The Window Of Opportunity

Lovely chat with a prospective new client this week who, being in the mid stage of their career, is slap bang in the middle of their “window of opportunity” for pension savings.

Broadly the three stages of a corporate career can be framed as thus:

1. Apprenticeship - Your sole job is to make your bosses’ job more tolerable. And to make the tea to a half-decent standard.

   
   

   Over time you learn the ropes, and become more trusted as you demonstrate your utility.

   
   

2. Traction - Where the rubber hits the road. When you have gained sufficient trust internally, you are given more responsibility (work). Perhaps you become accountable for winning business, or managing a small team.

   
   

   This is usually an inflexion point for earnings, maybe along with a “capital event” like the granting of shares or invitation into a partnership.

   
   

3. Maturity - “Congratulations”. You are in senior management.

   
   

   You now have a few jobs - to “give back” through the development of others at stages 1 and 2, to ensure that the business is broadly steering in the right direction and finally, to ensure that any bombs that go off within the business aren’t enough to sink the ship.

   
   

Now I’m oversimplifying of course, and everyone’s journey will be different. But you can see what I’m getting at.

If we think about how this process would look visually, it may be a little something like this:

Image credit: Me (I'm not sure if you can tell).

When it comes to retirement saving, this middle portion really is quite important for a couple of reasons.

First off - if you are earning a lot, you are also going to be paying a chunk of tax. And one of the neatest ways to reduce your tax bill is by making a pension contribution.

Let’s say that, as a result of a real step up in their tea-making ability, our hypothetical employee receives a pay rise, along with a bonus, to take them to £150,000 total earnings for the year. Where previously they were earning £80,000.

A couple of things now happen from a tax perspective. Which it is probably easiest for me to walk you through.

So we can see that when someone begins to earn over £100,000 a year - making a pension contribution presents extreme value.

But here’s why I refer to this period as a “window of opportunity”.

First of all, assuming that you earn enough, you can currently only contribute a maximum of £60,000 a year into a pension (gross of tax relief). Don’t get me wrong, this is a substantial number, but high earners receiving hundreds of thousands of taxable income may very well want to put more than this amount.

There is the opportunity to “carry forward” any previous un-used allowance from the prior three tax years, provided that you earn enough to support such a large contribution.

But as the below video demonstrates, this tends to be a “one and done” planning opportunity that doesn’t tend to be repeatable all that frequently throughout a career.

The other thing for high earners to be aware of when it comes to pension contributions is the “tapered annual allowance”.

Now this can be a really complicated sum, but as a starter for ten anyone with taxable income of £200,000 or over should be aware of the issue. I have included a more detailed explanation below the line for anyone who is interested.

If we look again at the rather crude drawing above, we see that for our hypothetical career corporate employee earnings only increase. So once they begin to be affected by the tapered annual allowance, this problem doesn’t go away. In fact it is only going to get worse.

This is why it is so important for folks who are on an exponentially upward trajectory in their careers to contribute aggressively to pensions while they still have the full allowances available. It is kind of “use it or lose it”.

The third and final reason why it makes such sense to prioritise your pension in the mid phase of career is that it gives your investments more time to compound before retirement.

As we have seen in the past, when it comes to investing, time is the great healer. Your odds of an (incredibly) positive outcome from investing in capital markets only increase in line with your time horizon.

During this stage of life there will inevitably be other financial priorities - weddings, home buying, kids. You might even want to, y’know, enjoy yourself a bit too.

In this context, pension saving might seem a far bit down the list. But when it comes to the pure numbers, for high earners during this phase, the pension remains the best savings vehicle hands down.

If you are younger than 50, the idea that you should stop contributing into your pension now because of the (mooted) changes to the Inheritance Tax rules is just bonkers.

Even setting aside the compelling case that the numbers above provide, it is worth remembering that pensions are designed to save for your future needs in retirement. Not your kids’ or anyone else’s.

If you have anyone who is dependant on you financially, of course you would like to help them out in future. But I can think of no better way to do that than being able to build up the resources to independently fund a comfortable, dignified retirement for yourself.

None of the above is intended to constitute advice to any individual. If you have any questions regarding your specific situation, please consult with a regulated financial adviser. Pensions can be pretty complicated.