A pension, for most people, invokes a feeling of dread or a long off distant idea of retirement when they are old and grey. Most people have a pension or think they should be contributing more to one. Yet many don’t really understand it or for some reason are not a ‘fan’.
In this blog, I am going to give you 10 reasons pensions are awesome. Before I do, I want you to reframe your thinking around pensions. It is not about retiring. Just think of them as a vehicle for your money to help grow your net worth that you can benefit from when you are older.
Currently, you can get tax relief on a pension depending on how much you earn. For some people that will mean 20%. So, if you put in £1000 the government will contribute £250, leaving you with £1250 in total. Where it becomes really beneficial is if you are a 40% or higher taxpayer. In this case, you can get another £250 in tax relief from the government. This means the £1250 in a pension effectively costs you £750. Now imagine instead of a £1000 contribution it was £10,000.
As a higher rate or additional rate taxpayer, the tax relief becomes really attractive.
Many people don’t realise it but you can actually pay 60% tax on part of your income. Your Tax Free Personal Allowance (£12,570) goes down by £1 for every £2 of your adjusted net income that is above £100,000. This means your allowance is zero if your income is £125,140 or above and the effective rate of 60% between £100,000 and £125,140.
If you make a pension contribution this can reduce your income effectively benefitting from 60% tax relief. You need to be aware of the rules on annual allowances and how adjusted net income works.
With a pension, you are taxed on your income when you access the pension. Currently, 25% of your pension pot can be received tax free. When you access the pension you may no longer be working so you could potentially receive other money from it at 0% or 20% tax. This depends on other income and how much you take out. So, if you have benefitted from 40% tax relief on contributions you are well ahead.
Even if you take out money and pay 40% you would at minimum be tax neutral (actually you’ll be ahead because of the 25% tax free). Plus, you can benefit from the growth on the tax relief you received over the long term.
If you receive 60% tax relief it is even better news.
If you are employed your employer will also contribute to the scheme. Ths means more money going into the pension. There are minimum contribution levels but many employers offer even more generous amounts where they will match your contributions up to a certain level. So, if you put in 5% they will contribute 5%. Some are even more generous and will contribute much more.
Make sure you are contributing up to the maximum your employer will match to maximise your company benefits and pension contributions. It’s the closest thing to free money you will ever get.
In my opinion, I am yet to come across a better investment vehicle for extracting money from a business, subject to the various allowances, than a pension.
Pension contributions from a company to a director’s pension count as an allowable business expense for corporation tax purposes (currently 19%). This means that your company could receive tax relief and receive a reduced corporation tax bill. Not only that but your company also doesn’t have to pay employer national insurance contributions (currently 13.8%) on any pension contributions.
Additionally, there is no personal tax to pay.
if you would like a guide with some more specific details and figures email support@worktolivefp.com and quote subject Business Pension Contributions Guide.
Not only do you benefit from tax relief, but any investment growth in the pension is also tax free. Tax only comes into play when you withdraw money.
If you have a particularly good year or receive a great bonus then you can make a lump sum contribution to your pension, up to various allowances. You can also make regular monthly contributions which you could increase over time. This gives you great flexibility over how you contribute to the pension.
Fancy owning a piece of Apple, Tesla, Facebook or Amazon? it is possible to do this through your pension and if you have one it is likely that you already do. A pension means you get to benefit from the brilliance of these companies that are selling real things to real people. If they grow either they share price or return dividends to the value of your pension so it can increase.
Investing in a pension long-term means that you are regularly investing and buying more of these great companies. You also get to benefit from compound growth of previous investments. Essentially this is growth on the growth you have already received. It is called the 8th wonder of the world by Alber Einstein and is how you can grow real long-term wealth.
Below shows the power of compounding over the long term (Graph 4).
You’re thinking that this sounds like a bad thing but it’s actually a really good thing. It encourages good investment behaviour such as investing for the long-term, ignoring short-term noise, avoiding market timing etc.
It means that the money is there for when you need it rather than you pulling out money as you go. So, you can take full advantage of the power of compounding where the real magic happens further down the line.
Your pension can be used in combination with other investments and the restrictions on access means it is a great long-term vehicle for when you are older and wanting to work less or not at all.
There are many other advantages to pension, from pound cost averaging of regular contributions to being able to buy commercial premises via a SIPP. It is outside of your estate for inheritance tax and you can contribute a larger sum in a tax year if you haven’t made full use of your allowances over the last three years.
The benefits far outweigh any negatives of the pension and should be a foundation of your financial planning. There are many things to consider when it comes to investing in your pension and ensure that it is working as hard as possible for you. This is an area we have a great deal of expertise in so if you would like to discuss how we can help you with your pension, please contact us here.
If you have any other questions about pensions then this blog may help.
A reminder that this article doesn’t constitute financial advice and is intended as information only. Should you need financial advice you should speak to a trusted financial adviser. There are limits to how much you can put into the pension, and it can be complex especially for those affected by tapering of the annual allowance
You should do your own research before acting on any information within this blog. Remember the value of your investments and pensions can go up as well as down, and there is no guarantee you will get more than you put in. Past performance is also not a guide for future performance.
Graph 4 The graph above is for illustrative purposes only; figures presented are hypothetical and not indicative of any investment. Past performance is no guarantee of future results.
In GBP. UK Small Cap is the Dimensional UK Small Cap Index. UK Marketwide Value is the Dimensional UK Marketwide Value Index. UK Market is the Dimensional UK Market Index. UK Treasury Bills is UK One-Month Treasury Bills. UK Inflation is the UK Retail Price Index. The Dimensional and Fama/French indices reflected above are not “financial indices” for the purpose of the EU Markets in Financial Instruments Directive (MiFID). Rather, they represent academic concepts that may
be relevant or informative about portfolio construction and are not available for direct investment or for use as a benchmark. Their performance does not reflect the expenses associated with the management of an actual portfolio. Index returns are not representative of actual portfolios and do not reflect costs and fees associated with an actual investment. Actual returns may be lower. See below for descriptions of the Dimensional and Fama/French indices. The Dimensional indices have been retrospectively calculated by an affiliate of Dimensional Fund Advisors Ltd. and did not exist prior to their index inception dates. Accordingly, results shown during the periods prior to each index’s inception date do not represent actual returns of the index. Other periods selected may have different results, including losses. Backtested index performance is hypothetical and is provided for informational purposes only to indicate historical performance had the index been calculated over the relevant time periods. Backtested performance results assume the reinvestment of dividends and capital gains.
