Is a pension really worth it while trying to clear £15k credit card debt?

[georgieporgy12]

@aubree Sort of. You get the income tax you paid back, but not NI or student loan contribution. This is one of the reasons that salary sacrifice is better; you never pay those things in the first place so the fact you don't get them back is moot.

 

[kunsgnos]

@georgieporgy12 You do get the employers NI, I think.

 

[ldp735]

@aubree Only difference is salary sac also gets NI relief (and benefits like Child tax)

 

[pamiam]

@anonymess Salary sacrifice is the easiest one to see the effect of this since it’s the most simple and has the best benefits for you & your employer (hence why it is most common). But effectively all pension contributions have the tax advantage that you don’t pay tax on them. In a salary sacrifice it’s done in your gross pay to reduce your income tax & national insurance. Likewise you could just contribute £100 to your SIPP or other pension vehicle and the government will top it up to £125 (as if you earned £125 you’d get taxed £25, so they’re effectively giving you the £25 back). The only differences really are to do with national insurance and certain limits on contributions etc, but the overall message is the same that pension contributions are tax advantageous.

 

[ahunbleservant]

@janecruz You don’t pay tax on your pension contributions- so it reduces your taxable income. And you get 25% tax free lump sum on the way out

 

[jonsee]

@ahunbleservant

And you get 25% tax free lump sum on the way out

For now. I'm not counting on this one being around by the time I retire.

 

[drstevejsock]

@therese1234 This is just copy paste bollocks, OP has thousands of pounds in debt at 30+% APR which is accumulating right now. Tackling this should be the absolute number 1 priority.

I'd have thought that the net worth balance sheets would look very similar with/without paying into pensions in this case if every penny taken as additional income is ferried directly into paying off the cc debt.

If OP can keep their net worth roughly equal by decreasing the debt they have NOW why on earth would they choose to pay into a pension which they won't see till they retire? You want to have the maximum net worth possible by retirement, you don't want the "largest pension" and sometimes those aren't the same thing.

 

[therese1234]

@drstevejsock Nah, because the cash saved by avoiding the pension (c £150pcm) is far less than they'd get by continuing with the contribution (£150 + 20% tax + employer contribution, even regardless of compound growth), and isn't going to make significant inroads on the debt, relatively speaking. Do the maths - you'll see that if OP aims to clear the debt within 12-18 months, their pension contributions (all in, including growth) will far exceed what they own now.

Given the 7k inheritence, OP would be better off refinancing to reduce the rates, tightening their belts to pay down the debt quicker, and continuing to pay into the pension.

You're also discounting the sticky effect of stopping the pension contributions. If OP cancels their pension payments, and clears the debt, having the financial discipline to reinstate the pension (given their existing lack of financial discipline) will be very very difficult - so it's likely they'll end up not contributing for far longer. Maintaining the contributions is a form of financial discipline - which is exactly what OP needs right now.

 

[drstevejsock]

@therese1234 Would you take out 30% interest rate credit card debt in order to put more money into your pension?

 

[therese1234]

@drstevejsock You're just making daft statements now.

But do the maths. £150pcm into the pension - but to earn that net, you'd have to earn £190 gross. Then add the employer's contribution - let's say 3%, so another £75-80, if you're earning £40k like OP is. So every month, your pension increases by around £265 per month, for a cost of £150.

So you're gaining far more than 30% of your £150 investment, courtesy of the taxman and your employer's contribution - and that's before you factor in the compound growth.

Let's say it took OP 2 years to clear the £7k debt. During that time they'd have added over £6k into their pension, plus any growth they got from it. Alternatively, if they scrapped the pension and put all the money into their debt repayment, they'd have only reduced the debt by £3600 more.

So it's not as simple as you suggest. I'm sure somebody could spreadsheet it out, but I think you'll find that OP would not save enough money over the 2 years of interest to warrant skipping their pension contributions - because they'd lose out on nearly £130pcm of tax and employer contribution during that time.

To answer your (somewhat strawman) question - if the 30% credit card debt going into my pension also accrued the tax relief and an equivalent contribution from my employer, then yes, I probably would.

 

[drstevejsock]

@therese1234 I'm making daft statements but you'd be willing to burden yourself with 30% credit card debt in order to increase the size of an investment fund you're not allowed to touch for 30 years. Also you realise cc debt compounds as well right?

CC debt is so much worse than just a negative number on a spreadsheet, I never claimed the numbers were better for paying off the cc debt instead of the pension. But if it's relatively marginal (we're not comparing "spending the pension money on going on holiday Vs putting it in a pension here, we're comparing 30% compounding credit card debt with putting it in the pension) then the burden of debt should always always be a priority imo.

 

[therese1234]

@drstevejsock

CC debt is so much worse than just a negative number on a spreadsheet,

It's literally not. It's literally just like any other debt or investment, only with a larger interest rate.

This is getting into one of those pointless discussions now, so I'll step out. It's a bit like when people try and argue that overpaying the mortgage makes financial sense, even if their savings rate is significantly higher than their mortgage rate.

I mean, sure, there's a psychological aspect to all of this which can't be dismissed, but when it comes down to it, these are all just numbers on a spreadsheet.

 

[drstevejsock]

@therese1234 A mortgage sits somewhere from 2-6% and you've got a house as collateral on it.

Cc debt of 30% with no collateral is an extremely different proposition.

You do you dude, I think it's very possible to over optimise and lose sight of the important things, like sleeping at night.

 

[davidtitor]

@drstevejsock And there is no guarantee they will still be alive at retirement age. The only people I know who can afford to pay into pensions right now who have zero debt are friends on high salaries with zero mortgage or rent outgoings. I've got friends who pay into pensions but could do with the money now yet have been scared into continuing to contribute to the pension then I have a few other friends with several ks in credit card debt who have wisely opted out of the pension to pay towards the debt and have now got their debt almost cleared.

The excuse of 'if you stop paying pension now you will never do it in the future' is bs. The OP can use their own brain and initiative and decide if they want to keep paying in the future. Pensions are not what they used to be and nobody now under the age of 55 will get anywhere near as much out of a pension as those who are currently 65-70 years old in 2023. Employers contributions have decreased greatly whilst employees contriubtions have increased.

 

[newcreation17]

@therese1234

Given the effects of compound interest and growth, he best time to pay into a pension is last year.

True, although you could equally say

Given the effects of compound interest, the best time to pay off debts is last year.

So this is mostly only helpful when coupled with the exact interest rates etc. Surely there must be some situations where it's better to pay off debts first. Presumably it's most likely it'd be better to pay into the pension before paying off debts, but if they're stuck with extremely high interest debt then I can imagine it being possible that this should be paid first.

 

[therese1234]

@newcreation17 Given the free money, there's no time at which paying into the pension doesn't make sense. Nobody ever got to 50 and said "phew, I'm glad I missed out on that 30 years of compound interest on that free money".

OP should leave the pension and focus on refinancing so the interest rate is as close to zero on the debt as possible, and on budgeting to clear it without digging into the pension contributions.

And I say this as somebody who had large debts when I was young, and chose to service them instead of contributing to a pension, and am now scrabbling around in my 50s to try and get my pension to a state where I can retire - all the while cursing my younger self for not chucking a paltry amount into a pension 30 years ago, because I'd be set to retire comfortably now if I had.

 

[newcreation17]

@therese1234

Given the free money, there's no time at which paying into the pension doesn't make sense

Ok, I agree completely with what you're saying, from a practical perspective. All I'm saying - in a poorly explained way perhaps - is that quotes such as the above aren't technically answering the question from a theoretical/mathematical perspective, as I can construct (I know, artificial) scenarios where this isn't the case due to the power of compounding interest.

For example, suppose you have debt that grows at 20% (which for an artificial reason you can never reduce), and a pension that grows at 10% (and gives you free money when you pay into it). Suppose (again, completely artificially) that each year you have literally £0 left to pay off debt after pension payments and everything else, with no way of changing this, but that by not paying into your pension you can clear your debt within one year. Then nipping that debt in the bud would give you more money long-term than the pension, even with the free money, if over a long enough timeframe.

Again, I'm not saying the thought experiment above is actually realistic (lots of artificial assumptions). So what I'm saying is that matras like "free money means it's mathematically certain that paying into the pension is the best option" aren't actually mathematically fully justified until you include the particular interest rates and figures. Of course, given the real scenario I agree with you 100%: keep paying into the pension, put the debt somewhere with as low an interest rate as possible and push to pay it off as soon as possible, after also contributing to the pension.

 

[therese1234]

@newcreation17 Yeah, you'd have to run the numbers, but if OP pulls out of the pension, they'll lose the higher-rate tax benefit, plus the employer's contribution, and all of that compounded. I can't see any scenario where that's likely to be a good idea.

Plus, OP clearly has spending and saving issues. Putting the money into the pension is a good way to lock in savings in a way they can't be spent or frittered away.... it's great for discipline.

 

[gr3g]

@therese1234 well said. v similar here.

 

[gr3g]

@newcreation17 except for last year for real, where i paid a chunk in and lost 20 percent of it due to the Tory budget. That really stung me about the whole thing and the risk of one shit government breaking it all.