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More Presents from the Taxman

  • By Alex Sullivan

Regular IFA Magazine columnist and pensions guru Steve Bee

You don’t think pensions are a good way to save? Check your logic, says Steve Bee

Well, and apropos nothing I suppose, I thought I’d write down why I think pension saving through auto-enrolment ought to appeal to Joe and Josephine Average. Apropos nothing? Well no, not exactly.

The truth is, I’m getting a little bit fed up with reading here, there and everywhere at the moment about how likely it is that these new pension reforms will fail – and about why saving in a pension might not be such a good idea any more, and all that kind of negative stuff. You’ll know what I mean; you’ve read it all too. And don’t get me wrong; I know that things that drag you down are easier to get sucked into than things that lift you up. Negativity is like that. But, just for once, humour me and step back a bit and look again at the pension proposition that’ll be on offer when the auto-enrolment scheme kicks in.

Free Money

First, auto-enrolment doubles your money before you’ve even started. An auto-enrolled employee will of course be required to save 4% of his (or her) qualifying earnings each year in the employer’s workplace pension scheme. But employees sometimes forget that that 4% will have become 8% by the time we’ve added in the 3% contribution that’s required from the employer, plus an extra 1% that’s added by the taxman.

To put it another way, a £4 payment becomes £8; a £40 payment becomes £80; a £400 payment becomes £800; a £4,000 payment becomes £8,000; and a £40,000 payment morphs instantly into a life-changing £80,000. That simply doesn’t happen with any other type of investment. If you put £40 into a building society account, you’ve only got £40. No contest.

EET, Think and Be Merry

Pension savings are said to be EET, which stands for Exempt, Exempt, Taxed. That’s to say that the money paid in is exempt of tax, after which the fund grows (mainly) in a tax-free environment, but the pension, when drawn as retirement income, is subject to tax. Building Society savings, on the other hand, are TTE: the savings paid in are made from taxed income, and the account grows in a taxed environment, but the money saved is not taxed when it is eventually drawn from the savings account. And an ISA is described as being TEE – but heck, you can probably work that one out for yourselves.

The big point with all this is that the more Es you get in your three-letter acronym, the better. What’s more, the Es near the front of the acronym are generally better than Es near the end, because they allow the magic of compound interest to work on the full, untaxed body of your savings.

A Triple E Rated Investment

But here’s the bit that I really don’t get with all this negativity. If you save money into a pension plan, you’ll be able to take out 25% of your pension pot as a tax-free cash sum when you get older. (Under current rules, obviously.)

Think about it. That’s EEE – Exempt, Exempt, Exempt. Now how many people have ever looked at it that way? It really doesn’t get any better than that.

January 2012