Is adding money/capital to a UK pension savings plan still relevant and should you consider it for you personally or even for members of the family?
Main reason why not
Reasons why it is beneficial – free money!
Longer term thinking
Risks to take into account
WHY NOT
POSITIVES – FREE MONEY, INHERITANCE TAX BENEFITS & MORE
The fundamental reason why adding money to a pension savings plan is a good idea is the tax relief offered by HMRC.
I am sure that you know what tax relief is – it is the tax that you would have paid if you had taken the money in earnings (or dividends) instead of directing that money into your pension.
Mathematically this means a pension contribution can be very attractive, let’s assume a gross contribution of just £3,600 and look at how much the relief would be:
- Basic and non-tax payers relief (20%) – £720
- Higher rate taxpayers (40%) – £1,440
- For some it can be as much as (60%) – £2,160.
I guess that there is no such thing as free money but for a non-taxpayer this is pretty close, you pay some and the government agrees to add some too and this is what makes paying money into a pension better than any other form of investment and subject to your own needs. This is likely to be more beneficial than taking out an Individual Savings Account (ISA).
Please note that you may have to pay tax when you withdraw taxable income from any pensions.
TAX FREE GROWTH
Pensions also benefit from a tax free environment so any income and growth generated within the pension from the underlying investments is also without taxation. Over a long time this can mean a significant extra boost to returns on your underlying investments.
INHERITANCE TAX (IHT)
When we think about IHT we mainly think about children but as fewer people are getting or staying married a partner cannot inherit assets without taking into account the impact of tax (IHT) should that person pre-decease them and leave them assets in excess of the Nil Rate Band.
If you have saved money into a pension for the specific reason of spending it in retirement it seems nonsensical to keep saving that pot of money and to avoid spending it. If you have other sources of capital, if you have an exposure to inheritance tax and want to reduce that exposure then it makes sense to not spend your pension pot but spend other money or sell other assets in order to pay less in inheritance tax. I can see that it is logical to think this way but we don’t always see the logic when we are planning to pay our everyday bills.
It is clearly complex when thinking about what money to spend and what to not spend but here is my simple order of what money to spend first and what to spend last.
THE ORDER IN WHICH MONEY IS SPENT
- CASH – until reserves are at a level where you remain comfortable
- OTHER – this can mean property assets as they can be less tax efficient
- ISAs – ISAs are not normally IHT free
- PENSION – pensions benefit from more tax breaks than any other assets
RISKS TO CONSIDER
Please don’t forget that all the above is true but we do need to consider other aspects of your general circumstances such as access to liquidity, personal rates of tax now and in the future, changes in legislation that may reduce the tax breaks and the flexibility of investment within the pension contract. All of this as well as many other aspects that can impact on deciding if it is right for you to add to your pension or not as well as the limits imposed by current pension rules.
GET IN TOUCH
Pension planning remains complex and to avoid any pitfalls we would strongly recommend taking advice.
Please let us know if you would like to discuss the above with your advisor.
