Key Post Should someone paying tax at 20% contribute to a pension

C

ClubMan

Registered User
Messages
49,202
Brendan Burgess said:
And if you are getting only 20% tax relief on your pension, you should not be contributing to a pension.
Click to expand...
I would take issue with that as a hard and fast - or even firm - rule.
As I said, standard rate tax relief on contributions to the pension are not to be sniffed at.
And then the pension grows tax free and yields a tax free lump sum at retirement.
 
Last edited by a moderator:
The first rule is this

If your employer is matching your pension contributions, then you should contribute the maximum amount which your employer will match, irrespective of the tax rate.

So if your employer pays 5% if you contribute 5%, you should contribute 5%.
If you employer pays 10% if you contribute 10%, you should contribute 10%.

Even if you are not paying tax on your income, you should avail of this.
 
Last edited:
The second guideline is that, other than matching your employer's contribution, you should not contribute to a pension until you have purchased your home. You should save the money instead towards the deposit. It does not matter if you are paying 40% tax. You should save your money outside a pension scheme so that you can buy your home.

The advantages of home ownership are huge
  1. In general, paying the interest on a mortgage is a lot cheaper than renting a house.
  2. You get the security of tenure - as long as you pay your mortgage, you are going to keep your home. With rental accommodation, you might be turfed out at any time.
  3. You are in charge of repairs, decoration, extension. You do not have to get a landlord to do it.
  4. If you hit bad times, your home is not included in the means test.
The pensions industry will argue that the sooner you start a pension, the better because of compounding. But the exact same applies to buying a house and paying down a mortgage. The rule should be "The sooner you start saving the better."

The third guideline is that if you have an uncomfortably high mortgage, you should probably pay it down to a comfortable level before starting a pension. This is a bit subjective. But 4 times your income and negative equity is very uncomfortable. Three times your income and 80% Loan to Value is comfortable if your job is very secure.
 
Last edited:
So, you have matched your employer's pension contributions, you have bought your house, and your mortgage is down to a comfortable level, should you contribute to a pension if you are getting only 20% tax relief on the contributions?

If you are never going to be paying 40% tax because you are in your 50s and you have reached peak earnings, then getting tax relief at 20% is worth it.

However if you are early on in your career and can expect to be paying tax at 40% in future years, then you should wait until you are paying 40% tax to get the full value of your contributions.

Let's look at the following case:
Age 29
Salary €30k
Expect to earn €50k next year
You can contribute 15% of €30k or €4,500. You will get 20% tax relief, so the net cost will be €3,600
If you wait until next year, you will be able to get 40% tax relief, so a contribution of €4,500 will cost you only €2,700

What confuses people is that they look at this year in isolation. And if you ask "Does it make sense to contribute to a pension this year at 20% tax?", you can do the arithmetic to show that it does. But it makes much more sense to do it next year when you are getting 40% tax.

An objection people raise is that pension contributions are on a "use it or lose it basis".
Next year the person is earning €50k and can contribute 20% or €10k.
So he could contribute €4,500 this year and €10,000 next year.
If he does not contribute €4,500 this year, he is still limited to €10,000 next year.

But not many people are so well off that they can contribute 20% of their salary every year in their 30s, and 25% in their 40s.
Especially if they are on 20% tax now.

So I would strongly recommend paying down your mortgage when your tax rate is 20% and maxing your pension contributions when the tax rate is 40%.

If you pay down your mortgage when your tax rate is 20%, you will have lower repayments later and will have more scope for making pension contributions.
 
Last edited:
Brendan Burgess said:
Should I start a pension

No, If you don't have a house - that is a higher priority
No, if you have an uncomfortably high mortgage, getting it down to a comfortable level is a priority
No, if you are not paying 40% tax. Wait until you can get 40% tax deductions.

Yes, if you have a comfortable mortgage and are paying 40% tax.

Even if you have an uncomfortably mortgage, it might be right to start a pension if you are older as you might be limited in what you can contribute later.

The tax benefits are huge
You get 40% tax relief on your pension contributions.
The fund grows tax free.
On retirement, you will probably get 25% tax free.
The balance will be subject to tax at your top rate - which might be only 20% in retirement.
Click to expand...
Hi,

Can I ask why not start a pension if not in the 40% tax bracket? Do you mean in this particular situation or in any situation?

I am self employed, at the moment not in the 40% tax band, and thinking about a pension for first time, in my early 50s.
I am keen to start a pension but this has made me think twice.

If not starting a pension and say I never reach the 40% tax band, what should I be doing instead?
 
Geronim02019 said:
Hi,

Can I ask why not start a pension if not in the 40% tax bracket? Do you mean in this particular situation or in any situation?

I am self employed, at the moment not in the 40% tax band, and thinking about a pension for first time, in my early 50s.
I am keen to start a pension but this has made me think twice.

If not starting a pension and say I never reach the 40% tax band, what should I be doing instead?
Click to expand...
No. This is bad advice.

Saving to get a 20% tax break is a better option for most people than almost all the alternatives
 
Last edited:
It depends on your age and your expected earnings.

If you are paying tax at 20% but expect your earnings to rise so that you will be in the 40% tax bracket, then you should not contribute to a pension. 40% tax relieve is much better than 20% tax relief.

However, if you are in your 50s and don't expect to be in the 40% tax bracket, then you should contribute to a pension if you can afford to do so.

Brendan
 
Brendan Burgess said:
It depends on your age and your expected earnings.

If you are paying tax at 20% but expect your earnings to rise so that you will be in the 40% tax bracket, then you should not contribute to a pension. 40% tax relieve is much better than 20% tax relief.

However, if you are in your 50s and don't expect to be in the 40% tax bracket, then you should contribute to a pension if you can afford to do so.

Brendan
Click to expand...
Boss,
I don’t think it’s that simple. Many 40% taxpayers during their working lives may be 20% marginal taxpayers or possibly 0% taxpayers in retirement . If someone is a 20% taxpayer or expects to be for most of their working life, then they will very likely be a 0% taxpayer (below the tax threshold) during retirement. So even tax relief at 20%
(plus tax free investment growth) is still a good deal, whether above or below age 50.
 
The fact that it’s ‘use it or lose it’ for employees or self-employed people is very relevant.

It’s not possible to make ‘catch-up’ contributions, so I’d be inclined to crack on and claim relief at the 20% rate.

It’s the tax-free returns compounding over time that are the biggest plus, not the tax relief. There are people who put money into PRSAs when they’ve no income at all as an aside.
 
I think you are all missing the point.

I am a 25 year old at the start of my career paying tax at 20%.

I contribute €5,000 to my pension and it costs me €4,000. That is good value.
But the following year I am paying tax at 40%. I contribute €5,000 and it costs me only €3,000. That is much better value.

If someone is paying tax at 20% in their 30s but expects to be paying tax at a higher rate when they are older, then it's unlikely that the use it or lose it will kick in as they are unlikely to be able to contribute 20% of their gross salary to their pension every year.

But if they are uncertain if they will ever pay 40% tax, then they should make pension contributions even if they are getting only 20% relief.

Of course, other factors enter into the equation as well. If they have a large mortgage and they are getting only 20% tax relief, they are probably better off paying down their mortgage.

Brendan
 
Most employees match contributions up to 6 or 8 %, so if you are 25 and contribute €5000 to a pension, the employees does as well so you may have €10K in your fund with a cost to you of €4K. The next year you have €20K in your fund at a total cost of €7K.

So this 26 yr old has “spent” €7K and is worth €20K, while your 26 yr old has spent €3K and is worth €10K.

When the 26 yr old gets to 67 will they appreciate that extra €10K? I suppose that is the real question?
 
Brendan Burgess said:
I think you are all missing the point.
Click to expand...
I think I am but I still don't understand your point.
Brendan Burgess said:
I am a 25 year old at the start of my career paying tax at 20%.

I contribute €5,000 to my pension and it costs me €4,000. That is good value.
But the following year I am paying tax at 40%. I contribute €5,000 and it costs me only €3,000. That is much better value.
Click to expand...
Yes, but that doesn't necessarily mean that they shouldn't have been contributing at all when paying 20% tax.

Convince me otherwise.
 
Someone in their 30s can contribute 20% of their salary each year.

The 40% tax band kicks in at €40,000 for a single person

That allows them to contribute €8,000

It is unlikely that they can afford €8,000 every year.

So say they contribute €5,000 - that will cost them €3,000.

But if they have spent their savings contributing when they were getting tax relief at 20%, they won't be able to afford the €5,000.

Do you think that someone can afford to pay 15% of their salary every year up to the age of 30 when they are earning under €40,000 and 20% every year up to the age of 39 and pay their mortgage and meet all their other expenses?

I don't think so. So when they are paying 20% tax, they should be paying down their mortgage so that they will have scope to increase their contributions and use up the maximum when they are paying 40% tax.

Brendan
 
The person in your example will only get tax relief at 20%.
They would need to earn 45000 to get tax relief at 40% on 5000.
Your person might never earn enough to be taxed at 40%.
It is a good idea to start young and make small contributions into their pension.
Maybe 1000 per year.
They should get into the habit young to see their pension fund grow over time.
This will incentivise them to build up a decent pension fund.
If your person started at age 20 they would have 45 years of investment growth to age 65.
 
You might think its pointless but I did start saving for a pension when I was just gone 30 and only earning around 23k pa. I didn't earn enough to pay the upper rate for another 3 years, but that tiny 3k 17 years later became a 17k deferred pension which will probably slowly grow for the next 15 years when I actually retire. The long term plan is to take it as a lump sum on my retirement and use it to supplement my retirement income to cover mortgage payments which will continue for 3 years after retirement. Even if it doesn't grow a cent it would pay a full year of projected repayments.
The benefit of making small contributions at a young age is that they have a very long time to grow, so the overall growth is probably going to be a lot higher than contributions you make later in life.
 
S class said:
The person in your example will only get tax relief at 20%.
They would need to earn 45000 to get tax relief at 40% on 5000.
Your person might never earn enough to be taxed at 40%.
It is a good idea to start young and make small contributions into their pension.
Maybe 1000 per year.
They should get into the habit young to see their pension fund grow over time.
This will incentivise them to build up a decent pension fund.
If your person started at age 20 they would have 45 years of investment growth to age 65.
Click to expand...
Don't forget many companies match contributions which effectively double them, no matter how small. In the example above I was contributing just 1k per annum but my employer paid the same. It only made a small difference tax wise but in the long term, the benefit will be very useful given that I will be looking at paying a mortgage until I am 69. This and another modest (albeit a larger) pension should help me when I need it.
I've worked for a large insurer since my early 40s who have far better retirement planning so there was considerable compulsory retirement plans I had to buy into, mix of a hybrid pension and a DC for anything over the threshold for that. I also make modest AVCs which I can decide on later on. I am fortunate enough to have this in place and enough years service for it to be meaningful (the employer puts a whopping 16% into our pensions and this also helps).
 
Brendan Burgess said:
Someone in their 30s can contribute 20% of their salary each year.

The 40% tax band kicks in at €40,000 for a single person

That allows them to contribute €8,000

It is unlikely that they can afford €8,000 every year.

So say they contribute €5,000 - that will cost them €3,000.

But if they have spent their savings contributing when they were getting tax relief at 20%, they won't be able to afford the €5,000.

Do you think that someone can afford to pay 15% of their salary every year up to the age of 30 when they are earning under €40,000 and 20% every year up to the age of 39 and pay their mortgage and meet all their other expenses?

I don't think so. So when they are paying 20% tax, they should be paying down their mortgage so that they will have scope to increase their contributions and use up the maximum when they are paying 40% tax.

Brendan
Click to expand...
This is a common dilemma. I was in exactly that position as when I originally started my pension I realistically thought I would never be able to afford a home. But it did remain that while I got 20% and after 3 years 40% on my contributions, you don't get any relief (and indeed pay DIRT and CGT) on savings and investments made to save for a deposit or other savings. However the long term growth that results from starting saving at a younger age is well worth the loss in tax reliefs.
 
You must log in or register to reply here.
Back
Top