Use a pension or not? (deferred access to money)

[RichUK]

Hi all.

I'm from the UK. The income-tax bracket that I'm in is 40%. I have the option to contribute X% of my salary to a pension where the contributions come off the top line, before tax. The benefit of doing this is that I do not have to pay the 40% tax on any of that money (eg I could draw £100 as my salary, and receive £60 take-home... or I could put all £100 into my pension). The catch is that I cannot access any of that money until I'm 57 yrs old (I'm 32 now).

For ERE, it doesn't make sense to maximise my pension contributions, as I will want to start spending some of those savings before 57. I.E. If I put all my savings into the tax-free pension and then retire in 5 years, I would have to wait another 20 years to access any of the money. On the other hand, if I put nothing into the pension I'll have to pay 40% tax on the money I receive right no — that seems like a high premium to pay for money that I probably(?) don't need right now.

So I'm thinking a better strategy is to have a split of some sort - two pots of money. One that is inside the pension structure and one that is outside. My problem is that I'm not good with the long-term vision and perspective. I want the money now, even though it will cost me in the long-run; I hate the idea of it being locked up and untouchable until 57. I'll be so OLD then .

(For UK peeps, assume I'm maxing out my ISA contributions already.)

A worked example for the next 3 years with 2 options (fairly arbitrary): -

A: £141k savings + £72k pension
B: £184,000 savings.

- i.e. £43k "liquid" savings, vs. £72k pension

Seems like a bit of a no-brainer (pick option A), but in this example I feel £43k poorer, rather than £29k richer. (How weird is that!). FWIW this 3-year period is about maximising my income (in my IT career) before maybe switching careers and lifestyle (running away to the mountains and going off the grid, or something like that). I think that is a reason why I want access to the cash – so that I can use that £43k in my exit/switch strategy, rather than drawing it later.

Any advice or comments?

[George the original one]

I'm in a similar situation(*).

Probably you should work out the various amounts required to cover your expenses during the "gap years", the years between when you are FI and the years when you can use the pension. You'll want to make sure your future self is adequately funded, yet also have your gap years covered.

Sheltering from 40% tax seems very worthwhile when it can fully fund your age 57 future self and then backfilling for your present self.

(*) In my case, future self was more fully-funded than I understood via employer's pension, so adding money to retirement funds should have been halted sooner. Fortunately the USA rules let me have penalty-free access to a portion of the retirement funds outside the pension. The difference between you & I is that you need to cover 20+ years and I only need to cover 5 years of expenses.

[Egg]

I'm in the 20% tax bracket so income tax doesn't suck quite as bad for me, but even if I were at 40% I figure a bird in the hand is worth two in the bush. 57 is such a long way off your retirement will come earlier by not contributing to your pension and you'll still be fine by the age of 57.

The only exception would be if you plan to work to 50+ in order to fund an expensive retirement. If you can afford retirement without the pension payout, though, I don't see why you'd hold on. A bigger number past a certain point doesn't really matter. "When can I pull the trigger" is more important for you imo than "how much could I save by 57".

[vexed87]

I've been reading about peak oil, the future economy and pension plans and I'm starting to doubt that the schemes will ever pay out, I'm currently contributing to one of the better UK penisions in the NHS... I'm 27 and concerned I will never see a penny of it. So much so that I'm thinking leaving the pension scheme altogether and investing the cash myself. Obviously there's additional cost in doing so, I'll lose employer contributions and the tax break on personal contributions... if peak oil turns out to be a myth I'll be looking like an idiot

[sky]

I did a quick model (hopefully correct) here: https://docs.google.com/spreadsheets/d/ ... sp=sharing

If 10% of savings goes to the pension account, at age 57 you would have about 25% of your investment income coming from the pension account, compared to the taxable investment account. This would have cost you about 4 months extra work to get you to the FI Target Amount (with no pension - 36 months, with pension - 36 months + 10% = 39.6 months). Both cases assume a 2% inflationary increase in expenses and a 6% annual investment gain.

If unspent, the pension account exceeds the investment account at age 76. It might be worthwhile for a health care or senior living savings plan.

[underscored]

I am also in the identical basket at an identical age. Please be aware that the age that you can draw your private pension is State Pension Age for Your Cohort - 10 years. There is no guarantee that we will access to our savings at 57. As it is deliberate government policy to keep us working as long as possible and 30 years is a long time, I am not topping up my pension.

Instead I am going the route of Venture Capital Trusts 30% tax back in the pocket, on top of ISAs (me, wife and children).

[Fuzzy]

Taxes are probably your biggest expense, so it's important to think them through. I also think having lots of different piles of cash is better than having all your eggs in one basket, especially if you can cover different sorts of risks. For example high inflation vs low inflation.

The details really come into play, but I can't help on that. I tried researching UK pensions, but I somehow know less than when I started. It's similar to the US in that it's really complicated.

There's always the risk of having the pension terms change, but that's a universal risk. Governments can freeze other assets, or suddenly change rules. Markets can do all kinds of crazy things in decade-long stretches. Your brokerage could pocket your money and disappear like MF Global. Generally you get at least a partial restoration of your money if you don't panic.

[FRx]

Do you know if by chance that money is accessible any sooner? In the USA our pensions are not accessible unless there is a death (at least the pension that my company offers). However there is a Cash Balance Plan that sort of acts like a pension and that one we can take with us so it actually has a cash value. Naturally the cash value will be whatever it is after taxes and 10%+ of penalties for early withdrawal.
Also, is there other tax reducing options that you can utilize besides the pension?

Your income is high enough and your taxes certainly high enough to argue in favor of using the pension. But in my own personal situation if I had no way whatsoever to access the pension until age 57 then I would have to do the math and see what my years to age 57 would be and how much extra work I would have to do to make up for the money disappearing into the pension.

[underscored]

Do you know if by chance that money is accessible any sooner?

https://www.gov.uk/early-retirement-pen ... e-pensions

[RichUK]

Thanks all.

I created a spreadsheet similar to @Sky's and my conclusion so far is that "it doesn't really matter". For simplicity, assume at the end of my accumulation phase in Scenario-1 (S1) I have £X + £60k cash, and in the Scenario-2 (S2) I have £X + £100k pension (the difference being the 40% tax).

(X = 190k)
S1: 250k, 0 pension
S2: 190k, 100k pension

My prediction is that either scenario I will be able to draw a suitable WR: A 4% WR in S1 == 5.25% WR in S2.

The FIRECalc risk looks pretty similar too.

S1: 40 years, 250k, 10k => 85%
--------------------------------------
S2: 20 years, 190k, 10k => 87% (i.e. risk of bust before accessing the pension)
S2: 40 years, 290k, 10k => 99% (total value of investments, ignoring limited access to pension)

Coin toss? S2 looks better on paper, but S1 means having access to an extra £60k. My gut says that may provide me with more utility than having extra cash/security later (maybe it's the deposit on a house or some land). I also don't trust the pension situation in the UK and it would surprise me if it doesn't change in the next 20 years.

Anything I've obviously missed from this?

[sky]

If it are me, I would focus all saving on FI, not the pension. Age 57 is too far into the future. Being able to access and control your money is important.

[Noedig]

'I want the money now, even though it will cost me in the long-run'
A bald statement. But why should you want to be like a kid in those studies of deferred gratification, who given a choice between a cake now and two in five minutes, just scarfs the cake now? Or, put it another way, you will have enough cake now: savings outside your pension to spend before pension age. But you will also reach pension age then need money. So it seems that because the pension money is outside of your control, locked away, inaccessible, this feeling that drives the viewpoint.

But I would argue against that view, even that you would be nuts not to max out your 40k GBP untaxed Pension Contribution, for these reasons:

-On retirement you can get 25% of it tax free and the rest at your marginal rate of tax. This beats 40% tax now.
-The annual contribution limit has been continually reducing ... was 255k, then 50k, now 40k...and the next Govt step will likely be to reduce the tax relief on it. This may tell you, it's a better deal than you think.
-Maybe the govt will increase private pension age. Maybe not :http://www.thisismoney.co.uk/money/pens ... -axed.html
-It's out of immediate consumption but I would point out, *not* out of control: stick it in a low cost SIPP e.g. YouInvest - and manage your investments yourself. I do that, have about 60% in Pension, 40% in ISAs.

As for investing in VCTs instead of a pension, for 30% tax relief: there is an entire industry that wants you to do this. I know, I did so, around age 32 myself, on urging from my then accountant (who got commission! Boy, was I green!). My view now, is that an investment chosen for tax reasons is likely to be a poor one, with high charges. This view is widely held, e.g. 'Money for nothing among VCT Managers" article:http://www.ft.com/cms/s/0/3c658664-9567 ... z3ciXfACSn

As for quitting an NHS pension scheme in order to invest yourself: my wife is in the current new joiners NHS scheme, and it is rather generous in comparison with most, being one of those "Accrue a percentage of your career average salary each year" style ones. She gets more for her contribution than investment outside the scheme would get her.

That said, you have wised up to ERE at a young age: Saving so much now, you will do well in either circumstance. Well done, and good luck.