UK's IFS proposes reducing tax reliefs on pensions

[garbanzo]

I have seen guys on already great pensions piling into AVCs with a couple of years to go and simple calculations would show this was not optimal.

Could you expand on that Duke with a bit more detail, example or perhaps a calculation? Very interested in this.

Cheers

g

 

[Duke of Marmalade]

I have seen guys on already great pensions piling into AVCs with a couple of years to go and simple calculations would show this was not optimal.

Could you expand on that Duke with a bit more detail, example or perhaps a calculation? Very interested in this.

Cheers

g

It was in a 1.5 TFLS context. AVCs where effectively going to buy more pension. But pension is taxed at c.50% and their relief was at 40%. In a 25% TFLS context it is more complicated depending on whether they are already above the 200k TFLS threshold.

 

[Gordon Gekko]

That is oversimplistic.

If someone with, say, €600k in a pension makes a €30k AVC, the relief is at 40% and the withdrawal is a blend of 0% and ‘it depends’, but let’s say it’s 48% (no PRSI at 66+).

€7.5k at 0% plus €22.5k at 48% is €10,800, which on €30k is 36%.

 

[Duke of Marmalade]

I totally agree. The people I was talking about were already well entitled to their 1.5 salary TFLS so none of the benefits from their AVCs would enjoy 0% tax. I admitted it was complicated for 25% TFLS folk especially if they were already above the 200k threshold.

 

[DazedInPontoon]

That is oversimplistic.

If someone with, say, €600k in a pension makes a €30k AVC, the relief is at 40% and the withdrawal is a blend of 0% and ‘it depends’, but let’s say it’s 48% (no PRSI at 66+).

€7.5k at 0% plus €22.5k at 48% is €10,800, which on €30k is 36%.

I think I'd also factor in the compound gains you're likely to have on the 30k too, versus if you had paid tax on it upfront and invested it outside of a pension wrapper.

 

[Duke of Marmalade]

I think I'd also factor in the compound gains you're likely to have on the 30k too, versus if you had paid tax on it upfront and invested it outside of a pension wrapper.

I was talking of folk with a couple of years to go. With 30 years to go the tax free roll-up will always tilt it in favour of making the pension contribution.
My entry into this thread was as follows:

I really don't see how our tax system can be argued to favour high earners.

I stand by that.

 

[Gordon Gekko]

It’s also good to think about it another way:

Say I make a €10k AVC today and I’ve 20 years to go to retirement.

I’m funding €6k of it and Michael McGrath’s funding €4k of it.

Assuming long term equity returns, my €10k could be worth €40k.

Even for a higher rate tax payer, I get €10k taxed at 20% and €30k taxed at 50%, so €17k of tax on €40k, so 42.5%.

Key point being, I’ve got the lion’s share of the benefit from the growth.

 

[Duke of Marmalade]

It’s also good to think about it another way:

Say I make a €10k AVC today and I’ve 20 years to go to retirement.

I’m funding €6k of it and Michael McGrath’s funding €4k of it.

Assuming long term equity returns, my €10k could be worth €40k.

Even for a higher rate tax payer, I get €10k taxed at 20% and €30k taxed at 50%, so €17k of tax on €40k, so 42.5%.

Key point being, I’ve got the lion’s share of the benefit from the growth.

Well there are different ways of looking at this depending on which mirror you use. You have finished with 23k. If you had invested your 6k outside the pension regime it would have grown to 24k but of course the 18k growth would be subject to tax(es). So it can be seen that the benefit, and it is a big one, is that the growth on your 6k has been tax free. Michael McGrath got his 4k back plus the 12k interest it earned plus a 1k bonus.
Key point I am making is that having access to Michael McGrath's 4k up front is an illusionary benefit. You would have marginally preferred not to have the tax relief but instead have the growth tax free. Note that this is much more beneficial than Gross Roll Up which refers to tax being deferred during roll up but eventually being deducted.

 

[Gordon Gekko]

Key point I am making is that having access to Michael McGrath's 4k up front is an illusionary benefit. You would have marginally preferred not to have the tax relief but instead have the growth tax free

Sorry, but that makes absolutely no sense at all.

€23,000 after tax is clearly a lot better than €24,000 before tax.

It’s not ‘marginal’ at all and the benefit is far from ‘illusionary’.

 

[ryaner]

If you had invested your 6k outside the pension regime it would have grown to 24k but of course the 18k growth would be subject to tax(es).

Short of some lucky stock picks, deemed disposal would make sure that the taxes are paid quicker and growth is much smaller.

 

[Duke of Marmalade]

Sorry, but that makes absolutely no sense at all.

€23,000 after tax is clearly a lot better than €24,000 before tax.

It’s not ‘marginal’ at all and the benefit is far from ‘illusionary’.

I am obviously very bad at explaining myself. Mind you @llgon seemed to get it.
There are 2 tax advantages touted for pension provision.
(1) Tax free growth. In your example that would have given 24k in retirement for 6k investment on its own. Why have you interpreted this as 24k before tax?
(2) Tax relief on contributions, which is really only tax deferral. In your example that would knock 1k off the 24k. It is actually a negative feature - no thanks. That is what I mean about this aspect being an illusion.

Michael is actually taking the mickey here. (did you see what I did there?) He has appeared to be the fountain of generosity in giving 4k upfront and has some advisors waxing about what a nice man he is. He knows that he has only loaned the 4k and gets it paid back with 12k growth plus a bit.

 

[Gordon Gekko]

I am obviously very bad at explaining myself. Mind you @llgon seemed to get it.
There are 2 tax advantages touted for pension provision.
(1) Tax free growth. In your example that would have given 24k in retirement for 6k investment on its own. Why have you interpreted this as 24k before tax?
(2) Tax relief on contributions, which is really only tax deferral. In your example that would knock 1k off the 24k. It is actually a negative feature - no thanks. That is what I mean about this aspect being an illusion.

Michael is actually taking the mickey here. (did you see what I did there?) He has appeared to be the fountain of generosity in giving 4k upfront and has some advisors waxing about what a nice man he is. He knows that he has only loaned the 4k and gets it paid back with 12k growth plus a bit.

I still don’t get you.

If €10k invested in a pension quadruples over 20 years, it nets out at around €23k.

You’re now talking about €6k, which is the ‘like for like’ starting amount if one doesn’t invest in a pension. If that quadruples, you have €24k, but that’s before tax, and clearly inferior to €23k net of tax.

I do agree that Michael does well out of the trade, a point that Sinn Fein/IRA and the chancers on the Left would do well to understand.

 

[Duke of Marmalade]

I still don’t get you.

If €10k invested in a pension quadruples over 20 years, it nets out at around €23k.

You’re now talking about €6k, which is the ‘like for like’ starting amount if one doesn’t invest in a pension. If that quadruples, you have €24k, but that’s before tax, and clearly inferior to €23k net of tax.

I do agree that Michael does well out of the trade, a point that Sinn Fein/IRA and the chancers on the Left would do well to understand.

I definitely must be to blame!! I am tearing my hair out as to how to get my point across, can someone else help
I am saying that in your example the only support that was needed was TAX FREE* growth on the 6k.
The further complication of deferred taxation actually takes 1k back but some see it as a straight 4k (in your example) upfront support. Others recognise it as deferred taxation but think the punter benefits from the growth during deferral - that is the illusion I am trying to highlight.
* By that I mean like a life policy with Exit Tax = 0%. No netting out. I am talking about a much greater benefit than gross roll up with deferred tax on the growth.

 

[Duke of Marmalade]

Trying a different tack. Simplifying the example still further. Let tax relief at entry be 50% and let tax at exit be 50%.
Then 10k gross investment has grown to 40k and 20k is the net return
Thus the 5k net contribution has grown to 20k which it would have done all on its own without the complication of deferred taxation. But the difference now is that no tax is payable on the 15k profit.
I said earlier that describing how this happens depends on what mirror you use. My simple explanation is that you have been allowed to earn tax free growth on your after tax income.
Now a different mirror might say that you should pay tax on this growth but because of the mechanics of the deferred taxation you are spared having to do so. This somehow makes a merit of the deferred taxation. Fair enough but you can't describe it as two benefits - tax free growth plus the benefits of deferred taxation.

 

[Itchy]

I definitely must be to blame!! I am tearing my hair out as to how to get my point across, can someone else help
I am saying that in your example the only support that was needed was TAX FREE* growth on the 6k.

Are you trying to say that from the punters perspective, a marginally better pension system would be that your net income could grow tax free rather than current design i.e. tax relief (deferral) and tax free growth?

6k -> 24k net
vs.
10k -> 40k less 17k = 23k net

Interesting.

 

[Duke of Marmalade]

Are you trying to say that from the punters perspective, a marginally better pension system would be that your net income could grow tax free rather than current design i.e. tax relief (deferral) and tax free growth?

6k -> 24k net
vs.
10k -> 40k less 17k = 23k net

Interesting.

In GG's example, yes. More generally tax deferral does bring additional benefits on top of tax free growth either because of the tax free lump sum or because the tax rate in retirement is lower than the relief in employment.