Pension if I am not paying top rate tax?

Hi all,
I've been reading the AAM guide in relation to pensions and wondering if the advice given still holds true today (for my situation). I'm thinking the current state of property prices changes some things - but I'm interested in what others think.

First some background:
I'm 30; married; combined net income ~ 45k (me ~30k, spouse ~15k); neither of us have pensions; total savings ~40k; renting in Dublin.

The guide gives 4 instances where starting a pension might not be advisable, two of which we fall into. Namely not having a PPR and being in the 20% tax bracket.

My spouse and myself have been saving hard for the last 2 years but with property prices the way we they are we seem to be priced out of the market. I'm trying to figure out what is best to do.

Do we give up the idea of buying a place of our own for the moment and start a pension? (My company will add 10% to PRSA contributions) I'm thinking the sooner we start a pension the better, as compounding should see it grow.

Or do we continue saving as much as we can (maybe in a unit linked fund). If there is a property price crash then maybe we could consider buying and then consider a pension once we have a PPR.

Also from the guide:

[FONT=Verdana, Arial, Helvetica, sans-serif]IF YOU ARE PAYING TAX AT THE LOWER TAX RATE
Pensions are only attractive if they save you tax at the top rate of 42%. If you are on the 20% band, don't bother with a pension. You might end up in a situation where you save tax at 20% only to pay it at 42% on your retirement.[/FONT]

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Again is it not better to start sooner rather than latter. I don't know if we'll ever be in the higher tax bracket, does this mean we should never contribute to a pension fund? Is it the case that you only pay 42% tax on your retirement income if it goes over the tax band limits. Isn't unlikely that the pension income would go over this limit if we are in the 20% band during our working lives and contributing what we can afford. i.e. someone in the 42% bracket could afford to contribute more money to a pension fund so they are more likely to have a pension income which would fall into the 42% bracket. Sorry if my point is not clear here.

thanks.

Re: The AAM guide (Pensions) and current thinking!

Hi Kirian

I don't think that you should start a pension. The benefit to you by saving through a pension scheme instead of saving directly is too small. It might appear that you will never be able to afford a house, but this might well change. Your income might improve, house prices may fall, you may qualify for affordable housing, you might get an inheritance. If this does happen, it's important that you have as much money available as possible.

The 20% tax saving simply does not justify the inflexibility of a pension scheme.

If someone knows for sure that they will always be on the 20% tax rate, while they are earning and when they retire should they start a pension? It's a difficult one. If you are approaching retirement, it's probably a good idea. Let's say that you put together a pension fund of €10,000. You will get 25% tax-free on retirement and pay 20% tax on the balance. So you are effectively reducing your tax rate to 15%. Again, I still don't think it's worth it.

One issue that you might consider is taking advantage of the special relief for switching from an SSIA into a pension scheme. Although I am instinctively against the idea of low rate tax payers putting money into an inflexible pension, this might be an exception.

Brendan

Re: The AAM guide (Pensions) and current thinking!

I don't fully agree with Brendan on this point. If one expects to be on the lower rate of tax throughout ones life, then contributing to a pension plan still makes some economic sense (since 25% of the accumulated fund comes back tax-free) whilst the 75% will be taxed (assuming still lower rate tax) when drawn down as income. It may be marginal, but one is getting 20% relief PLUS PRSI on contributions and being taxed on income at a composite 15% PLUS health levy (2% currently). So their is a tax gain, though small.

In Kirian's case however he seems to be forgoing the 10% Employer contribution by not contributing personally. For example, if the Employer is prepared to pay 10% on the proviso that Kirian pays say 5%, then the situation is substantially different. I cannot see that it makes sense to forgo the Employer's 10% because the personal tax gain might only be small.

I fully accept the inflexibility argument, particularly when the net tax gain is marginal. But in Kirian's case, I can see no reason to forgo the Employer's 10%.

Re: The AAM guide (Pensions) and current thinking!

I agree fully with Conan - the 10% Employer contribution is crucial.

In addition, is it true to say that the tax-free income allowance gets higher for someone who is older (i.e. >65) so the OP may be able to get almost all income back at 0% TAX or at least some of it...that is in addition to taking a TFLS of up to 1.5 times final salary (it sounds like an occupation plan, not a personal pension).

Re: The AAM guide (Pensions) and current thinking!

kirian said:

My company will add 10% to PRSA contributions

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This is a little ambiguous.

If they'll contribute 10% of your salary provided you contribute a (relatively modest) minimum percentage of your salary yourself, then it's too good to refuse.

If, on the other hand, they're only prepared to top up whatever you contribute by another 10%, then I wouldn't touch it in your case.

Brendan, here and in other media, is correct - the number one contributor to long-term financial comfort in this country (given our unregulated rental market) is owning your own house. While tax relief on pension contributions may sometimes make the taking out of a personal pension more attractive than saving for/funding PPR purchase, this should only be in circumstances where the individual is paying income tax at the marginal rate now and not anticipating being significantly into the marginal rate bracket on retirement.

What about the 25% tax free lump sum? Most people can fund that in a relatively short period of time long after buying their PPR.

Re: The AAM guide (Pensions) and current thinking!

The lump-sum would be a fraction of salary (not 25% of anything) if the poster is talking about an occupational scheme.

Re: The AAM guide (Pensions) and current thinking!

Just to clarify, my employer will add 10% to my contributuions to the PRSA not 10% of my salary. i.e. if I put 100 euro in my employer will add 10 euro (I think they get a 10.75% PRSI rebate - so essentially they are passing this on to the employees).

Interesting food for thought from all.

Re: The AAM guide (Pensions) and current thinking!

I read the original question correctly. A few employers add the PRSI saving to the pension contribution. It's nice but not enough to make a pension attractive.

I don't think you should contribute to a pension at age 30 if you are only paying 20% tax + PRSI. There is a good chance that the tax rate will be higher in later years and you will get better value for your contributions then.

If an employer offers to match your contribution, then it would be worth doing.

Brendan

I was doing some calculations based on the following 2 options:

1) invest 200 euro/month in an investment fund (e.g. Quinn direct)
2) invest 200 euro/month in an PRSA

Making some assumptions: continue for 35 years (i.e. till I'm 65), average growth 5%/year.

1) will be worth approx. 214370 euro after 35 years but the fund will be accesable at all times.

2) the effective contribution each month will be aprox 272 euro (200 + 10% employer contribution + 26% tax rebate). After 35 years this will be worth approx. 291541 euro. But 25% can be taken tax free and the rest taxed at 20% (correct me if I'm wrong here). This gives an effective total of 247810 euro. But this money will be untouchable until I reach retirement age.

So there is some monetary advantage to the PRSA (about 33441 euro based on figures above, the difference grows in the monthly contribution is greater of if the annual growth rate is more) but the disadvantage is that the money in a PRSA fund is not accessable until retirement.

So the question is, is the extra growth of the PRSA worth the fact that the money is inaccessable.

Is my analysis above resonable?

kirian said:

I was doing some calculations.....Is my analysis above resonable?

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I haven't run the numbers but they look reasonable.

However, your thinking ignores the logic that I and the other posters are pursuing.

There's no doubt that if your only options were a PRSA (with employer contributions added) or any sort of unit-linked fund, then the PRSA option (despite modest level of employer contribution and only basic rate tax relief) would win if you could live without the resources you'd be tying up until retirement.

But that's not our point.

We think that home ownership is so important in securing long term financial security that you shouldn't consider putting resources out of reach which you should be using to fund the purchase of a house.

When the house is bought, that's the time to get serious about a pension (for a basic rate taxpayer).

Are there tax implications for Option 1 above. Have you taken these into account.

Yes, of course, there are tax implications for Option 1 - and these have not been taken into account in the illustration shown.

Also, buying into property in Ireland at the moment - even for yourself - is not, in my very humble opinion, the great investment that a couple of other posters are implying because of - again my very humble opinion - the possibility that we are currently in the midst of a PROPERTY BUBBLE!

Hi all thanks once again.

In my calculation above I didn't figure the tax into option 1. I'll have to work that one out. Is it just CGT that will be payable?

Oysterman, I do get the point that Brendan and yourself are making about the importance of home ownership and that funds shouldn't be put into a pension before buying a house. I see the logic in this. I guess I'm just worried as it seems that house ownership is out of reach at the moment and unless something happens to property prices it'll probably be out of reach in the future too.

I'm coming to the conclusion though that at this stage it's not worth putting money out of reach in a pension. For the moment it will be best to save into a unit linked fund so that the money will be accesable and if circumstances change and home ownership becomes a possability we will be in position to buy a place.

Capital CCC raises the prospect that we may well be in the middle of a property bubble. I think the chances that house prices will go down are higher than the chances that they will go up. But no one knows for sure.

Kirian does not need to panic as there is a good chance that houses might become affordable again.

If someone needs a home and they have the funds to do so, then they probably should buy a home as the risk that they will be put out of the housing market by rising prices is far more serious in its impact, than the risk that house prices will drop after they buy the house.

Brendan