6

UK-based.

I'll be receiving a Christmas bonus of somewhere in the range £6-11k. I have the option of sacrificing bonus directly into my pension fund, and I'm trying to check whether that's the right thing to do.


If I take the bonus as cash, I'll pay:

  • 40% higher rate tax.
  • 2% National Insurance.
  • 9% towards my Student Loan (currently £8.5k, 1.25% interest, projecting to be paid off in ~3.5 years)

If I put the bonus into Pension, I pay no tax, NI or Student Loan, and the 13.8% Employer's NI that my employer doesn't have to pay gets added to the pension too. Under current rules, when the pension matures I get 25% tax free, and the rest is paid as an income, taxed at 20%.

So for each £1k of bonus:

  • I could take £490 cash-in-hand, plus £90 deferred by 3.5 years (the Student Loan gets paid off £90 earlier), plus save £5-10 interest on the loan.
  • Or I could take £1138 into my pension, of which (before growth) I would get (£285 + £683 = £968) back when it matures.

If I were to take the case, then I could spend the windfall, or put it in a 1.5% interest account (other higher interest accounts are "interest on the first $X k, and are all saturated.), or I could make an early payment on my mortgage (£175k, 3.84%)

  • Paid against the mortgage, that £490 could save me ~£1k of interest over the lifetime of the mortgage.
  • Put into savings that £490 would earn £880 in interest over the same period in the savings accounts.

I currently have £8k of savings, saving ~£150/month. No other CC debt or loans, but a predicted upcoming housing expense of ~£5k expected to be billed over the next 3-5 years.


Taking all the above into account, it seems like sacrificing into the pension pot is the clear choice, as it instantaneously gains about half of what the cash option could gain over 30 years.

(I'll probably still take some small (£500-800) windfall, to enjoy)

Are there any factors that I've missed in this consideration?

8

The pension is indeed the clear winner and you haven't missed anything.

It's easiest to just compare everything in current numbers as you've done and ignore investment opportunities. Given you expect to pay off your student loan in full, you should consider the repayment as a benefit for you too, so the balance is between £580 after tax and £1138 in your pension. As you say under the current tax regime you'd probably end up with £968 in your pocket from the pension.

Some harder to value considerations:

  • You might consider there's political risk associated with the pension, as laws may change over the years - but the government has so far not shown any inclination to penalise people who have already saved under one set of assumptions, so hopefully it's reasonably safe (I'm certainly taking that view with my own money!)

  • Paying more towards your student loan or your mortgage is equivalent to investing at that interest rate (guaranteed). If you do the typical thing of investing your pension in the stock market, the investment returns are likely higher but more risky. In today's interest rate environment, you'd struggle to get a "safe" return that's anywhere near the mortgage rate. So if you're very risk averse, that would tilt the balance against the pension, but I doubt it would be enough to change the decision.

  • Your pension might eventually hit the lifetime allowance of £1mn, after contributions and investment growth. If that's a possibility, you should think carefully about the plan for your contributions. If you do go over, the penalties are calibrated to cancel out the difference between higher-rate and basic-rate tax - i.e. cancelling out the tax benefits you outlined, but not the national insurance benefits.

    But if you do go over, the amount of money you'd have mean that you might also find yourself paying higher-rate tax on some of your pension income, at which point you could lose out. The lifetime allowance is really complicated, there's a Q+A about it here if you want to understand more.

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