Should this also not be qualified by the fact that you contributions can be carried forward i.e. that you can claim tax relief in the future, so you should have to expect to max out your tax relief percentage in future years also. There are limitations on this imposed by Revenue but I would over contribute by a couple of thousand some years rather than hold it back for future contribution years or invest it elsewhere, and claim the tax relief in the following year. Extra year of tax free growth vs. opportunity cost of the tax relief.
Pensions vs. other forms of investment
- Thread starter Ent319
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Should this also not be qualified by the fact that you contributions can be carried forward i.e. that you can claim tax relief in the future, so you should have to expect to max out your tax relief percentage in future years also. There are limitations on this imposed by Revenue but I would over contribute by a couple of thousand some years rather than hold it back for future contribution years or invest it elsewhere, and claim the tax relief in the following year. Extra year of tax free growth vs. opportunity cost of the tax relief.
First off - I made an error in my table above re ETFs - I forgot to allow a credit for the deemed disposal tax already paid in the tax calculations after year 8. This increases the performance of the ETFs so that the expected value at year 16 is now €1,114 rather than €1,008. I will update the table in my post above now to reflect that but I will leave the rest of the text as it is as the overall point is unchanged.
It depends to some extent on the term. Using the same figures as in my original (now corrected) calculations above, the return for both options looks something like this. (I have added in another 8 years to show a total of 24 years.)
I find that I need to drop the Exit Tax to ~7% to get reasonably similar returns for both options (see below).
Happy to share my calculations for verification.
It depends to some extent on the term. Using the same figures as in my original (now corrected) calculations above, the return for both options looks something like this. (I have added in another 8 years to show a total of 24 years.)
I find that I need to drop the Exit Tax to ~7% to get reasonably similar returns for both options (see below).
Happy to share my calculations for verification.
BigPineapple
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Can you clarify this? I'm not familiar with carrying forward process.
@Ent319
If I understand your last post correctly, I think your point is that pensions are better than any other vehicle for growing wealth due to the fact that investments can grow almost indefinitely without triggering a tax event. You are saying that the marginal tax rate is not that important if your plan is to grow your pension all throughout your retirement.
You also argue that even contributions at 20% tax relief and taxed at 52% on drawdown are worth it if they have 50-60 years of potential growth.
The obvious counterpoint to this is the 4% / 5% imputed distributions but your argument on this point is that pension investments may well achieve returns higher than this amount and therefore your pension could continue to grow if the actual withdrawals are kept close to the imputed distributions.
Have I understood you correctly?
Based on the above, I presume that you expect to need to only make modest drawdowns from your pension when you retire and your goal is not about running your pension down to zero at the end of your life but it is more about maximising what you can pass on. If this is the case, then your investment horizon is probably very long (depending on your age and health) and a pension is definitely better than ETFs or shares in my opinion for that purpose.
And I agree that as the investment term gets longer, the tax relief on contributions is less and less important. According my very quick calculations, even at 20% tax relief, pensions overtake ETFs in terms of performance after ~14 years (assuming 45% marginal tax rate). Even pensions at 0% tax relief overtake ETFs eventually (~25 years).
My circumstances are different however. I aim to spend my pension entirely during my retirement and in fact I hope to retire early in order to achieve this. So I will drawdown and pay tax on all of my pension, hopefully. The main question I have is whether my current level of pension contributions make sense given that I could be in the 52% tax bracket for part of my income in retirement. And as I explained in my earlier post, I think it does make sense for me, and indeed for most other people also in most circumstances.
I have faced a dilemma which reminds me a little of your scenario. I could plan to drawdown less in the early years of my retirement and this would allow the investments in my pension to grow more - a lot more. For example. I was to take 5k less /yr in the first half of my retirement, I expect that I could afford to take 20k more /yr in the 2nd half. But I think more income when I am younger will be more useful.
If I understand your last post correctly, I think your point is that pensions are better than any other vehicle for growing wealth due to the fact that investments can grow almost indefinitely without triggering a tax event. You are saying that the marginal tax rate is not that important if your plan is to grow your pension all throughout your retirement.
You also argue that even contributions at 20% tax relief and taxed at 52% on drawdown are worth it if they have 50-60 years of potential growth.
The obvious counterpoint to this is the 4% / 5% imputed distributions but your argument on this point is that pension investments may well achieve returns higher than this amount and therefore your pension could continue to grow if the actual withdrawals are kept close to the imputed distributions.
Have I understood you correctly?
Based on the above, I presume that you expect to need to only make modest drawdowns from your pension when you retire and your goal is not about running your pension down to zero at the end of your life but it is more about maximising what you can pass on. If this is the case, then your investment horizon is probably very long (depending on your age and health) and a pension is definitely better than ETFs or shares in my opinion for that purpose.
And I agree that as the investment term gets longer, the tax relief on contributions is less and less important. According my very quick calculations, even at 20% tax relief, pensions overtake ETFs in terms of performance after ~14 years (assuming 45% marginal tax rate). Even pensions at 0% tax relief overtake ETFs eventually (~25 years).
My circumstances are different however. I aim to spend my pension entirely during my retirement and in fact I hope to retire early in order to achieve this. So I will drawdown and pay tax on all of my pension, hopefully. The main question I have is whether my current level of pension contributions make sense given that I could be in the 52% tax bracket for part of my income in retirement. And as I explained in my earlier post, I think it does make sense for me, and indeed for most other people also in most circumstances.
I have faced a dilemma which reminds me a little of your scenario. I could plan to drawdown less in the early years of my retirement and this would allow the investments in my pension to grow more - a lot more. For example. I was to take 5k less /yr in the first half of my retirement, I expect that I could afford to take 20k more /yr in the 2nd half. But I think more income when I am younger will be more useful.
Exactly.
If we take the ARF example – I think you also need to factor in the tax-free growth from the rest of your pension into the equation, and in particular that deriving from Value B which you wouldn't have had growing there if you had chosen to invest in something else.
Even in your case, if you were planning on taking 6.66% of the pension pot each year over 15 years, the growth over 15 years of Part B would be significant, and wouldn't be something you'd have from any other investment option. It seems appropriate to factor this in to the overall value proposition of investing in the pension vs. investing in something else.
In essence, yes. I expect to have €35,000/€40,000+ PA from my DB pension, so the ARF would really be about increasing wealth / dipping in every now and again for something special. I feel lucky I learned about the value of investing while I was young enough to take advantage of it (30 year time horizon till I retire).
You must be planning on taking some pretty serious drawdowns in your early years to hit a 52% marginal tax rate, given the fact the 8% USC rate only kicks in on income over €70k (plus change).
Would it not make more sense to use the lump sum to partly fund your early retirement years and keep your annual drawdowns from your ARF at a somewhat lower level?
Apologies if I have misunderstood your proposed strategy.
Hi Sarenco,
You are not wrong - my USC will drop so my marginal rate will be 48.5%. My mistake.
My current projections (which involve lots of assumptions) are that even if I take 42k/year combined total from all pensions, I will not use up my pension fund. This is largely due to the fact that I expect to have both Irish and UK pensions kicking in from age 68 & 67 respectively.
I can't see how living off the lump sum to fund the early years would help. I would just need to withdraw a larger amount over a shorter period in that case.
I am probably better just drawing down 42k every year and see how things progress. At least it is nice to know that even if some income does fall into the 48.5% bracket, it was still a better return than ETFs / shares.
Thanks...
If my allowable relief is €8k and I pay €10k into my fund, I will claim relief on the €8k this year and on the €2k next year (which would form part of next years allowable relief). I wouldn't invest the €2k surplus outside the pension wrapper, unless I expected to exceed the allowable relief in the following/subsequent years. There are limitations on excessive contributions I believe.
BigPineapple
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Interesting, I wasn't aware that you can give a cut off after you over contribute to move to the year after.. I have only ever heard of back dating.. How would you notify Revenue or what mechanism is there to do the cut off??
I was always under the impression that once it goes it, it goes in. If you hit past your limit, you don't get any extra relief for that particular year until next year roll around, the limit resets.. I must look into this.
Hi Sarenco,
Thanks - that's good to know. Is the UK state pension also exempt from USC and PRSI or is it just the Irish one?
Thanks,
3CC
My understanding is that a UK state pension is not liable to PRSI or USC.
Taxation of foreign pensions
This page describes tax relief for pension contributions and how pensions are taxed
www.revenue.ie
This is a very important topic for me, as I have passive income that will push myself and my wife into the top rate. So any pension contribution I make now is not as valuable as it is to someone with no passive income.
i.e. I put 10000 into a pension and it costs me 6000 in terms of cash value (i.e. I have forsaken 6000 in net personal income to put that 10000 in the pension)
(Ignoring growth.)
But when that pension comes out the other end, I can theoretically take 2000 in TFC, and then get about 50% of the rest after tax, i.e. 4000. So I get about the same 6000.
So basically if you have a lot of personal passive income, then putting money into a pension is of almost no value to you.
I think that's fair enough, as someone who has a stack of passive income already doesn't really need the benefit of the pension tax relief.
What am I missing?
i.e. I put 10000 into a pension and it costs me 6000 in terms of cash value (i.e. I have forsaken 6000 in net personal income to put that 10000 in the pension)
(Ignoring growth.)
But when that pension comes out the other end, I can theoretically take 2000 in TFC, and then get about 50% of the rest after tax, i.e. 4000. So I get about the same 6000.
So basically if you have a lot of personal passive income, then putting money into a pension is of almost no value to you.
I think that's fair enough, as someone who has a stack of passive income already doesn't really need the benefit of the pension tax relief.
What am I missing?
What you're saying would be broadly true if you took your entire pension as a taxable lump sum at your marginal rate. In that case it would be headline tax rate in vs. headline tax rate out.
What you're missing is the aggregate growth of your pension in retirement from the tax relief you received (assuming you ARF it).
If you draw down 4% of your pot per year 96% of your pension can continue to grow tax free. 40% of that growth from that 96% can be attributed to the tax relief you received. You only pay the marginal rate on a very small amount of your total pension each year.
That €4,000 you received in tax relief could continue to generate income for you for 10, 20, 30 years in retirement etc.
What you're missing is the aggregate growth of your pension in retirement from the tax relief you received (assuming you ARF it).
If you draw down 4% of your pot per year 96% of your pension can continue to grow tax free. 40% of that growth from that 96% can be attributed to the tax relief you received. You only pay the marginal rate on a very small amount of your total pension each year.
That €4,000 you received in tax relief could continue to generate income for you for 10, 20, 30 years in retirement etc.
You're missing the effects of tax on any alternative investment you'd choose
That's a really really good point.
Will the passive income continue when you retire, at what level will it be, or will you sell those income generating assets?
The plan is for it to continue indefinitely, and pass the assets (and income) to the next generation. There is the possibility to sell as state and small DB pensions kick in later in life, and keep income flat, but at the moment they are being acquired on a never-sell basis.