There’s been some fuss recently about the miseries of those hitting their annual and lifetime pension limits (£40,000 tapering down to £10,000 for high earners and £1.03m respectively) and having to pay taxes as a result.
Most of the commentary around the issue has been about ways to avoid paying those taxes – mostly by leaving schemes or cutting contributions. But there was a sudden outbreak of common sense in the papers at the weekend; in the Mail and in the Telegraph, Sally Hamilton and Laura Miller both asked whether paying the extra tax might be worth paying – after all, paying tax on something usually suggests that you have something in the first place and at least some of the something left at the end.
Hamilton runs some numbers. A 50-year-old saver has a salary of £215,000 – which gives them an annual allowance of only £10,000 – and hopes to retire in ten years. Their employer pays 6% into their pension. They pay the same – so £12,900 each and a total of £25,800. Whoops. £15,800 of the contribution ends up taxable at 45% – a bill of £7,110. But this leaves £18,690 invested.
Say it grows at 4% a year in real terms, it will be worth £27,665 in a decade. So an effective personal contribution of only £7,095 (£12,900 after the tax relief) ends up being worth rather more. Staying in the scheme under circumstances such as this, as Hamilton quite rightly says, a “no brainer”.
You can do similar sums with defined-benefit pensions and with the lifetime allowance for both types of pension, but in each case the key game-changer is your employer’s contribution – which is effectively (from the employee’s point of view, anyway, free money). Leave the scheme and you lose that – which rarely makes much sense (although you can of course attempt to attempt to negotiate a pay rise in lieu).
It’s also worth noting, says Miller, that being inside a pension scheme often comes with extra benefits, such as life insurance and a pension for dependents should you die, and that the generosity of these schemes can change if you are no longer an active member of the scheme.
This is important stuff – if you are over your allowances and are wondering quite what to do, reading this from Royal London will be a good start. You might also read this – it makes an interesting case for ignoring the lifetime allowance completely if your plan is to pass your pension on to your heirs intact. This comes with the usual warning – the lack of IHT on pension assets is such a generous part of the current pensions regime that we would be amazed if it lasted a generation.