There’s been a lot of discussion about the March 2014 budget and what it actually means to clients with savings.
This article puts the pension changes into easy to understand numbers.
I’m assuming that the investment returns from all sources are the same and with the same charges.
Option 1
Basic rate taxpayer (BRT):
Saving
Cost of a pension contribution 80p
Total in pensions savings with 20% tax relief 80p + 20p = £1
At retirement
Pension savings £1
TFC 25p
Taxable savings pot 75p
Tax @20% x 75p 15p
Leaves 60p
Total 60p+25p 85p
Pension lump sum = 85p
Therefore, for a BRT, the (assumed) tax ‘advantage’ for saving in a pension (without access) for 30 or 40 years (and longer with the new proposals) is a 5p tax gain on the 80p investment, which is 6.25%.
That’s why neither the Tory or Labour party will get rid of TFC – there would be no incentive to put savings away for 40 years; why do it? For 6.25%?
Come on?
Tell me why do people save in a pension?
It can’t be for 6.25% given by the Chancellor?
Option 2
When you add in the cost of national insurance deductions @14%, the cost for £1 in a pension is actually £1.18
Cost/Gross Earnings 1.18
Tax @20% 23.6p
NIC @14% 14.2p
Net pension 80p
Gross pension contribution £1
How about we put the full £1.18 into the savings pot for the same cost of 80p net income?
What would that give us?
Contribution £1.18
Cost 80p
Access/return
£1.18 x 20% BRT deduction 94p
14/80p is a tax advantage of 17.5%
Now we’re talking. That’s what makes pension saving a bit more attractive for BRT’s when compared to an ISA, where the cost of entry/exit is the same, with no tax advantage over a pension.
Saving
Net contribution 80p
Access
Cost of access 80p
An ISA is less tax efficient than a pension, but provides immediate access and a whole host of self-servicing options on low-charging platforms. It’s easier to understand. Clients can see, feel and smell the cash. They understand the benefits. It’s easy to understand and they can access it all at once. George doesn’t stop people spending their ISA on Lamborghini’s?
Why shouldn’t they spend their pension on the same?
If you save your pension in the right way. It makes a lot of tax sense for a lot of savers.
Let’s go back to our pension and look at HRT’s – for a HRT who is ‘managed’ as a BRT in retirement the tax gain is substantial at @37%; phasing down the pension in lump sums at marginal rates is going to be important.
There are huge financial planning opportunities for financial planners. They can ensure their clients chose the right option.
You intuitively know these numbers. This will help you add them up.
Pension planning it properly gives nearly x3 times the advantage for BRT’s than they’d get from an ISA – and still have full access. For HRT’s pension contributions make a LOT of tax sense, where pension ‘phasing’ becomes even more important.. And they continue to make tax sense. Pensions are dead, long live pensions.
And we never mentioned salary sacrifice or auto enrolment once.
