Pension or ISA/savings

[Orangeradiorabbit]

Imagine you're a higher rate tax payer and have recently started to save £40,000 per year in a pension. Would you stretch to max out your contributions to the new £60,000 limit, or put the extra £20,000 per year in an ISA (other "instant access" saving product) - at least for the next few years or so?

Putting the 'extra' in the pension now would be the most tax efficient and would generate excellent gains (potentially) through compound interest, but the money would be locked away and you would struggle to have any other savings - I.e. you would be living very frugally now, but could afford all bills and some limited treats (no new cars, house upgrades, renovations, small holidays only). However, you could retire in 20 years at 55 with an approx. £2 million pension pot (if you kept the savings up) - and this would "cost" from take home pay only around £550,000 due to compound interest, tax savings and employer contributions. Obviously, once retired at 55 you couldn't access the pension for a couple of years (the age that people can access a private pension might also go up...). No children, inheritance or partner income/savings are in this picture.

I know many won't be able to relate to this, and are struggling to make ends meat in a cost of living crisis, but I'm keen to gather opinions of people who might be able to relate. I think financial advisors say to max out pension contributions first, after saving your "unemployment buffer".

This is about finding the right financial balance for you.
Pension locks away the money, ISA is accessible. You need a balance between the two. If you are 100% in one and 0% in the other, then that is wrong.

Mathematically the pension wins, so you would tip the scale more to that side.

Think about how much in ISA would make you happy... £40k, £80k, £100k? Maybe look at it in terms of a number of years of expenses if you want to retire early. You may need 5 years of expenses in accessible money.

Podcast about financial balance. meaningfulmoney.tv/2021/04/13/a-checklist-for-financial-balance/

Thank you for the reply. This makes sense. I will check out the podcast.

Do you not have a financial adviser? I would be getting one pronto if I were you!
Ours advises that you should have enough accessible money to live for at least 6 months, I prefer a year tbh. On a personal note, what is the point of scrimping and scraping just to have a large amount in retirement, you need to have a balance and enjoy your life, you might not even live to enjoy it in retirement! (gloomy I know but possible).

If you don't have children then I guess just take what you need/makes you happy/safe into ISAs and put the rest into a pension.

OTOH I suspect if (hopefully when) the next Govt is Labour they will likely reverse this change, so if you can get as much in as possible now it might be sensible, just for the next 2 years. I doubt they will be able to penalise you if they reset the cap (ie yours will remain if you have already breached whatever the amount is they bring it down to) I guess it depends on what is going on with the NHS and whether they still need the senior Drs that this is aimed at.

Savings
or work backwards from what pension you want
it's a surprise to me that you mention living frugally with that much going in a pension

that said, I always want to weep when someone dies before retiring, especially if they prioritised their pension.

@OldieButBaddie thank you for this advice. I did think about the liklihood of future governments reversing the decision. I tried to get a financial advisor before, but it didn't seem like they were interested in building a relationship - I'm not sure why, maybe I don't earn enough, or maybe they felt there was nothing they could "sell" me. I had the free 30 minute meeting, which they ended early and never followed up.

@EmmaEmerald you're right. Perhaps I need to find more balance.

Frugal is relative I guess, I have two jobs and putting a large amount into a pension means I can't do what I see a lot of other people doing (buying clothes, makeup, nails, hair, big house, house decorating, new furniture, cleaners, leasehold cars, concerts, mini breaks, shopping at Waitrose/Sainsbury, regular pup/takeaway/restaurants/cafe visits, buying coffee etc.) At the same time, I can pay my bills, save and afford a nice holiday per year.

I think I will listen to the podcast suggested earlier, and see if I can prioritise more balance and living for now, rather than put everything in a future that I might not get to.

Depends. Are you saving to buy a house or any other purchase? What sort of disposable income would you have after maxing out £60k a year in pensions? Will any of that go into savings/investments?
Personally I would want a buffer of readily accessible cash. So I would put the extra £20k p.a. into readily accessible savings for 2-3 years, and then increase to £60k pension payment

@Londongent I've just bought my first house, which wiped out most of my savings, and still have some work to do, and furniture to buy, for the house. After food, bills etc putting 60k into pension would leave me with around £400 disposable, so I worry it would take a long time for me to save anything substantial. It sounds like building the accessible savings first would be a better strategy.

Do you have any pensions from previous jobs? If it's just this one that you are still paying into then I agree, nothing in it for them. Nothing to stop you seeing someone and paying for advice rather than products though!

I'm grappling with how much to put into pension at the moment. It's really tricky. Have been putting around 25k a year in for the last three years so the cap isn't relevant to me but I can't decide whether to up it a bit - have historically been saving about 10k a year on top. I have about £65k across two ISAs (one SNS and one cash) and then around 45k in premium bonds. I feel like that may be enough savings really and the rest into pension but putting so much into pension feels a bit risky too.

I am weirdly shit at these decisions!

Thanks for your reply @Hobert , it sounds like you have a good range of investments. Can I ask, what feels risky to you about putting a lot in a pension? This is a genuine question because I've heard people say this in passing before, but never asked specific details. For example, i can chose where to invest my pension and I have bought into a range of ETFs. This feels the same as I would with a S&S ISA or general investment account, unless I am mistaken. The difference is I cannot access it until after a certain age.

I worry that I'll have some mega emergency or become unable to work and have too much money that I can't access. I think I am probably too cautious generally though. I also may have one more house maybe in which case I would like to be able to have a large deposit.

@Hobert thank you for your answer. This makes a lot of sense. I've only relatively recently had a job that pays well, and previously always lived month to month (never imagined being able to save or buy a home), so I tend to worry less about emergencies as I've always gotten by. However, what you've said is right - it is important to prepare for emergencies too now that I am able to.

I was like that - I changed professions when I was 30 and went from having slightly less income than I needed for essentials (so getting into debt) to having quite a surplus. I then built up a bit then completely cleared every saving to buy a house and have been building up over the last 5 years.

I think there is a balance to be struck definitely!

I also would like to give my child a lump sum to help with a house at some point (he's only 7 now) but vague plan is to either downsize or remortgage depending on the circumstances at that time.

I’ve been thinking about this too. My salary has gone up quite a lot in the last few years and also have 2 kids under 5 so maternity leave and childcare costs have really impacted savings but starting to see light at the end of the tunnel on that.

I’m probably going to put in about £50k this year (costs c£20k to me). I’ve got 6 months worth of expenses saved so going to put any other spare cash towards overpaying the mortgage I think as we’re on a cheap fix for the next 4 years. Once DC2 starts nursery in Sept 2024 will have a lot more disposable income.

In your position OP I think I’d try to build up some savings in an isa before maxing out your pension contributions. Pensions benefit hugely from the tax breaks but are effectively locked away until late 50s and the goalposts are constantly changing. I’d do a couple of years of isas to have that buffer. Who knows what might happen in the future, you might want to move, meet someone, travel - lots of positive scenarios as well as the gloomier ones.

once you have that, I’d then look at potentially maxing out pensions. In the meantime, you will still be putting in a tidy sum to your pension.

Also got to keep in mind that when you take your pension you will pay tax on the drawdown (ok not the first 25%, but after that you will). People rarely mention it, but pensions are not completely tax free.

Pensions are only made sound good with tax breaks etc when u are putting money into them, u try getting it out (speaking from bitter experience!)

Pensions are invested into pretty much the same stocks and shares u can do yourself w/o locking money in for many years.

Max your pension when it comes with contributions from your employer. If you're a higher rate tax payer, it also makes sense to maximise your pension as much as possible. But also balance some liquidity (stocks/funds/bonds/cash/etc) for the unforeseen.

When you get a lump sum like this, I'd look at the balance of your portfolio.

Do you have good liquidity if you needed 4-6 months living costs? No? ISA (cash or S&S). Yes? Pension or Mortgage.

I think it depends in part which tax bracket you will be in after contributing £40k (gross) to the pension. If you would then have taxable income between approximately £100k-£125k, putting you in the 60% tax band, then extra pension contributions do have a pretty strong argument behind them (£1 into your pension only costs you £0.40 in after tax income). .

However, I also have a lot of sympathy for the argument to put at least some of it into an ISA, assuming you are not already doing that. The funds remain accessible if you unexpectedly need them sooner. Conversely if you end up leaving the money in the ISA invested for a multi-year period, then there will be an excellent chance to receive income and gains within the ISA that are tax fee (where as in a pension, at least 75% of the appreciated amounts will then get taxed as ordinary income).

Join the UK FIRE groups on fb and you will find your tribe :)

Also read monevator blog

Personally I was on the train , and I decided to take a more moderate approach as I am not prepared to live that frugally ( I had a change of heart)

I have seen here and elsewhere that the years between ages 50 and 60 are known as snipers' alley amongst some healthcare professionals. Meaning that that is the age group when some quite serious health issues first start arising. eg heart problems, cancers, strokes. So I would say bear that in mind when you're thinking of saving a large retirement pot until aged 67, which you might never get to enjoy.

I knew someone who had made nice retirement plans with his wife, they were looking forward to becoming grandparents soon etc etc. He was only 56 but dropped dead at work totally unexpectedly. Completely out of the blue had a heart attack. It was a shock to everyone and I can't even imagine how his widow felt knowing that all their plans had come to nothing. As I approach that age myself that is always at the back of my mind. It is so important to get the right balance of making sure you have enough for a nice retirement but not living so frugally in the run up to it that you just don't enjoy actual LIFE.