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Thanks Dad! for starting me on my first pension

How much should you save in a pension? Greg Kingston, the man who lived on the state pension for a week, had a shock finding out. 

 

by Michelle McGagh on Aug 31, 2012 at 12:51

Thanks Dad! for starting me on my first pension

Greg Kingston (pictured) knows a thing or two about pensions as he works for Suffolk Life, a company that provides self-invested personal pensions (Sipps), and he used to work as a financial adviser.

However, even those people working in financial services need reminding about the need to start saving early and saving often – even if the amounts are small.

Living on the basic state pension for a week recently was the kick-start Greg needed to look at his own pension savings to make sure that he can live the life he wants in retirement.

You can read more about Greg's state pension challenge here.

We put Greg in touch with Arthur Childs, managing director of Arch Financial Planning, an independent financial adviser in Guildford, to make sure Greg was on the right track.

Here’s what Arthur found:

Name: Greg Kingston

Age: approaching 40

Wants to retire: 68

Greg’s plan: He plans to retire at 68 but continue working part-time for a couple of years. Although he has aligned his retirement age with the impending increase in the state pension age he is assuming the state retirement age will continue to rise and does not expect to receive a state pension until age 70. Greg would like to own properties in two countries in retirement and split his time between them.

Ideal retirement income: £35,000 a year

Minimum retirement income needed: £20,000 a year

Pension savings: Greg has £36,000 in a company stakeholder pension into which 20% of his salary is contributed by his employer each month as part of a salary sacrifice scheme. He also has £38,000 in a Sipp. A combined total of £74,000.

What he’s saving: Greg saves 20% of his salary each month.

The goal: In order to fulfil his retirement ambitions Greg needs to save at least £500,000 in today’s terms.

What the expert says:

Arthur (pictured) said the milestone birthday of 40 is a good time to assess your retirement plans because there is still sufficient time to make changes that can positively impact your retirement, leaving it another 10 years and any changes won’t have enough of an impact.

‘This is an important time [for Greg] to be considering whether he is heading in the right direction to meet his retirement goals. He has picked up the point that relatively small sacrifices today can make a bigger difference to retirement income. This works best if the lesson is learned as early in life as possible,’ said Arthur.

Arthur said Greg’s retirement date is ‘late but realistic’ and agreed with the idea of working part-time in the first two years of retirement. ‘This is an excellent plan and takes away something of the shock to the system of stopping work altogether. It also gives Greg time to adjust to his new financial situation,’ said Arthur.

Saving 20% of salary may seem like a lot, Arthur called it an ‘acceptable level’ for someone approaching 40, but said Greg would need to increase his saving to 25% of salary if he is to reach his retirement goals of £35,000 a year.

Greg has 75% of his Sipp money invested in higher risk emerging markets funds and his stakeholder is also invested in high-risk funds. Although Arthur said investing in risky funds now is fine, Greg should think about reducing the risk levels in the 10 years before retirement.

Greg is not just saving through a pension, he is also putting aside money into his company’s different share save schemes. In the ‘partnership scheme’ £75 is taken from his gross salary each month and £20 is matched by his employer. He saves a further £250 per month into a save-as-you-earn (SAYE) scheme but does not see this as part of his long-term savings.

Arthur recommended looking not just at pension saving when determining retirement income but also savings and investments squirreled away elsewhere.

‘Rather than simply use pension plans to build up funds for retirement I would always recommend a two-pronged attack for pensions, that is, to make use of general investment as well as pension plans,’ he said.

How is Greg doing?

According to Arthur’s calculations, Greg is not going to hit his ideal income of £35,000 a year in retirement. He is on course to receive £25,000 a year.

‘The shortfall could be fully addressed if Greg were to put a further £450 per month in his pension funds. The real cost to Greg of this additional contribution would be £337.50 per month as Greg would receive 40% tax relief [on his pension contributions] in due course,’ said Arthur.

‘This is not such a drastic increase as Greg is already saving £250 per month through [his employer’s] SAYE scheme that we have ignored for his pension funding.’

Arthur said Greg should plan a ‘steady increase’ in contributions over the next five years until he reaches 25% of salary, then move to 30% of salary when he finishes contributing to the SAYE scheme.

‘One quite frightening fact is that Greg’s future pension contributions at 20% of his salary over the next 28 years will only provide a pension of the same value as the £38,000 that is currently invested in his Sipp and assuming that no further contributions are added to it,’ said Arthur.

‘This is the result of compound interest and it shows how vital it is to build up pension funds as early in life as possible.’

What Greg says:

‘Having had time to reflect longer on the living on the state pension project, I’m more determined to do what I need to now to avoid reaching retirement and find that I’m short. Like most people though, I need to prioritise the demands on my income.

‘£450 per month is a lot to lose from my disposable income. It means that I’m going to have to plan quite differently for the next few years but overall I think it will be worth it. The money might be gone for a while but it is still mine and there’s no doubt I’ll need it in the future fare more than I need it today.’

Greg said the fact that the £450 extra saving each month will not catch up with the £38,000 he already has in his Sipp is ‘sobering news’.

‘That pension came from my first job and I remember my Dad telling me, almost forcing me, to join my company pension scheme. I did what I was told. Suddenly I wish I’d saved a few more pounds per month all those years ago. I’m eternally grateful for the financial advice I received, even if it didn’t come from a financial adviser. Thanks Dad!’

If this article has got you thinking and you want more information, read our guide to pensions. We've also got a guide to ISAs.

29 comments so far. Why not have your say?

Anonymous 1 needed this 'off the record'

Aug 31, 2012 at 13:11

Always seem to quote pensions as a ''figure' are we talking gross income or net income. The tax man will take at least 20% in tax. Also are we including state pension? Figures a bit misleading unless explained.

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Greg Kingston

Aug 31, 2012 at 13:15

I would just like to add a final footnote, with a huge thank you to Arthur Childs and his team who provided the retirement advice for this final update on my experiences of living off the State Pension for a week.

There's simply insufficient space to share everything they provided (plus I really do need to keep some details to myself!) but I found their Retirement Planning Report both professional and utterly invaluable.

A final thank you to the Citywire and Get The Lolly people, especially Michelle, for working so hard on these blogs and giving me the opportunity to share my experiences and, of course, to all those readers who took the time and effort to make comments.

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Anonymous 2 needed this 'off the record'

Aug 31, 2012 at 13:45

Rather than increase monthly payments by £450 into a pension fund where it can't be touched until you retire, better off putting £5400 into an ISA, either by monthly contribution or lump sum.

Main advantages are:-

1) You have full control, with probably much lower charges. More likely to outperform the pension savings fund in my opinion

2) Gains are tax free

3) It's flexible - if you need it earlier than retirement for a rainy day emergency you can access it. You can't do that with pension savings.

The article may have hinted at it euphemistically, ("general investment") but people need real practical advice in plain English.

Article focuses a little too much on just pension savings instead of the whole picture. I wonder why that would be?

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PensionMan

Aug 31, 2012 at 14:06

"Article focuses a little too much on just pension savings instead of the whole picture. I wonder why that would be?"

Because its about pensions??

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Anonymous 2 needed this 'off the record'

Aug 31, 2012 at 14:19

Pensions can be made up of savings in all sorts of places. They don't just have to be in a "pension scheme".

Ultimately, one needs a pot of money from which to either drawdown or buy an annuity. Where that pot of money comes form is immaterial.

Now Both you and I know it suits the industry very well to confuse the masses by saying it has to be "put into a pension scheme" but it doesn't.

All that matters is the pot at the end, not where it comes from.

Yes, the article is about pensions. But there are other ways of building up a pension pot than putting money into a "pension scheme", and they have several advantages, as per my previous post.

There is simply no point in building up a pension that pays over £10-15k per year gross because it will be taxed as income.

Income from ISA's however is tax free, no matter how much has been accumulated over the years.

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El_Duderino

Aug 31, 2012 at 14:31

Oh good grief, please list your assumptions and estimations when reporting calculated figures!

1) What inflation rate is used?

2) What growth rate is used?

3) What charges are assumed?

4) Do the calculations assume Greg's salary increases or remains static over the next 28 years? As Greg contributes a % of his salary, doubling his salary will double the value of his contributions for the same % contribution...

5) What annuity does he want? The £500,000 pot will buy a best buy single person flat rate annuity (5.8%-ish) today... But if he wants a joint plan with escalating or index linked income, the annuity rate drops by over a third...

And the maths in the article appear to be wrong:

"The shortfall could be fully addressed if Greg were to put a further £450 per month in his pension funds. The real cost to Greg of this additional contribution would be £337.50 per month as Greg would receive 40% tax relief [on his pension contributions] in due course"

Er, it's a salary sacrifice scheme meaning 42% tax and NI relief. And the net cost of £450 a month at that rate is £261, not £337.50. In fact the £337.50 net cost calculates through as £421.88 (20% tax relief), £496 (32% salary sacrifice), £562.50 (40% tax relief) or £581.90 (42% salary sacrifice)... None of them match the £450 mentioned!

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Rob Walker

Aug 31, 2012 at 14:42

I'd reiterate the preference in an ISA investment. Denying yourself 20% off the top-end of an income at 38 seems bonkers to me. Much better to save in something you can withdraw easily if needed. No-one knows how their lives will change between 38 and 68. Thecompulsion to stuff hard-earned cash into pensions just pleases the financial services folks. Any extravagant fun you have today can't be taken away whereas if you're on your deathbed at 64 you might be a tad bitter about all those sacrifices you made for that pension you'll never spend.

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Ian Hawkes

Aug 31, 2012 at 14:43

It seems you're ignoring the likely effect of deferring tax through to retirement. At 40 years old and working where he does (and aiming for £35k in retirement), Greg sounds like he's a higher rate taxpayer. As such, he likely gets 40% tax relief on payments into his pension.

Easiest way is to look at this in real money terms.

£1,000 into the pension will cost Greg £600.

Assuming no growth, he will then be able to take back £250 on retirement, the remaining £750 will be taxable at his highest marginal rate. If that's 20%, then the overall effect is to get £850 out of the pension for a contribution of £600, with no growth (ignoring any NI savings), assuming he lives long enough to break even on an annuity purchase. That's growth of over 40% just by manipulating the tax relief available. Admittedly you lose flexibility, but you can get a lot in exchange for that loss.

Additional growth available is the same between pensions and ISAs - the exact same investments are available in both tax wrappers using modern providers.

In addition, if he's already on track to get £25,000 a year, he may well opt to use flexible drawdown to unlock a large chunk of his pension as he phases into retirement, which would allow him to take out money as he wishes, subject to tax at his highest marginal rate once the PCLS is used up.

In short, for higher rate taxpayers with plenty of annual and lifetime allowance left over, a pension can be and extremely efficient way to save for retirement. It's less pronounced where the tax rate is liekly to remain unchanged, but there are still benefits due to the tax relief and the PCLS.

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Gill Pelosi

Aug 31, 2012 at 14:53

Anonymous 2

While I agree that it doesn't matter where your retirement income comes from don't overlook the advantage of a pension that gives you tax relief on the money paid in. I am a 40% tax payer so I get 40% relief on the money going in which I don't get in an ISA. I also have a salary sacrifice scheme so do not pay N.I. on the money going in either. If I have to pay 20% on my pension I'm still better off

Also, if your company is willing to pay into the pension scheme as well it's a no brainer. My company pays in 1% more than I do which means I actually pay in less than 30% of the total

I use ISA's as well for the flexibility but it can also be tempting to take money out of the ISA and end up with not enough to live on in retirement. Not being able to touch your pension until age 55 can also be an advantage if you are not strong willed enough not to dip into it!

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ALANR

Aug 31, 2012 at 15:11

I don't believe what I am reading, the only pensions which have any merit are Public pension and some Banks. Where is the logic of saving every month to a provider who when you reach 65 gives you back 25% tax free.

Then you receive less than 5% on the balance which may be taxed. If you die after five years they keep the lot, assuming they are still in business of course all to save 30% tax

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Ian Hawkes

Aug 31, 2012 at 15:26

ALANR: you are assuming that an annuity is purchased. This is not mandatory, and for larger portfolios there are other optiosn which can leave a large sum of money to dependents and other beneficiaries on death.

There's no need to wait until 65 either(or to commence benefits then if it is not convenient), unless you have specifically tied yourself into a policy with severe penalties for an earlier retirement.

You're also ignoring the effect of employer contributions, which can make it even more efficient. An employer matching 5% salary sacrificed contributions, for example, will result in a contribution of 10% of the employee's salary in exchange for a reduction in net pay of 3.4% of the gross salary - an excellent deal for an employee even if the employer isn't a bank or a public body.

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Ed the 5th

Aug 31, 2012 at 15:46

Avoid any scheme run by insurance companies which provide annuities or 'with profits' packages.

The only people who benefit are the insurance companies.

You don't know what the annuity-rates will be in 20 - 30 years time; but you can be fairly certain they will be pretty dismal.

Keep maximum PERSONAL control over your retirement savings, because the so-called experts don't succeed in providing a decent retirement income with YOUR savings.

I found this out 20-years too late.

Stick to ISAs.

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Greg Kingston

Aug 31, 2012 at 15:52

Thanks for the comments everyone. Just a quick note to respond to a couple:

- I deliberately gave Arthur Childs a very narrow brief - just to review my pensions. Despite that he did try to recommend balance, taking a look at my other savings I do with my employer.

- ISAs vs. pensions could be debated until the cows come home. I do already save into an ISA and my current tax year allowance is already fully exhausted.

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joe stalin

Aug 31, 2012 at 16:16

manage your pension yourself just like the ISA's, there are plenty of funds available to choose from to suit your needs/risk appetite. just keep an eye on the charges some of them levy.

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Eddie Merryweather

Aug 31, 2012 at 16:54

Pensions get tax releif so for £100 you only need to pay in £60 if you a higher rate taxpayer, you get 20% added in at source and get 20% extra annual allowance.

If at retirement you are a basic rate tax payer you only pay 20% on the income ( at todays rates).

Isa you pay in £100 and get £100 invested.

Pension no brainer for me. Plus you cant access it till 55 which means you can't be tempted to blow it.

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Franco

Aug 31, 2012 at 17:40

Unexplained assumptions and growth rates and meaningless results fitting one special case. Boring advertising rubbish.

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snoekie

Aug 31, 2012 at 18:25

A note of caution, beware of Gordon Brown (with a Balls) MkII, and the successor of an Osborne MkII, theft of part of the pot, with a continuing theft by the successor.

BTW, I would avoid an annuity like the plague. With increasing longevity, I would take the income from the divis, With the passage of years and, hopefully, increase of divis, it would only be a matter of about 10 years (my non actuarial guesstimate) before the divi income would be materially higher and capital to resort to in cases of emergency (not available in where an annuity has been taken). If you have a decent share pickung ability there will be the inevitable profit from take overs, with more to be invested, rather than the annuity provider picking up those tasty morsels, with no benefit to you.

In that case there would be money for the offspring, if any, or a charity, rather than the "charity" of HMG, who pour part of that money into the likes of India and pockets of despots.

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Maverick

Aug 31, 2012 at 19:35

Assume that we are talking about pensions here and not ISAs, and assume that you have built up a sizeable "pot" and transferred it into a SIPP which lets you select your own investments and manage them online.

Snoekie is absolutely right and you should avoid annuities like the plague.

But you should also consider longevity, in that you may live for 20 or 25 years after you retire.

There seems to be a dreadful case of tunnel-vision here. If your pension is a stream of income payments, people say, what you need is an investment that provides an income, that is, shares that pay dividends. Absolutely wrong. All that your SIPP provider asks is that you have available in cash on the day the pension is paid each month enough to pay the pension. Neither the SIPP provider, nor HMRC, nor you, have the slightest interest where that cash sum has come from. It could be dividends. It could equally well be capital gains. Remember capital gains are entirely tax-free in a pension fund, whereas dividends have tax deducted (thank you, Mr Brown!).

Now fast-forward three years to your next pension review date. Your high-dividend-payers (Aviva, Drax Group, Halfords, MAN Group, Resolution etc) have paid your pension just fine, but their shares have all dropped in value by 20%. The calculation HMRC requires your SIPP provider to carry out uses the capital value of your SIPP fund as a multiplier. Suddenly your pension has dropped by 10%.

Say instead you decide that as you have a 20-year horizon, you can be a little more adventurous. You invest in shares that rise in value (Babcock, Intertek Group, Next, Oxford Instruments). When you need cash for your pension you sell one of the less-well-performing shares. At the three-year review your pension fund has risen in value by 25%. Your pension rises by 10%.

I fully accept that the second approach needs much more hard work on your part, but hey, aren't your retired? There ain't no free lunch . . . . .

The modern pensions legislation is not designed for pension income via dividends. It is designed for pension income via capital gains. You may think that's tough, but you have to learn to live with it.

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ALAN FERRIS

Aug 31, 2012 at 20:01

Remember that if you do not claim income relief on pension savings then when you buy an annuity some of the pay back is capital and that part is free of income tax.

The current appalling annuity rates do not make the tax free savings element attractive

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Michael Hellman

Aug 31, 2012 at 20:12

The headline says it all. "Thanks Dad For Starting Me On My First Pension".

If each child was given a pension account at birth which can already be the case, just think of 60 years accumulation.

To have Greg's desired amount, I do not see how this can be quantified at this stage, there are two many variables. Is that 25% tax free lump sum still going to be around? Annuity rates what will they be? I guess all we can do is save using the most effective tax regime that suits us. The rules will change, but as we do not know what they will be, we have to save because in the future, the state I am sure will be less likely to be as generous in its handouts as seems the case now.

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peter montgomery

Aug 31, 2012 at 23:13

Sipps and ISAs are the way forward,allowing control of investments,with low costs and possible IHT advantages if you dont make it to retirement/drawdown.Remember that certain pension plans only allow the return of contributions paid and are opaque in the extreme.Remember also that your hard earned contributions go to finance the lifestyles of an army of salesmen,OTT offices and all the other detrius that surrounds this tarnished industry.Ever seen a poor pension salesman?

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snoekie

Sep 01, 2012 at 04:32

Thanks for the reminder Maverick. Yes, I had developed tunnel vision.

It is not inconceivable the GB MkII etc will close the CGT 'loophole' when the SIPPS pots become a sufficiently large pool, the dishonest politicians piggy bank. Think for a moment on the green eyes of the deputy prime minister. His pension pot is average joe, the tax payer, who will have to keep upping their contributions for him to keep pace with inflation without him having stir a finger or bother his grey cells (and with no SIPP providers annual charges or charges for individual services), whereas for SIPPs each pot can be individually assessed, at the drop of a hat, and work has to be done to keep it fit.

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Hilary Gowen

Sep 01, 2012 at 13:02

Interesting thread.

My thoughts on this are that a pension is compelling if:

A) you are a higher rate taxpayer and expect to be a standard rate retiree

or

B) you are a standard rate taxpayer and your pension after the 25% tax-free lump sum) is likely to be less than your future tax-free allowance

or

C) you are a non-taxpayer (pension contribution is limited - but you get a standard tax refund)

or

D) you are retired and have excess income (again the contribution is limited - but an interesting option)

Otherwise there is not much difference in likely returns compared with an ISA - and an ISA is much more flexible.

http://www.the-diy-income-investor.com/2012/03/sipp-vs-isa-optimise-tax-savings-uk.html

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Mark22

Sep 01, 2012 at 15:45

Most of the above comments say effectively "saving as a pension is a good idea".

The only question I have is whether it needs to be saved as a pension starting now. Rather than saving 25% of his salary year on year into the pension (which would then be tied up and inaccessible), the government today allows him to save up to £50k and get full tax relief. If Greg's salary were more than £50k above the higher tax rate threshold, then he could save his 25% into ISAs (and other savings) and then (nearer the time) transfer those savings into the pension and get the tax relief on £50k, rather than 25% of his salary.

From a "pension pot" perspective, the difference this makes is the growth on the additional 40% that the taxman would put into the fund between now and retirement which could be factored in to the calculations. The benefit would be that the savings would be available in the short term to do things like paying off the mortgage which is also compound interest at probably a higher rate than can be guaranteed from equities.

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snoekie

Sep 01, 2012 at 18:12

There is a lot of talk about ISAs, which I have never used. I confess I know little about how to use them, There is a limit to how much you can put into an ISA, and from what little I know, your investment is tied up for a period, and if good you can roll it over, but surely there must be a limit to how much it can grow.

I have probably lost out, which investment to you tie up and for how long?

Hilarey, I did not fall into any of your categories, I was always a standard rate taxpayer, and still am, as a retired person.

I started my pension pot quite late, after 40, and was fortunate enough to get a surpise and unexpected inheritance, a decent amount, 20 years ago. The bulk of it went straight into shares, decent enough at the time, but as event turned out some expensive, albeit apparently solid, Vodafone, Invensys (a cur) Cookson, another dog, HSBC, RSA, totally indifferent. Mostly, but not always, I reinvested the income and with a subsequent accretion now have a half decent portfolio.

My pension pot, now a SIPP, but for the likes of Brown Balls ( whose "good" work has been continued by Osborne) would have matched the portfolio and perhaps left me scratching at the door of the rate unearned income tax threshold.

That threshold has hardly moved for years, when it should, if the MPs were honest, (and that is a pious, but unrealistic, hope) have moved with inflation and be at least 5 figures higher.

Justice should dictate that for every year that the thresholds are not raised with true inflation, MPs/ministers pensions should be adjusted downwards by the rate of inflation, CPI at least, for that year. A penalty, if you will, for not doing the right thing.

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Anonymous 3 needed this 'off the record'

Sep 02, 2012 at 13:23

Snoekie, If you are talking about cash ISAs, yes the annual limits aren't huge, but for shares, the limit is double and over the years a sizeable pot can be built up. Earlier this year The Telegraph ran an article on ISA millionaires who had utilised them from the start (and PEPS before that). The people who had accumulated £million sums did tend to be the ones who picked their own shares in a self select ISA.

You aren't tied to a minimum investment period with a elf select ISA and can switch your holdings around.

Income from ISAs in the form of dividends isn't tax free as the standard 10% is taken by HMRC at source but it's better than 20% on pension income.

Should anyone be a higher rate taxpayer in retirement, 10% is the max they pay on dividends so for them, ISAs are very advantageous.

Of course, nobody should be paying the 10% at all and that takes us back to our mutual Brownballed enemies.

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Mark22

Sep 02, 2012 at 15:46

The other point about ISAs is that any capital gain is tax free which gives you greater freedom when realising the investment.

Anonymous 3 you imply that pension investment dividends are not also liable to the 10pc. I thought they would still be liable to this so the question is about differences between locking money away in a pension fund or using it as an ISA or paying off the mortgage.

My opinion is still that if Greg "ought" to be adding £337 per month to his pension pot, he's probably better off overpaying his mortgage or putting it into an ISA.

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Greg Kingston

Sep 03, 2012 at 08:05

Thanks everyone for all the comments over the weekend.

Alas it is never a perfect, simple world we live in. I do make overpayments to my my mortgage, but my partner and I run our finances separately but are buying our house jointly. So unless we're both in a position to pay off equal amounts at the same time it isn't fair on the other.

My ISA allowance has already been used in the current tax year.

And no, sadly I'm nowhere near earning £50k above the higher rate tax threshold!

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Mark22

Sep 03, 2012 at 18:16

Then there's something wrong with the figures quoted in the article. On the One hand you have to increase your savings from 20 to 25 percent. On the other you need to save an additional £450 per month. Those two statements together give your salary £108k. If £450 is not 5 percent of your salary then the calculations by the pensions advisor are worthless.

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