Pension Saving and the Lifetime Allowance

by George Hatjoullis

Grim warnings about inadequate provision for old age abound. For the typical 30-year-old trying to make rent and save for a deposit on a home, such warnings will most likely have the effect of persuading them to ignore the whole pension saving issue entirely. They will do nothing. This a shame and rather unnecessary. It is all in the presentation.

Pension saving is a specific example of saving. The difference is you are targeting a pot to provide income 38-40 years hence ( I stick with my 30-year-old). Pension saving can get help from an employer through employer contributions and own contributions are relieved of tax. The amount invested on your behalf can be significantly greater than you give up in disposable income. If say you earn £25k and your employer contributes 3% (£750 pa) and you contribute 10% (£2500 pa) tax relieved at 20% (£2000 pa) then £3250 pa is invested on your behalf and you disposable income is reduced by £2000 pa or £166 pm. This is still a substantial sum for someone on £25k pa but not impossible. Moreover you could start with a £100 or less and increase later. The important thing is to start and get into the discipline.

The amount £3250 pa invested on your behalf might, on reasonable assumptions, enable a pension of £19500 pa in today’s money. This is worth having. The important thing to note is that it is not necessarily worth saving much more through a pension scheme. This is because of the lifetime allowance being set at £1m. If your pension pot exceeds this figure in 38 years then penal tax rates are imposed. To achieve £1m in 38 years may be easier than one might think. On my assumptions this would be achieved by investing £398 pm for 38 years. On more conservative assumptions it might require £617 pm for 38 years. Bearing in mind nominal salaries increase this could be achieved by starting lower and increasing saving over time. The message is there is not much point in saving more than say £500 pm through a pension scheme, including the employer contributions, as long as the LTA is £1m.

This does not mean it is not worth saving. ISAs provide a very useful savings wrapper. This is because everything within the wrapper is free of tax. If your pension contributions have you on course to achieve £1m LTA by retirement it is fruitless to invest more in a pension even if contributions yield tax relief. If you exceed £1m the excess will be taxed back. The constant complaint one hears is that people do not make enough provision for retirement and specifically through pension contributions. But the rational amount of pension contributions is logically capped at a fairly low-level. General saving still makes sense but this is subject to current needs.

My advice to young people is think about achieving a pension pot of £1m. You have a 40 year or so time horizon so you can start small. The important thing is to start and keep going. Invest in assets that have good growth prospects (not cash). Low cost passive equity funds are ideal. Keep the costs low. Keep saving and make sure you use an employer scheme, if the employer makes a contribution. Increase your contributions in line with income but remember you need only increase up to the point that makes £1m over the 40 years likely. If you have the correct investment strategy and are consistent then it is unlikely that you will need to contribute much more than £600 pm into a pension plan and part of that will be an employer contribution. And once you are a 40% tax payer (which happens quicker than you might imagine if inflation picks up), every pound you contribute only costs you 60p in deferred disposable income. Do not let sensation seeking journalists put you off saving for retirement.

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