Opting out of UK Workplace Pension

[stewpot]

Hi,

I'm 20, been a software developer for two years. I started reading MMM when I was 17 and thought it was great. My plans are set to aim for FI by 30. I live in the UK and the government is bringing in a new opt-out workplace pensions scheme that is coming into effect at my office sometime this year. In short, the first year employer puts in 1% of salary, I put in 0.8% and government adds 0.2% tax relief to give me 2% total contribution. This increases each year until 2019 when the company puts in 3% I put in 4% and tax relief puts in 1% giving me an effective contribution of 8%.

It is free money, however, I can only get at that money once I am at least 55 by which time I will hopefully be 20 years retired. I can't use the money and by the time I can, I won't need it. Sacrificing 4% of my income is going to delay my retirement, so why bother when I can just put that money into paying off my mortgage or a Stocks and Shares index fund ISA?

Is there something I haven't considered or is this a good way to go?

Cheers, Stew

[Cathy]

... I'm 20, been a software developer for two years. I started reading MMM when I was 17 and thought it was great. ...

Congratulations on getting an early start!

Is there something I haven't considered ...?

If your goal is to retire early, you should consider opting out of the UK entirely, not just opting out of a particular UK pension. You'll want to look into moving to the United States and working for a top tech company there. During a 10 year working career with some amount of professional growth over that time, you can reasonably expect to save 3-4 times as much money total in the USA as in the UK, because the cost of labour for skilled software engineers is radically higher in the USA than in the UK (or in almost any other country). This only applies to the top tech companies, but if your goal is to retire early, those are the companies you will be working for anyway. Don't take my word for it though; apply for top jobs in the USA and see what you get offered.

[AdrianC]

It is free money, however, I can only get at that money once I am at least 55 by which time I will hopefully be 20 years retired. I can't use the money and by the time I can, I won't need it.

Why won't you need money at age 55?

[AdrianC]

If your goal is to retire early, you should consider opting out of the UK entirely, not just opting out of a particular UK pension. You'll want to look into moving to the United States and working for a top tech company there.

I did pretty much this at age 26. More than doubled my earnings immediately. Tripled within a few years. But that was then. I understand tech work in the UK pays better these days.

Not having the equivalent of a four-year degree might be a problem for the H1B. A friend of mine did it, but he was 20 years older with tons of experience.

[stewpot]

Haha. I don't know about something that drastic. Surely, factoring in health insurance and travelling home once a year it can't be that much of a difference. Earning more is definitely gonna help me get there, but I'd rather start a business on the side in that case.

I wouldn't need the money at 55 because I would already be covering all of my living costs by that point anyway. The question is, do you want more money later in life when you already have enough to live off or do you want half as much now that can be used to buy your freedom a year earlier? At least, that's how I see it?

[Cathy]

Haha. I don't know about something that drastic. Surely, factoring in health insurance and travelling home once a year it can't be that much of a difference. ...

If your goal is early retirement and every year matters to you, you need to do more research. There are a lot of years of your life on the line, and the two excuses for not moving you just gave are both totally without merit. In particular:

• The cost of extremely comprehensive health insurance while working at a top tech company is somewhere between $0 per year and $1,000 per year, depending on the company and your elections; either way, it's negligible.
• The cost of a roundtrip between anywhere in the USA and anywhere in the UK is approximately zero thanks to extremely generous credit card promotions on offer in the USA (which you will be able to milk once you have lived in the USA for about a year).

I'm sure you can come up with other excuses as well, probably no more meritorious than those ones. Of course, it's your life, but if you want to retire early, I suggest researching this more.

[former player]

I don't understand the premise.  If you have a pension starting at 55 you just add that in to your FIRE calculations: if the pension will be enough for you to live off it reduces the stash you need to the amount which will support you between stopping work and 55.  If the pension will be a partial support, it still reduces the stash you need to a stash that supports you between stopping work and 55 plus a remaining stash that will partially support you after 55.

Leaving free and tax advantaged money on the table just because you can't deal with a bit more complication in your FIRE calculations is self-defeating.

[cerat0n1a]

It is free money, however, I can only get at that money once I am at least 55 by which time I will hopefully be 20 years retired. I can't use the money and by the time I can, I won't need it.

TDLR; - don't be stupid - stay in the pension.

Giving up free money is not usually a good idea - and the pension system currently gives you quite a lot of free money.

Think about the rate of returns. If you pay off your mortgage, that's a return of a few % on your cash, depending on the interest rate you pay. If you put  money in a pension you're getting way over 100% return - a contribution from you this year of £80 is adding £200 to your stash.

That money which you can't access until you're 55 (and almost certainly later than that in reality, they're bound to change the rules in the next 30 years) is still part of your stash. Between your RE date and your pension age, you're spending the part of the money that is outside the pension, but the money in your pension is continuing to grow, waiting to handle the 30+ years after the age of 55. The trick is to balance appropriately between the two so that you have enough money to handle the years before you get to the pension pot.

If you get to the point where you're paying 40% or 45% tax (or the horrible 60% zone between £100k and £122k), the pension contributions become a very efficient way to save because they are from pre-tax income.  I'll pretty much hit my FIRE target number today, but I'm still contributing 75% of salary into my pension (using up previous year's allowances) because it's so efficient. OK, 55 is only a decade away for me, but the tax advantages make it by far the best investment.

[Playing with Fire UK]

Stay in the pension.

The pension forms part of your stache, so your 25x expenses can include the pension as long as you won't spend down all of your ISAs and other savings before your pension access age(PAA). Don't model this as 55 in your spreadsheet, unless you trust this and all future governments not to increase the PAA.

Have a read of The Financial Zombie's Bridge to Early Retirement (both parts). It is excellent and describes the balancing act that @cerat0n1a mentions.

If you are currently paying 20% tax and wouldn't get any national insurance and expect to be paying 40% tax soon and don't think the rules for pensions are going to change again and you will definitely end up funding your pension enough in the years after you pay 40% tax then this can be reconsidered. We will need to see a spreadsheet before approving this plan.

Consider that you can use a mortgage to balance out the pension at 55+ issue. Remortgage your home the last year you plan to be in work, get as long a term as you can and then after you are 55+ you can pay the mortgage with tax-advantaged money. Don't pay off your mortgage if you are planning to do this, I'm finding it a royal pain to mortgage an unencumbered house.

[ShoulderThingThatGoesUp]

Stay in the pension - but do consider moving to the United States. Flights to Europe are not expensive (sometimes under $100) and health insurance is not a problem if you have a good job. Cathy's style is a little blunt but she has strong points. (We of course don't know your UK salary currently.)

[cerat0n1a]

If you are currently paying 20% tax and wouldn't get any national insurance and expect to be paying 40% tax soon and don't think the rules for pensions are going to change again and you will definitely end up funding your pension enough in the years after you pay 40% tax then this can be reconsidered. We will need to see a spreadsheet before approving this plan.

(confess I haven't thought about it too hard) - but does waiting until you're a 40% taxpayer ever make any sense? The OP would get the extra top-up from the govt in the form of paying less income tax, but misses out on the employers contribution, which is more than doubling his money. Unless there's some short-term debt or other urgent cashflow problem, surely more than doubling your money always wins out over alternatives?

[Playing with Fire UK]

If you are currently paying 20% tax and wouldn't get any national insurance and expect to be paying 40% tax soon and don't think the rules for pensions are going to change again and you will definitely end up funding your pension enough in the years after you pay 40% tax then this can be reconsidered. We will need to see a spreadsheet before approving this plan.

(confess I haven't thought about it too hard) - but does waiting until you're a 40% taxpayer ever make any sense? The OP would get the extra top-up from the govt in the form of paying less income tax, but misses out on the employers contribution, which is more than doubling his money. Unless there's some short-term debt or other urgent cashflow problem, surely more than doubling your money always wins out over alternatives?

I see cashflow. I was thinking of if you were going to be moving jobs then the hassle and admin of contributing 1%  might weigh against the benefit.

[stewpot]

Well I see what I was missing now. You only need to bridge the gap between retirement and pension. I never thought about it as just bridging the gap and the finance zombie post explains a lot. So yeah, I guess I'll stick with it.

I'm sure that moving to America does makes pure financial sense but I dislike the idea of living in America and I doubt I would be very happy living there. I might consider Canada, I've got some family over there but I think living costs are quite high in Canada so maybe there is little benefit to be had. I'm really happy in my current job, I have some good friends there and working in the healthcare sector makes me feel like I'm doing something worthwhile. Salary is typical of a comp sci graduate (although I went the apprenticeship route), house prices and living costs are pretty low in this part of the country which helps. The company I work for is young and have tripled in size since I started there, I'm responsible for a good chunk of projects at the company and they are good at rewarding hard work.

I've been offered other jobs, like one 6 months back in another city with a decent bit higher pay and lots of "fun" benefits but they were just a scummy company that had some pretty horrible billing practices so I stayed put. Morals > Enjoyment > Salary IMHO which perhaps is not an ideal world view if your trying to be as efficient as possible.

[stewpot]

Ok. Here is the plan. I built a little spreadsheet model where I can fiddle with pension contribution to try to optimise the setup. I bumped up the pension contribution to as high a percentage as would just about tide me over to 55. This is where your meant to use the 4% rule because some years you make interest and others you make none, I think this is a bit more like the 6.69% rule. Except isn't the 4% meant to last forever and my 6.69% doesn't need to last forever so I dunno. I also assume a pessimistic 5% return on ISA and Pension savings. I think living expense is perhaps a little optimistic, unless I am planning on being alone forever :D The salary is also assuming low raises that are definitely a worse case scenario. I've tried to optimise it down to a 29 years old retirement but to survive to 55 I need to reduce pension contribution to 11-12% and then I don't have enough to survive for more than 15-20 years after that. So I think that is about as good as I can get it without cutting living or increasing income.

It is late so there are probably some obvious failings in this model. What do you think?

https://docs.google.com/spreadsheets/d/1PvIS0Zn0NoIIAizFDy8WYKoyln0mMzLJ1-w1QQ_I5AM

[cerat0n1a]

Ok. Here is the plan. I built a little spreadsheet model where I can fiddle with pension contribution to try to optimise the setup. I bumped up the pension contribution to as high a percentage as would just about tide me over to 55. This is where your meant to use the 4% rule because some years you make interest and others you make none, I think this is a bit more like the 6.69% rule. Except isn't the 4% meant to last forever and my 6.69% doesn't need to last forever so I dunno. I also assume a pessimistic 5% return on ISA and Pension savings. I think living expense is perhaps a little optimistic, unless I am planning on being alone forever :D The salary is also assuming low raises that are definitely a worse case scenario. I've tried to optimise it down to a 29 years old retirement but to survive to 55 I need to reduce pension contribution to 11-12% and then I don't have enough to survive for more than 15-20 years after that. So I think that is about as good as I can get it without cutting living or increasing income.

It is late so there are probably some obvious failings in this model. What do you think?

I think the statistics say that for the majority of people in their twenties, salaries rise significantly, particularly if you put the effort in to your career in terms of gaining more valuable skills etc.  On the "being alone forever" thing, two people who both earn living together will have significantly more scope for saving than a person on their own/two people running two separate houses - aside from any non-financial benefits :-)

I probably wouldn't worry too much about exact percentage details of your spreadsheet at this point in your life.