OK 3CC your post has inspired me.
OK, so reading through all the comments in the thread again:
- No-one has argued that the rate of tax relief you receive on your contributions should be determinative of whether you do or do not invest in a pension;
- Everyone would seem to agree that the fact the additional money you receive to invest in a pension comes from tax relief (referred to as value “B” in the OP) is mostly irrelevant. The net issue is that it’s more money to invest with your capital (referred to as value “A” in the OP), all of which then becomes subject to the pension taxation regime.
- No-one seems to disagree with the general way things have been conceptualised in the OP (subject to amendments / additions that were made to reflect comments).
- People also emphasised the other benefits of pensions in different places (e.g. availing of tax credits again).
Bearing in mind this thread was to explore whether investing in their pension was beneficial vs. something else, I did a bit of thinking about the significance of the headline rate of tax on a pension and its relevance to your decision to invest or not.
As discussed in the OP, pensions get to compound continually without being taxed until any portion is drawn down. You also get the benefit of investing more money than any other investment with a pension (the value of A
and B).
Investing in an ARF allows you to continue to generate wealth from your pension in retirement. I’m ignoring the annuity option for this thread because it’s mainly focused on wealth creation.
When you retire tax is only ever payable on the
portion of the pension you draw down. You can continue to generate wealth from the rest of the value of your pension without paying tax on it.
A simple way to conceptualise this is to imagine you had an ARF worth €1 million, received 40% tax relief on all your contributions and all matters relating to lump sums had been dealt with / sorted:
- €600,000 of the AVC would derive from your original capital (A)
- €400,000 of the AVC would derive from your tax relief (B)
So long as you’ve got money in the pension pot, you’re
still generating wealth from B in retirement. You
also had the benefit of generating wealth from B when your pension was accumulating in the years before you retired.
So if we go back to the issue of the Headline Rate of Tax,
this is only ever paid on an even smaller amount of the small amount you draw down from the pension e.g. a portion of the 4% of imputed distribution from the ARF, assuming you’re not taking out large amounts of cash at your marginal rate.
The other 96% of your ARF (60% from A, 40% from B) would continue to generate wealth tax free, potentially in excess of what was distributed each year.
So my conclusion is that
so long as your pension is in a position to continually generate wealth in excess of what is taken from it, the headline rate of tax you might pay on a small portion of it is a red herring, because it only applies to a miniscule portion of the overall pot, and it has to be seen in the context of the overall value of portion B to generate wealth.
Even if you were receiving only 20% tax relief and were paying the marginal rate of tax in retirement, it would seem to still make sense to contribute to your pension if you never planned to draw it all down because the money received from tax relief is money that you can continue to generate wealth from for potentially the next 50/60 years.
@3CC – does this impact your thinking / sums ?
I'm currently at home with a fever so I may be delirious / have missed something big here.