposed to make intelligent decisions?

Speaking for myself I am not an expert on anything.

There are a number of posters on here who certainly expert on certain matters. However I am reminded of the old idea that becoming expert is the process of learning more and more about less and less until you know everything about nothing.

The expertise of people who are expert in pensions is essential when you come to buy a pension, those people are not necessarily the best people to answer the question, "should I invest in a pension"

Finally, its no harm to remember the essential point, if you put money in a pension you get tax relief on the money going in and you get tax relief on the growth of the investment. Thats all good.

There are charges that you don't have with other investments. There are restrictions on what you can do with the pot when you retire. Not so good.

But come retirement age if you invested in a pension at worst you will have suffered an opportunity cost.

 

[Maybrick]

Speaking for myself I am not an expert on anything.

There are a number of posters on here who certainly expert on certain matters. However I am reminded of the old idea that becoming expert is the process of learning more and more about less and less until you know everything about nothing.

The expertise of people who are expert in pensions is essential when you come to buy a pension, those people are not necessarily the best people to answer the question, "should I invest in a pension"

Finally, its no harm to remember the essential point, if you put money in a pension you get tax relief on the money going in and you get tax relief on the growth of the investment. Thats all good.

There are charges that you don't have with other investments. There are restrictions on what you can do with the pot when you retire. Not so good.

But come retirement age if you invested in a pension at worst you will have suffered an opportunity cost.

Hi Cremeegg,

Well, maybe 'experts' isn't the right word but you're certainly people who have analysed these issues far more than the average person - which is why I find the diversity of opinions so worrying!

Would everyone at least agree on this - that the advantages of a pension for someone paying the lower tax rate are vastly less than someone on the higher rate?

 

[orka]

But also worth bearing in mind that if tax relief is only 20% whilst working, it's probably unlikely that he will be on higher tax rate in retirement.

This is true if the person is expected to be on the 20% rate throughout their working life. Someone in their 20s/30s on a career path that will take them to the higher rate would be ill-advised to contribute until they are on that higher rate. Getting 20% relief and then having to pay 40% + USC on marginal extra income in retirement is a bad idea.
And then there's the issue of the hopefully never-to-be-forgotten government raid on private pensions. There will be a permanent 2.4% surcharge tax on pensions for those who had saved prior to the raid. So in the 2030s/40s/50s/60s..., some patsies will still be paying this charge for the 2008 financial crisis.

 

[The Horseman]

It is likely someone paying the low rate of income tax on the way in will most likely be paying the low rate on the way out.

For the same reasons above I would expect the above to be true for higher earners.

I suspect the tax break to the higher earner is only really relevant on the tax free lump sum limits.

For what its worth I understand the Govt are looking at operating a single rate of allowance of circa 25% irrespective if you are a low or high earner.

 

[Oisin19]

I think ye are getting too focused on the tax relief aspect. Why not look at it this way? If you don't put the funds into a pension the alternative is to invest them personally.

Take two identical twins who have the same money to invest. One goes for the pension option and the other goes for the non pension option. The investments are made at the same time and are accessed at pension age. Which one of these will have the bigger pot at retirement age and thus will be better off in retirement?

 

[noproblem]

I think ye are getting too focused on the tax relief aspect. Why not look at it this way? If you don't put the funds into a pension the alternative is to invest them personally.

Take two identical twins who have the same money to invest. One goes for the pension option and the other goes for the non pension option. The investments are made at the same time and are accessed at pension age. Which one of these will have the bigger pot at retirement age and thus will be better off in retirement?

Very well put and that's the way it is. The OP should also remember that he could drop dead tomorrow.

 

[Protocol]

What? We have two tax rates in Ireland + USC + PRSI.

You are looking at the average tax rate I assume, which is not relevant. It's the marginal rate.

Brendan

Yes, their average or effective income tax + USC rate is 8-10% approx, on income of 48-50k approx.

PRSI is zero for over 66.

So my father got tax relief at up to 50%, and now pays max 10% direct income taxes.

Yes, his MTR on extra income is 20%, ok yes.

 

[Daddy Ireland]

At 40, he definitely should not be contributing to a pension which attracts tax relief at only 20%.

My son is starting his career at 22 on a graduate program starting salary 26k. If he pays 4% his employer will pay 9%. So would you advise him as you would advise the 40 year old ?

 

[Brendan Burgess]

Absolutely not.

I will do a Key Post on it to lay it out systematically.

The first point will be that if your employer matches your contribution, you should max your contribution.

Brendan

 

[NoRegretsCoyote]

My son is starting his career at 22 on a graduate program starting salary 26k. If he pays 4% his employer will pay 9%. So would you advise him as you would advise the 40 year old ?

It would seem daft to discard a very good employer contribution like this, even if he is not paying tax at the higher rate.

Even a 3% real return increases the pension pot by a factor of 3.5 by the time he is 65.

Ignore tax relief, he pays in €4, his employer puts in €9 (€13 in total) and that turns into a fund of €46 at retirement age.

That's an increase of a factor of 11.

Tax-free compound interest is a very powerful force.

 

[Daddy Ireland]

Ok thanks.

 

[lledlledlled]

Brendan is mathematically wrong here

I addressed this very point recently in this thread

Key Post - Is it worth contributing to a pension scheme if you don't get 40% tax relief?

I’m working through some of this logic myself and at present I have some interesting working conclusions. You don’t need to save up in a unit linked plan and then add to a pension later you can contribute to the pension now. I take considerable issue with the assumption that it’s only worth...

www.askaboutmoney.com

I’m willing to go one further and say that for some people it’s worth paying into a pension even if you receive NO tax relief.

This takes up a whole chapter in my Irish Financial Planning book

Hi Marc,
Is your book available online?

 

[Marc]

Hi Marc,
Is your book available online?

I have broken it down into a series of stand alone guides which I am planning to release in the autumn.

I am literally writing the section right now on why almost "everyone in Ireland" between the ages of 18 and 75 should save in a pension even if they have no earned income at all simply because the alternatives for many people are so much less attractive over time.

For the avoidance of doubt, I'm not suggesting putting all of one's savings into a pension, just the "dry money" * - which I define as your long-term investments that you don't intend to touch.

As in all things it always depends on the exact circumstances of the investor and very specific guidance is necessary.


*'Cash' is 'airgead tirim' in Irish (literally 'dry money)'

 

[EmmDee]

It would seem daft to discard a very good employer contribution like this, even if he is not paying tax at the higher rate.

Even a 3% real return increases the pension pot by a factor of 3.5 by the time he is 65.

Ignore tax relief, he pays in €4, his employer puts in €9 (€13 in total) and that turns into a fund of €46 at retirement age.

That's an increase of a factor of 11.

Tax-free compound interest is a very powerful force.

I'd put it another way - ignore the tax for a minute... If by putting €4 in an investment, you get 225% return on day 1, it is attractive. The additional benefit is that the initial €1 is "before tax" which would mean an even higher return if you were looking at after tax income (doesn't really matter if on higher or lower rate). The drawback is that you can't access it for a long while.

Any matching scheme (assuming it is for something you use) is a useful benefit. Our place has a scheme where the employer matches contributions to a account which can be used for leisure activities (buying tickets, sports events, clubs etc) on a 2:1 basis. The benefit is taxable but even allowing for that it is free money as I would be going to these things anyway

 

[kevhenry]

Another point is that when you reach age 66 your personal tax thresholds change.

For example, a retiree with a financially dependant spouse can earn up to €36,000 a year before paying income tax i.e. they can earn €3,000 a month.

Anything over that is then taxed at the marginal rate.

Given that the state pension is around €2,000 a month, this leaves the potential to earn an additional €1,000 a month tax free.

A fund of €400,000 - regardless of the rate of tax relief received on the way in - is still a worthwhile objective because it perfectly plugs the gap as follows;

€400,000 fund.

1) Tax Free Lump Sum of €100,000 (25%)

2) The remaining balance of €300,000 can then be annuitised at 4% giving (€300,000 x 4%) = €12,000 a year or €1,000 a month.

Yes, it's more difficult mathematically to reach this figure if only getting 20% tax relief but it's still worth pursuing.

You can get tax relief on contributions and avoid tax on the way out if your fund is below €400,000 and you don't have other income.

The working age tax brackets don't apply in retirement.

In any case, I've never met anyone who complained of having too much money in a pension fund.

Kevin
www.thepensionstore.ie

 

[RMGC11]

Given that the state pension is around €2,000 a month, this leaves the potential to earn an additional €1,000 a month tax free.

I thought the state pension was around half that? Wasn't it around 250/week?

 

[Daddy Ireland]

Talking about a married couple.