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Thursday, 23 April 2009

Some pension advice

It now no longer pays high earners to pay into a pension fund in the last part of their careers. Assuming that they would still be paying tax on their income at the highest rate when retired (we are talking about FTSE chairmen) it doesn't make sense.

For these people income that is paid into a pension is taxed at 30% when first received from the employer and then the income that it produces is then taxed at a further 50% or 40% when paid out. The only benefit of holding the money in a pension fund is the tax free accrual of income although there are no credits for withholdings on dividends.

If we assumed that the time that the pension is held in the port is relatively short or the interest rate is very low then there is no benefit from holding the money in the pension fund, because the any pension money that is paid to the pensioner has effectively taxed at 80%. A better solution is to receive income net of tax at 50% and to invest the money outside the pension fund, where any income accrued will be taxed, but the capital may be drawn on free of tax.

So the strategy would be high earner contributes to pension fund until age 60, but continues working until 65 receiving taxed income which is invested. After retiring at age 65, pensioner draws on capital invested since age 65 but only draws on pension at a later date having agreed with the pension provider to defer the pension for a higher annual pension.

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