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Should I be putting most of my income into my pension or into an investment account?

Including Financial Independence and Retiring Early (FIRE)
treefrog
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Should I be putting most of my income into my pension or into an investment account?

#436211

Postby treefrog » August 20th, 2021, 12:11 pm

I'm 38 and have:
- approx 315k in various pensions, almost entirely in equity funds/ETFs
- 64k in equities/REITs/corporate bonds outside my pension (mostly in an ISA)
- 30k in cash (maybe I should move some of this into government bonds, though that's a different discussion)
- a house worth 390k without a mortgage
- an income that is pretty variable but for the sake of simplicity call it 100k/year pre-tax

For simplicity my outgoings are say 23k/year, though it varies quite a lot depending on occasional big expenses like:
- house renovations
- needing a new car
- going skiing for a few weeks

I take it as a given that I put the maximum 20k/year into an ISA, and that I make at least a token pension contribution of say 5% a year.

With the remainder of the money I save, I can choose to either invest it outside of an ISA, or invest it a private pension.

I assume these are important ages where things change (things may of course change):
- 57 - access private pension
- 68 - access state pension of 9k/year, assuming I pay in enough NI contributions
- 75 - at this point (and most likely much earlier) the equity in the house, plus possibly some inheritance, will be more than enough to buy a moderate annuity. In combination with the state pension that should provide enough to live off even if the private pension runs out shortly afterwards.

On this basis, the private pension needs to provide something like 24k/year pre-tax 57-68 (assuming only 1k tax, though rules might change), and 14k/year 68-75 (assuming almost no tax).

Ignoring all returns above inflation beyond retirement age, I need 24 × (68-57) + 14 × (75-68) = 362k in my pension by the age of 57.

Even with very conservative growth assumptions, 319k should reach 362k (plus inflation) over the 19 years before I can access my pension. On this basis, I don't really need to put anything in my pension ever again, and could put all my other income into an investment account. For every 23k-ish that I save, I bring forward my retirement date by one year.

Some possible contrary arguments:
- the stock market could crash by 50% plus at any point and then stagnate, on which basis assuming marginal growth over 20-30 years isn't really such a conservative assumption
- my assumption that my pension only needs last until 75 is somehow flawed (e.g. maybe I'm too optimistic about the state pension, or about equity release)
- given that for every £1 I put in my pension I get 50p of tax relief, maybe I'd be better off retiring a few years later but with a far more generous pension. If the stock market then did OK I'd be given the option of retiring in considerably more comfort than I'm used to, and/or being able to give a sizeable amount to charity

pje16
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Re: Should I be putting most of my income into my pension or into an investment account?

#436214

Postby pje16 » August 20th, 2021, 12:23 pm

If you are only putting 5% into your pension then the best return is made by putting more in
The 50% tax relief will walk all over EVERY other type investemt

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Re: Should I be putting most of my income into my pension or into an investment account?

#436231

Postby vrdiver » August 20th, 2021, 1:18 pm

At age 38, your pension pot has quite a few years to grow before you can access it. You might want to mock up a spreadsheet and look at different growth rates (with different contribution levels) with a view to understanding the odds of hitting the LTA threshold and having to pay that tax bill. (For simplicity, I'd assume the LTA increased by inflation each year, so you can ignore inflation from your growth calculations and the "answer" will be expressed in £££ in today's value.)

The other spanner in the works is that at 38, you face a lot of potential interference from successive chancellors, be they age change rules, taxation changes or some other wheeze to raise funds / decrease spending. Your state pension might fall foul of such changes (again) as well as your private pensions. Locking that money away, even with the 50% tax rebate, does come with some risk.

If retiring early is an important consideration, then investments outside a pension will allow you to do just that. You've already stated you are maxing out your ISA allowance, which is good, but even unsheltered investments can help you reach that goal (just remember to use up your CGT allowance each year to help keep the tax bill down!).

You mention selling the house to provide an annuity from age 75. Apart from still needing somewhere to live, you might not want to sell or might want to buy something that is almost as expensive; being forced to sell, especially if your health isn't 100% or your social network is well established locally may not do you any favours. If you are going to bake a house sale into your plans, I'd figure on doing it at the point of retirement, even if you don't need the funds immediately.

Alternatively, with your current income and expenditure, you could save quite a bit more and not have to sell the house at all. Then it becomes an added safety net to your planning, rather than a primary pillar.

Short answer
Inside the pension will maximise your pot, but beware LTA clawing a chunk of it back. Outside a pension maximises your options. Doing both (Pension, ISA and unsheltered) gives you balance.

VRD

pje16
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Re: Should I be putting most of my income into my pension or into an investment account?

#436238

Postby pje16 » August 20th, 2021, 1:38 pm

Good advice above
be mindful that, at present, the LTA is frozen at 1,073,100 until April 2026

ursaminortaur
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Re: Should I be putting most of my income into my pension or into an investment account?

#436243

Postby ursaminortaur » August 20th, 2021, 2:06 pm

pje16 wrote:Good advice above
be mindful that, at present, the LTA is frozen at 1,073,100 until April 2026


And there have even been rumours of the government thinking about cutting the LTA limit possibly to as low as £800,000

https://corporate-adviser.com/rumours-lta-will-reduce-to-800000-in-covid-tax-raid/

I doubt that will happen as it would cause too much trouble with groups such as doctors but you never can tell with Johnson's government.

pje16
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Re: Should I be putting most of my income into my pension or into an investment account?

#436246

Postby pje16 » August 20th, 2021, 2:12 pm

They had better not :twisted: :twisted: :twisted:

TUK020
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Re: Should I be putting most of my income into my pension or into an investment account?

#436257

Postby TUK020 » August 20th, 2021, 2:55 pm

View a pension as an arbitrage game between your tax rate now, and your tax rate when drawing the pension.

You talk of your earnings being variable, but about 100k.

Tax rate
Over 50k, you are paying 40% tax (plus NI).
Over 100k, you have your allowances withdrawn which results in a marginal tax rate of 62% (including NI)

Pension contributions
Currently tax free for the first 40k

You get to draw this on retirement
25% tax free
0% on first 12k5
20% on next 37k5

In a similar position until recently
a) everything over 100k in earnings should be going into pension (up to current max of 40k) - the screwball tax system is giving you a bonkers level incentive.
b) when you get to LTA, then decide whether you want to pay the penalty, or just scale back the number of days/week you want to work, to take the 'extra' as free time instead.

Worth keeping funding the ISA as well if you can, gives you extra flexibility in terms of earlier access to funds if you need.

Kantwebefriends
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Re: Should I be putting most of my income into my pension or into an investment account?

#436305

Postby Kantwebefriends » August 20th, 2021, 5:03 pm

Within the ISA funding I'd prioritise a LISA. It must be started before you are 40.

BigTim
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Re: Should I be putting most of my income into my pension or into an investment account?

#436342

Postby BigTim » August 20th, 2021, 7:58 pm

Others have ably set out the investment case for putting income into a pension and I concur. But will add that as you have been putting only a nominal 5% into your pension you will have years of unused relief that you can utilise via carry forward to take your income below the 40% threshold (or lower) for some years.

This is a strategy I used when moving from contracting through my own limited company to permanent employment a few years ago, in my situation it had the added advantage of red icing my income below the child benefit higher income charge threshold.

treefrog
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Re: Should I be putting most of my income into my pension or into an investment account?

#436348

Postby treefrog » August 20th, 2021, 8:50 pm

Re: increasing pension contributions to reduce income tax, that's what I've been doing for the last 5 years, it's just it seems I've maybe reached the point where I have more than I'll ever really need and putting in more can't possibly allow me to retire earlier. It's a good point that rules are highly likely to change, so maybe it's best to do a little bit of everything. On reflection I guess maybe I'll keep up fairly high pension contributions for a couple more years at least, just because HRT relief may well be removed in future so might as well do it whilst I still can.

Re: LISAs, the tax relief is less than for pension contributions for higher rate tax payers, and you can't access it until after private pension age, so as far as I can tell there's not much point unless you're at no risk of paying higher rate tax or looking to buy a first house. I do actually have a few k in a LISA from some years ago, but I've never put any more in.

I think I'm probably not at much risk of hitting the LTA, unless I'm lucky, in which case it won't matter anyway. Even with returns of 3.5% above inflation, and even if I contribute enough to get up to 400k within the next few years, a very rough calculation of 400×1.035^20 is still "only" 795k. Maybe if government rules radically change or the stock market does really well I might hit it, but there's not much I can do about that.

re: CGT I currently have so little invested in equities outside of ISAs/pensions I've never really had to consider it before, I'll make a note to look into it.

Hariseldon58
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Re: Should I be putting most of my income into my pension or into an investment account?

#436689

Postby Hariseldon58 » August 22nd, 2021, 4:59 pm

The advice Re pension contributions to minimise tax is sound, when tax rates are very high over the 100k

3.5% plus inflation may be the anticipated return but my experience over the 30+ years is that returns are very lumpy, ups and downs. Over rolling 10 year periods the returns in excess of inflation have been around 8%, that’s using mainstream investment trusts and ETFs and I’m not an investment expert by any stretch of the imagination.

ISAs and other general investment accounts provide flexibility until pensions become payable, or rule changes etc. Stuff happens and it isn’t what you worry about that gets you.

CGT can quickly become a problem, even if you don’t think it will be now.

Your anticipated income is very modest and I think your portfolio will grow a lot and allow you far more financial freedom if you continue along the same lines for the next 20 years.

tjh290633
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Re: Should I be putting most of my income into my pension or into an investment account?

#436693

Postby tjh290633 » August 22nd, 2021, 5:14 pm

I just looked at some information which I have about my portfolio, in this case only for the last 15 or so years, which compares the performance of my Accumulation unit with the RPI, and the RPI+3%, all brought to a common base:

Since               Acc Unit   IRR     Rebased   RPI do   RPI+3%
30-Dec-05 9.69 7.86% 1.00 1.00 1.00
31-Dec-06 12.25 6.70% 1.26 1.04 1.08
31-Dec-07 12.41 7.10% 1.28 1.09 1.15
31-Dec-08 7.41 12.16% 0.77 1.10 1.20
31-Dec-09 10.24 10.18% 1.06 1.12 1.26
31-Dec-10 12.32 9.27% 1.27 1.18 1.36
31-Dec-11 13.45 9.28% 1.39 1.23 1.47
31-Dec-12 15.80 8.38% 1.63 1.27 1.56
31-Dec-13 19.56 6.51% 2.02 1.31 1.65
31-Dec-14 20.34 6.89% 2.10 1.32 1.70
31-Dec-15 21.42 7.17% 2.21 1.34 1.75
31-Dec-16 24.37 5.80% 2.52 1.38 1.81
29-Dec-17 26.70 4.79% 2.76 1.39 1.86
31-Dec-18 24.06 10.95% 2.48 1.48 1.92
31-Dec-19 28.84 5.86% 2.98 1.50 1.97
31-Dec-20 27.01 28.19% 2.79 1.51 2.03

2008-12 is the dodgy period. The IRR is that from the date shown to the present time (20 Aug 2021).

TJH

hiriskpaul
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Re: Should I be putting most of my income into my pension or into an investment account?

#436749

Postby hiriskpaul » August 22nd, 2021, 10:26 pm

Someone in your position should not be concerned about the LTA charge and should be maxing out your pension contributions while you can get higher rate tax relief and are able to make maximum contributions. If you exceed the LTA before you can crystallise, the charge to the fund will be 25%. If you then draw down at basic rate tax the overall charge+tax on the amount you draw above the LTA will be 40%. As a higher rate taxpayer you will have received 40% tax relief on contributions, so you will be no worse off compared to putting the excess in an ISA. If you are filling the ISA each year, then you will be better off compared with making unsheltered investments as investments in the pension will grow free of income and capital gains tax.

All this assumes that the rules and tax rates don't change. They will of course, but I would not count on tax on unsheltered investments not rising significantly.

It is prudent to plan for poor investment returns and you can afford to be prudent. The chances are you will not get poor returns, but this cannot be relied upon. It is all very well for others to give you their experiences, but all have lived through a long period of good investment returns, albeit punctuated with some significant but relatively short lived drawdowns. The last really awful multi-year bear market ended in 1973.

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Re: Should I be putting most of my income into my pension or into an investment account?

#436756

Postby Alaric » August 22nd, 2021, 11:08 pm

hiriskpaul wrote:The last really awful multi-year bear market ended in 1973.


Don't you mean 1974 or 1975?

It sticks in my mind that the FTSE 30 index at the end of December 1974 had fallen to a level only previously seen during the Dunkirk evacuation in 1940. It was short lived as there was an immediate recovery with the index doubling in a couple of months. That was just as well as had the accounting standards required "mark to market", then financial institutions may have been technically insolvent for their 31 December 1974 reporting.

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Re: Should I be putting most of my income into my pension or into an investment account?

#436772

Postby Urbandreamer » August 23rd, 2021, 7:37 am

treefrog wrote:Ignoring all returns above inflation beyond retirement age, I need 24 × (68-57) + 14 × (75-68) = 362k in my pension by the age of 57.


I'm confused by that calculation.
The way that I read it you have decided to either die at 75 or to be willing to survive on what state pension you are entitled to at that point.

I would argue that you can't simplify either the state pension or life expectancy that way.

For example I recently read that life expectancy of a man your age was 88 on average but 1 in 10 could live to 100. Likewise, what fraction of 30 qualifying years will you have when you stop work (57?). If you intend to retire earlier it's a important consideration.

Assuming for a moment that you intend to wait until you can access a personal pension before retiring, as that's what your numbers suggest:

I would argue that both ISA and pension schemes provide significant tax advantages. You say that you need 24Kpa, If you take half from your ISA's and half from your pensions, your tax band will be 0% for the first 11 years. More if you reduce the amount you draw from pension plans at the point that you get your state pension. Yet the government gave you a 40% contribution (based upon your £100k income).

Think about that for a minute.

Back to the numbers. I'm going to assume a safe withdraw rate of 4% for simplicity and ignore complications* like the state pension or that 4% was back tested assuming a 30 year retirement.
You would need a total pot of 24*(100/4) = £480k
If we assume a more secure 3% then the calculation is 24*(100/3) = £800k

I recommend aiming at the higher number, which shouldn't be too difficult for you.
After all, assuming that you do invest £20kpa in a ISA you will have 19*20+64=£444k at 57, plus your pension schemes.

All the above revolves about pensions. But life is not so limited. My calculations and your words suggest that £20pa ISA contribution and 5% into a pension will set you up well to meet your desires by 57.

If you have more surplus you might consider VCT's to reclaim tax, intending to retire earlier than you can access a pension or simply as insurance against job loss.
You could make charitable gifts earlier.
You might put more into the pension to pass more on free from IHT or to cheaply increase your pension income.

*I've ignored complications, but there are some good calculators out there that don't. This is the one that I have been using.
https://firecalc.com/

hiriskpaul
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Re: Should I be putting most of my income into my pension or into an investment account?

#436777

Postby hiriskpaul » August 23rd, 2021, 7:56 am

Alaric wrote:
hiriskpaul wrote:The last really awful multi-year bear market ended in 1973.


Don't you mean 1974 or 1975?

It sticks in my mind that the FTSE 30 index at the end of December 1974 had fallen to a level only previously seen during the Dunkirk evacuation in 1940. It was short lived as there was an immediate recovery with the index doubling in a couple of months. That was just as well as had the accounting standards required "mark to market", then financial institutions may have been technically insolvent for their 31 December 1974 reporting.

Quite right, 1974/75.


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