Pension as an Investment

[Spydaman]

I'll be 55 in two years time when I think I'm correct in saying I can take 25% of my pension pot as a tax free lump sum. I think I'm also correct in saying and this is the bit I'm not quite sure how it works, if I pay in a certain amount to my pension the government tops it up by my rate of income tax. Therefore if I pay in x it becomes x + 40% when I'm 55? What could possibly go wrong?

[Zigster]

If you're a 40% taxpayer (but expect to be a 20% taxpayer once you retire) it works roughly like this:

Pay £60 to your pension out of your net pay.

Government tops it up by £40 to make it £100 in total. (It might be a little complicated by how the tax relief is received - in some cases you would have to pay £80 which the Govt tops up to £100 and then you claim the additional £20 back via your tax return - overall effect is the same though. You might also be able to structure it so that you save employers' and employees' NIC as well.)

Get tax free investment growth between now and retirement.

Take 25% of the fund tax-free at retirement. (Again, it might not be quite as straightforward as this - but it's close enough.)

Pay 20% tax on the pension (annuity) you buy with the remaining fund. (Annuities can be a little controversial - I won't go into that here.)

So you have paid in £60, got tax-free roll-up, and got £85 out (i.e. £25 + 80% x £75)

[Spydaman]

Thanks for the reply. That all makes sense expcept for the last line. If I put in £60 which gets topped up to £100. I can take 25% of the whole pension pot when I'm 55 which maybe more than £100 but would include the £60 I put in plus the £40 the government put in? I wouldn't be looking to buy an annuity at that time. Another question. If I take my 25% at 55 can I continue paying into my pension till I do retire.

[Zigster]

I'm pretty sure you can take the 25% lump sum but defer buying the annuity until another time. But, at some point, you will have to take that residual 75% as income which would be taxable. So the numbers work out the same - except, as you pointed out, that investment returns would hopefully increase the total amount invested.

So (ignoring investment returns) £25 tax-free cash lump sum with £75 still held in your pension plan to be taken as taxable income at a later date.

If you do take your 25% at 55, you can generally continue to pay into a pension scheme but you have to be pretty careful not to get caught by "recycling". The recycling rules are complicated but are designed to stop you taking out the 25% and then reinvesting it in your pension to get more tax benefits (including 25% tax free of that 25%). It all gets a bit complicated ...