Why You Shouldn't Pay Into Your Pension (UK)

We're always told that planning for your future is one of the most important things and pension contributions are the single best way you can do this planning.

You're told by the government, every financial advisor and every finance YouTube channel about the importance of putting money towards your pension. Many recommend you contribute much more than the minimum requirement of 8%.

I am generally a big proponent of financial planning and I agree that planning for retirement is very important.

But it's also really important to be aware of the fact that if you save too much into your pension, it can be a really bad thing.

The UK Government has introduced a Lifetime Allowance for pension pots which sounds very high - it is over £1,000,000.

But although that sounds crazy, if someone one a median wage contributes the minimum amount from 21 to 68 which is the current target retirement age, their pension pot will actually be bigger if it grows at an average rate of 8% per year.

If you happen to earn more than the median wage for a good chunk of your career or your investments do better, your pension pot could be much bigger than that.

And if it is... the UK Government will tax you 55% of any amount over the limit if you take it out as cash or 25% if you buy an annuity... before then taxing your annuity as income as well.

Unfortunately this is something that just doesn't get mentioned at all when people talk about pensions and given that this may actually apply to a significant number of people as it stands, it's important to take it into account when you're making your financial decisions.

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[SashaYanshin]

And just a few days after I post this video, news comes out that the Government is considering freezing the allowance to raise extra tax... Who would have thought...

[Mememeeeeeeeee]

You do a reasonable job of caveating this analysis in your video, though I feel you could emphasise two things more clearly: firstly, that all contributions to a pension are made from pre-tax income, so there is an immediate 20% (or even 40%) gain at the front-end, further supplemented by the mandated employer contribution that is not received if an employee actively "opts-out"; and secondly that there is a commitment to increase the lifetime allowance by CPI (which you do mention, but do not proceed to analyse). I recognise your comment that "government is considering freezing the allowance" but that is always the case (and note that, similarly, government enjoys increased tax-take every year as the higher-rate tax threshold rarely keeps up with increases in earnings). However, a reasonable CPI estimate based on 30 year historical averages would be around 1.5%, though even with a pessimistic 1% rate of CPI the lifetime allowance would always stay ahead of the "total pot" size by your analysis. I would make two further points: firstly, that your analysis assumes an 8% growth of investments. While I don't disagree that this may be appropriate (based on historical average stock market performance for the last 50 years or so), the further back you go the lower this would be, and your comments that this is pessimistic is not reasonable unless you use more recent stock market performance (circa the last 10-15 years) as your sole indicator (considering pensions are invested for 30-48 years); secondly, note the UK government's track record in protecting existing investments when it makes substantive changes to annual and lifetime allowances. In particular, note the allowance protection measures provided by government for existing savers when allowance changes are introduced. I note this only to recognise that, in the event the government seeks to make substantial changes to the allowance limits, there is precedent for existing pension pots (or portions of pension pots) to be treated differently and protected from such changes. In view of all this, I would say that the analysis in your video is less reliable as a basis for informed decision-making on pension savings and risks dangerous interpretation by viewers. My concerns in this regard are emphasised by some of the comments in response to your video that suggest some people may actually de-emphasise pension savings and (heaven forbid) opt-out of a workplace pension altogether. Otherwise, thank you for the though-provoking video.

[financialfreedomandeducation]

Sasha this is a dangerous video and title and is much more complex than you are giving to it. You made too little of the fact that the Lifetime allowance is likely to rise considerably and could easily be in excess of 2 million in 40 years time. Not sure I agree with you covering a topic like this in such a one sided way. There are some massive benefits to paying in to a pension as well as a mix of other investments.

[bbuirds]

Hey Sasha, maybe worth updating this video as its been announced the tax will scrapped from April 2024.

[BouncingBack]

Interesting points. In my long experience of work place pensions, they have returned on average 6% plus there will always be the market dips and subsequent recovery time to factor in too. Workplace pensions are still important and if ever I should even get close to the lifetime allowance, then I'll just retire. I want to retire before the state pension age anyway so my workplace pension is extremely important in achieving that goal otherwise we just flog ourselves until we die.

[theonlyroux]

First point.. I would love to see your investment recommendation on an 8% p.a. investment return for 45 years.. I think this assumption isn't conservative at all.. generally speaking most individuals choose to reduce risk on the approach to retirement (moving at least in part into cash or lower risk bonds) these asset types are not likely to produce 8% p.a.. Studies have also shown UK investors tend to be fairly risk adverse. Second more important point.. in most cases the biggest incentive in the UK is that employers have to make a contribution and in the majority of cases this is well in excess of those required within auto enrolment (to be clear the 8% isn't all coming from you!). Third point employers often offer contributions on a salary sacrifice basis.. clearly giving tax and NI savings (upfront). Forth point UK pensions give you tax free investment returns (no capital gains) and also a tax-free cash lump sum. Fifth point you've completely ignore the impact of investment charges (employers are often able with economies of scale to negotiate far lower charges compared to retail products) So overall your example is completely oversimplified.. a comparison against other long term savings is required to form a true view..

[uvscja]

Sorry but this is bad advice. My employer pays 13% contributions if I pay 5%. That, along with the tax savings, means I'm getting a huge boost to my pension for free, basically.

Also I can choose what funds I pay into and what proportions.

Making videos basically suggesting not paying into pensions is a bad idea, especially if someone who is clueless about personal finance watches this...

[tc]

8% is incredibly optimistic, you would need to be comfortable with a 100% equity portfolio, and bear in mind whatever % of that is taken up by inflation, the LTA may rise accordingly.

[djguf]

Employer contributions? You're getting a 60% return instantly by paying into any pension scheme, and that's the statutory minimum...most employers pay much more than 3% to your 5%. On top of that the tax relief at source of 20% (or 40% or 45% via self assessment return) is probably not as good if you tried to invest using a SIPP instead. The only real reason not to pay into a pension is if the provider is sh*t, that way you have control over what you invest in via tax relief using a SIPP. Not paying into a pension though and taking advantage of employer contributions is equivalent of paying down a smaller loan with a very low APR as oppose to paying down a larger loan with a higher interest rate because it 'feels good' aka, it's a bad decision.

Long story short, pay into your pensions people...its free money, the government have made it easy to do so you dont have to trawl youtube videos for investment advice - and if you approach the lifetime allowance (which you probably wont) then just stop paying in at that time, why opt out before you even reach that milestone?

[SagaraUrz]

People think that the government is doing you a favor with pensions? They never lose.

[kinamodk]

This needs updating seeing as the Lifetime Allowance has been abolished in 2023

[jamesedwards]

I have a works pension which is managed by the Royal London, I am now 55 years of age and trying to put as much in as I can afford. The company contributes 10% and I 20% but the pension this year as lost £1500. I contacted Royal London and they said we do not choose the investments your company does that, my account online it give you the impression you can change your own investments but when you hit save button it does not. The investment the company have chosen 80% of them are loosing money, when I got in touch with the person who deals with the company pension she seems not want to talk about it or moves the conversion in to another direction. Do you think some companies just tick the box because they have to provide you with a works pension by law and do not care about manage it properly.

[elliottjperry]

Note that as of March 2023, the lifetime allowance has now been abolished.

[Tensquaremetreworkshop]

I did not join any pension scheme until I was 35 (and then it was non-contributory). Instead I 'invested' in building a quality house (third property) and owning it outright. When, in retirement, I downsized, the returns from that were close to the pension limit- but were free from any and all taxes. Cash. When I add all the mortgage interest that I did not pay, plus rental returns from an annex, it was the best financial decision I ever made- or could make. I retired at 52, and travel the world.

[SashaYanshin]

Funny that right - encouraging people to do the right thing which may well mean a huge number of these people then pay a huge chunk of tax when they come to retirement. 👍

[xneurianx]

With all due respect, I would question some of your assumptions here;

1 - AE rules only come into play when you reach 22. You've added an extra year of contributions and an extra year of compounded growth onto the whole thing. Additionally you've added the extra year at average pay rate which most people simply won't be earning at 21. You probably want to knock that first year off because most people do not have a workplace pension until they are 22.
2 - SIPP growth rates are high, but SIPPs are not used for Automatic Enrolment purposes. Most people who are automatically enrolled will find themselves in a Master Trust pension which does't offer even nearly the same level of investment flexibility.
3 - You're assuming that if people start pension contributions now and retire at 68 (46 years time if they are 22 now - 2067) the LTA will be the same as it is now. Whilst the LTA has been frozen for the next few years it has also been announced that in future it will be linked to CPI. It's hard to estimate what rate CPI will be, but even at a rate of 0.5% (VERY conservative) the LTA would be c. £1.2m by 2050.

I mean, broadly speaking I don't disagree with you, I think ISAs can be a more sensible investment option, or investments in the stock market if you are particularly savvy or can afford a broker. I just think your assumptions are either flawed or disingenuous.

[markstevenson]

Are you actually qualified to give financial advice? You are using todays LTA and comparing against a future fund value. You are doing what pension providers did in the 80's by using an unrealistic growth rate and not taking into account inflation. The reality is that the vast majority of people will never hit the lifetime allowance and even if they did (which they wont) its really not a bad problem to have. Did you mention that funds held in a pension are free from Inheritance Tax? Or that the death benefits to a spouse are tax free? At least do a bit of research on a subject before purporting to be an expert

[wallen]

1. If you don’t pay into your pension, you lose that employer contribution.
2. You don’t get basic or higher rate tax relief on contributions into any other type of tax wrapper. That’s an immediate uplift of either 20% or 40% on your net contribution. (Even outstanding investments in an ISA won’t give you that).
3. The lifetime allowance charge only comes in when you crystallise 100% of your tax free lump sum. By managing your pension income properly, you can avoid that until the test at 75.
4. Legislation can always change, why avoid such generous contribution benefits because you’re worried about a tax charge that will be minimal in comparison to the additional employer contributions and tax relief.

Pensions are the most generous of all tax wrappers - take advantage of it while they still offer you relief.

[GSE]

I don't think young people turning down a 20% tax rebate and minimum of 3% free money due to being 'too much of a millionaire' in 35 years is wise. As you said at 6:45, this is the sort of tax issue you think about when you have hundreds of thousands invested and saved, not as a young investor. Cancel contributions at 500-700K in your pension, not at 10K! Imagine if the allowance double in 20 years and you said no at 25.

[Asif]

I get your point but in reality most people won’t get a pot over £1mil in today’s money. Point 2 5% increase is more realistic. Point 3 you are saving tax on your contributions via salary sacrifice. Point 4 there won’t be a state pension for anyone under 35 when they reach retirement age on my opinion.