Zeroing In On Your Workplace Pension Returns

Note: This post was first published in July 2020 and updated in April 2022

Do you know what your workplace pension returns are?

I mean, when it comes to stock market investing, it’s pretty easy to figure out your expected returns. This is especially true if you are young and hold a 100% equity portfolio.

Simply take the expected nominal long-term return. Historically, it has been somewhere in the 8%-10% range. Thus, I often use 8% in my calculations.

You may want to err on the side of caution and use a lower number, let’s say 6%.

Then, back out the fees which are hopefully no more than 0.2% in a low-cost index tracker plus whatever your platform charges you. This simple act of subtraction gets you to your expected long-term net nominal return.

Finally, you’ve got to take a view on inflation.

I like to think in nominal terms. That is, I know that ending up with £1m in 20 years simply isn’t the same as getting £1m today. Prices will certainly rise, some faster than others.

US inflation

That being said, I also know that my circumstances and spending habits are also going to be vastly different in 20 years.

I don’t like to waste time anticipating my life in retirement a decade or two before it actually happens.

Instead, I set the bar at an approximate level and look to re-calibrate closer to hitting the eject button.

Me, looking for the magic button in 2030!

Others prefer to think in real terms (i.e. in today’s dollars / pounds / euros).

If you are in this camp, you also need to make an assumption on what inflation will look like going forward. It used to be easy (just take 3%), but obviously, that’s no longer the case.

Still, if you think that longer-term inflation will stabilize around 3%, that means your 8% returns are being eroded to about 5% in real terms.  Slightly less, once you factor in those pesky fees.

It’s all fine and dandy – as long as you are investing in regular, tax-sheltered vehicles – i.e. an ISA or a LISA (or an IRA in the US).

False Start

Where it gets a bit more complicated is when you’ve got the wonderful option of contributing to a UK workplace pension.  All of a sudden, you’ve got multiple additional factors to consider:

  • Your current income tax bracket
  • Your expected income tax bracket at withdrawal
  • The quantum of your employer match
  • Whether your contributions are made through a salary sacrifice scheme
  • The investment return you get in your pension plan (some really crappy plans out there but thankfully you can always hack it with a SIPP)
  • Government’s rules around tax-free lump sum withdrawals

There are others, but the above items are critical.

All of a sudden, there’s a multitude of factors impacting your pension returns. In other words, you no longer have any idea how much money your money is making.

Apples And Oranges

This question of returns is far from an esoteric one.

In the finance world, the rate of return (sometimes known as the IRR) is by far the #1 decision that impacts capital allocation strategy at the enterprise level.

The logic applies to personal finance as well. To accelerate your wealth-building journey, you should allocate your savings to the investment vehicle that has the best risk-adjusted rate of return.

Tough to do that, if you don’t know what the actual rate of return is.

For example, you find a real estate deal that yields 11% – but will likely come with a baggage of admin and hassle. Should you pull the trigger?

Your brother-in-law offers to go into some kind of a business venture together.

You reckon you can make 15% on your money. Leaving aside the practicalities of doing business with family, is it worth the effort?

There’s an investment that you are quite confident will yield 10% over a long period of time. The challenge is that you will have to hold it in an ISA. Should you proceed?

If your alternative investment opportunity is putting money to work in your workplace pension, you cannot answer any of the questions until you figure out the actual return on your money.

Workplace Pension Returns: The Real Deal

Assume you are a basic rate (i.e. 20%) taxpayer, contributing to a workplace pension plan with a minimum employer match*, and generating a long-term nominal return of 8%.

Let’s also assume your withdrawals will be taxed at the same 20% rate in retirement – and that the government won’t kill the 25% tax-free lump sum option. Finally, let’s say your contributions are not done via salary sacrifice.

Running the numbers shows that the actual return you can expect is actually 12.3%.

The tax break and employer match combine to juice your pension returns by an extra 50%. Not too shabby!

If you happen to be a higher rate (i.e. 40%) taxpayer, and keeping everything else constant, the returns go up to 13.8%.

Finally, if you were to make your contributions via salary sacrifice, the returns would have gone up further still to 14.2% (but check the disclaimer at the bottom of the post).

Given the number of variables involved, the quantum of permutations is endless. Thus, I would encourage everyone to play around with the spreadsheet and plug in their own assumptions.

For those who just don’t feel like it, the tables below may just come in handy. All assume an 8% nominal return and no salary sacrifice.

Implied Pension Returns (Assuming A 75% Employer Match)

Scroll horizontally to find your current tax bracket. Then scroll down to find your anticipated tax bracket at withdrawal time.

The number you get is the effective return on your workplace pension, assuming your employer matches 75% of your contributions.

Pension returns depending on tax bracket

Thus, if you expect to be in the 20% tax bracket in retirement (as most people will) you could well realize a return somewhere between 12.3% and 14.3% on the money you contribute to your workplace pension.

Implied Pension Returns (Assuming A 20% Tax Rate At Withdrawal)

Some employers are more generous than others. The table below shows you how much extra oomph you can get from a more generous employer match.

Pension returns depending on employer match

In a world starved for yield, fortunes are made by people who manage to generate an extra few basis points of return on the money they manage.

And yet, you can get to the same place by simply working for a company that goes beyond the bare minimum when it comes to the employer match.

In other words, it pays to do the pension plan diligence when looking to switch jobs.

One For The Pessimists Purists

Even though the 8% return assumption is rooted in history, you may want to assume a lower number. If so, this table is for you.

Pension returns depending on nominal returns

The key assumptions here are a 75% employer match and a 20% tax bracket at withdrawal.

Even with a conservative assumption of a 6% nominal return, the actual pension returns you can realize go well into double digits.

Disclaimers Required

A few things to point out before you ask.

First, employers typically cap their match at a specific level. Just because you are contributing 20% of your salary doesn’t mean your employer will do the same.

Second, keep in mind your annual contribution allowance, the pensions taper, and the Lifetime Allowance.

When it comes to pensions, the sky is NOT the limit. That being said, you can still go pretty high before you hit those caps.

Third, you may end up moving between tax brackets while you are making the contributions.

Also, you may well end up with a zero tax rate in retirement if your taxable income (including pension withdrawals) falls below the personal allowance. If you expect that to be the case, simply put “0” in cell C6 of the spreadsheet.

Fourth, given your National Insurance contributions are based on your salary, the “salary sacrifice” option in the spreadsheet may be slightly imprecise. If you are in a salary sacrifice scheme, it might be best to leave it off and be surprised on the upside.

All of the above clearly add to the complexity. If one of these circumstances applies to you, you can still count on the tables above to get you very close to the right answer.

To zero in on a precise number, you’ll have to make some minor tweaks to the spreadsheet that reflect your own set of circumstances, which you are of course welcome to do.

Happy modeling – and investing!

*Minimum employer match defined as 3% of your salary (whereby you contribute 4% and the tax break adds up to another 1% for basic rate taxpayers)

About Banker On Fire

Enjoyed this post?

Then you may want to sign up for our exclusive updates, delivered straight to your inbox.

You can also follow me on Twitter or Facebook, or share the post using the buttons above.

Banker On FIRE is an M&A (mergers and acquisitions) investment banker. I am passionate about capital markets, behavioural economics, financial independence, and living the best life possible.

Find out more about me and this blog here.

If you are new to investing, here is a good place to start.

For advertising opportunities, please send an email to bankeronfire at gmail dot com

27 thoughts on “Zeroing In On Your Workplace Pension Returns”

  1. An interesting read. I’m with a workplace pension provider that I don’t like, instead preferring to pay the majority of my pension into a SIPP*. Still, I like to take solace in the idea that my contributions to the workplace pension no matter how small, is essentially ‘free money’.

    * The company I am with makes the minimum contribution of 3% on qualifying earnings. Furthermore, they do this after deducting my salary sacrifice from my wage, so my monthly contribution to the pension is actually quite low.

    1. Banker On FIRE

      It makes sense. Key is to max out the employer match, however small it may be.

      That being said, given your employer runs a salary sacrifice, have you considered putting all the extra contributions into your workplace plan (to take advantage of the 12% National Insurance saving) and then transferring out to a SIPP once a year?

      A 12% instant bump goes a long way, even if you are forced to invest into funds you don’t like for the first year. May be worth considering.

      1. In addition, you should be able to transfer, normally for free, to the SIPP you prefer. So contribute to you workplace pension and get the benefit of salary sacrifice, then once or twice a year transfer the whole lot minus £10 to your SIPP. Transfers from a workplace scheme are normally free, and normally very fast as they go through the automated Origo Options transfer system.

        1. Banker On FIRE

          Yes, that’s the way to go about it. I have two SIPPs (Hargreaves and Vanguard) that I “port” my workplace pensions to.

          That being said, my last employer just wouldn’t let me do it until I ceased to be a member of the scheme!

  2. I think it’s a tragedy how few people appreciate the importance of maximising their pension from a young age. My company pension default fund was some horrible multi-asset thing without about 1/3 in bonds and maybe 25% in UK equities! I honestly believe defaulting people at the start of their careers (early 20’s) into a fund with that level of bonds is criminal mis-selling. I now regularly transfer out to a Vanguard SIPP and pay into FTSE All World tracker so I can buy & forget.

    1. Banker On FIRE

      Spot on. Far too many pension plan providers still use sneaky choice architecture to route plan participants into sub-optimal, high-fee products. And it’s really disappointing many employees don’t even bother to try and understand their pension portfolio.

      Transferring out to a SIPP (once you’ve taken full advantage of the employer match, tax and NI breaks) is the best thing you can do as an investor.

  3. My dad gave me 2 pieces of advice at 18. One of which was rubbish one of which was good

    1) buy the biggest house you can afford (I amended this to if you’re going to move jump two levels while living within your means)

    2)start a pension at 18

    I am the only person I know other than the escape artist that seems to have had a mortal fear of being poor in old age. I had a goal to get to 100k knowing that that plus state pension I’d at least have a semi OK retirement with growth
    I’m now at about 220k at 39 and should hit a million around 55 or even before which I bonkers. I’m a high earner but not that high

    My daughter was born in December and I’m putting 2k to 2.5k a year in her isa and 500 in her pension. Will give her half a million at 65 without ever paying a penny in herself. The power of compounding writ large.

    1. Banker On FIRE

      I probably have that fear too. Likely a function growing up in an immigrant family where it always felt like we were balancing on the edge of a financial abyss.

      You make an interesting point about JISA and child pension plans. I’m reluctant to use a JISA (don’t like giving up control when the kids are 18) but a pension might well make sense from an estate planning perspective. You do take quite a risk on how government rules evolve over the next 60-odd years.

      PS: Our son and your daughter are the same age. Congrats on becoming a father!

      1. Interesting comments on the planning for children.I’m a new father too, my first was born in March this year.

        My wife and I have decided to retain investments in our name for the time being. Principally we decided not to contribute to a pension for him due to legislation risk as you point out.
        We do intend on opening a JISA in his name but only for money gifted to him and his future savings. We decided not to contribute regularly to this instead we have chosen to create a separate “child fund” within our ISA’s. We retain control and this also overcomes the issue of fairness should be have more children and one benefit from market conditions more than the other.

        I’m also of the opinion that pensions are most useful as a vehicle for controlling taxation. I think early in a career (assuming a lower rate tax payer) investments above the employer match would be better made into an ISA. Once one becomes a higher rate tax payer then increasing contributions to minimise the tax bill is a good strategy. This also forms part of my thinking for my children, that by investing for them outside of pensions they retain the option for taxation control later in their lives.

        1. Banker On FIRE

          Congrats on becoming a father! I’ve never experienced anything as exhilarating and exhausting at the same time.

          You raise an intriguing point with your strategy of utilizing pensions later on in life. There’s an implicit tradeoff here – you gain a larger tax break down the road but lose the compound interest on the smaller tax break at the beginning.

          That being said, if you plan to retire early then you need to have a decent balance in your ISAs anyway, so might as well build it up at a smaller “opportunity cost”.

          Hopefully our kids grow up to appreciate all the planning we are doing on their behalf.

          1. Thank you. Yes – i’m experiencing both of those in equal measure at the moment!

            Its interesting that you bring up the issue of loss of growth on nett vs gross amounts, it’s a common misconception that investing post tax early costs the difference compound returns in the long run.

            The sequence of contribution, tax and growth is not important.
            All other things being equal £100 earnings, taxed at a rate of 40%, invested (ISA) returning growth of 10% (£100 x 0.6 x 1.1) is the same as £100 invested in a pension and grown at 10% and then taxed at 40% (£100 x 1.1 x 0.6).

            The strategy is therefore all about minimisation of taxation.

          2. Banker On FIRE

            Cheers. We are just starting to come out of the zone of permanent sleep deprivation!

            You are absolutely right on sequencing, clearly I had a brain freeze there. Anything over and above the match can go into an ISA unless you expect to be in a lower tax bracket upon withdrawal.

  4. Congratulations, we’re only just getting used to it.

    Most people think about lower tax bracket upon withdrawal but I haven’t heard many people talk about timing on the front end. Unless you’re earning good money right from the start I think its worth holding off AVC’s above the match until earnings reach the higher threshold.

    We’re likely going to be a lower rate tax payers upon withdrawal so for us its about getting upto but not over the LTA.

    1. Banker On FIRE

      Yeah – and the other part of that equation is that you may well reach the higher threshold faster than you think. Given the direction of travel on public finances post-Covid, I wouldn’t be surprised to tax rates go up in some shape or form.

  5. New to this blog – an interesting read, thanks. I’m a Banker too !

    Having transferred my pension to a SIPP years ago I now find myself over the LTA and feel somewhat boxed in. No point in contributing more and creating a tax problem…,

    I find myself looking at VCT’s (and EIS) to gain some tax relief. I’ve tried a few small scale but remain nervous especially in the current market albeit the contrary view is prices could now be depressed and time to get in ? 30% tax relief very much appeals.

    Any thoughts ? I have a decent amount in ISA’s.


    1. Thank you – and great to meet another banker!

      Being over the LTA is a nice problem to have, but it’s still a problem.

      My concern with the EIS and VCT schemes is the quality of the underlying investments, which tend to be smaller and riskier than your run of the mill equity or real estate investments. The tax break is nice, but not if it comes with an increased risk of losing the principal.

      I have considered angel investing in the past to take advantage of the tax break, but haven’t gotten around to allocating a proper chunk of money to it / developing an investment strategy / executing on it, which can all be quite time-consuming.

      If you have a partner/family, another option you have is to contribute to your spouse’s or child’s pension. To the extent those are filled, ISAs represent the next step I suppose.

      Alternatively, you can load up your pension way beyond the LTA, get divorced and avoid the tax bill by splitting the pension pot 🙂

  6. Hi Damian, understand that a workplace pension is a top weapon to build wealth in the UK given tax advantages.
    What if one needs to move back to its home country (e.g. France, Germany, or the States in your case) after contributing for 10 years and having amassed a war chest?
    Can one move the pension on a tax free basis to a local provider? Or the UK pension is kept and drawn in the UK but with the pensioner living abroad?

    I’ve looked through your posts and have not found answers on this aspect. Guess this would guide many foreigners working in the finance industry in London.

    Thanks in advance for your help.

    1. Banker On FIRE

      It really depends on where you are moving to. I suspect that most likely, you will keep your pension with a UK provider.

      Assuming a tax treaty between the two countries, you can keep your tax-free lump sum free of tax in your home country. For the additional drawdown, you will pay the UK tax + possibly any incremental tax in your home country.

      I.e. if your effective tax rate is 25% and you pay 20% in the UK, you may be asked to pay an extra 5%.

      That being said, it’s a very unique situation, so good to consult a tax accountant.

  7. Hi Damian, I’ve been a reader for the past couple months and the blog has been an amazing source of info – have made sure to direct a couple friends here also!

    I just had a couple questions since I’ve just started my job in banking and using your spreadsheet to figure out what’s an efficient amount to put into pensions:

    1) Would it be more accurate to put in your effective tax rate (calculation below) in the ‘tax bracket at contribution time’? I’ve simply calculated effective tax rate using: (projected tax / gross income) * 100.

    2) How do bonuses interact with pensions? E.g. would 10% of my bonus be automatically contributed to my pension assuming I set contributions to 10%

    1. Banker On FIRE

      Glad you’ve been finding the blog helpful and congrats on commencing your banking career!

      On #1: you should use your marginal tax rate, not the blended one. That’s how much an incremental dollar / pound of income would be taxed at if you chose not to channel it into your pension

      For #2: of the three employers I’ve had, pension contributions were only made on salary income. The reason is that bonuses are highly variable, so it puts you at risk of exceeding (or undershooting!) your annual allowance should things go better/worse than you expected.

      That being said, one employer did provide some extra flexibility to make a top-up once the bonus amount was communicated.

      Hope this helps.

      1. Thanks for the response, I had a follow-up question regarding bonuses.

        The IRR of additional contributions becomes increasingly attractive if one finds themselves in the fortunate problem of being in the 60% tax trap between.

        Am I correct in saying that it’s possible to, if for example post-summer bonus you will be earning £110k for the tax year, to then increase contributions (either in a lump sum or by increasing regular contributions significantly) to ensure that the £10k that would be taxed at effectively 60% is redirected into a pension?

        Thanks in advance.

        1. Correct, escaping the 60% marginal tax rate territory is one of the best “use cases” of a pension

          You will need to check your pension provider to see if you can move your pension contributions up or down more than once a year though.

  8. If you’ve reached or are approaching the LTA and have filled up your ISA then clearly you need another potential tax efficient home for the extra cash. I’ve also looked at EIS and VCT schemes but have similar concerns to BoF……the quality of the underlying investment and risk of losing principal.
    I chose a different route…..a spread betting account in which I trade shares rather than than invest in them. It’s absolutely NOT for everyone since you really have to understand the risks and also learn some different techniques but I manage 15% – 20% return most years. All capital gains are also tax free.

  9. Not as hands on as you might think…….many people have an image of traders shouting “Buy” or “Sell” into a telephone but that’s far from the truth. I spend about 8 hours a week in total, taking trades, monitoring live trades and closing positions if required.

  10. Pingback: Weekend reading: three different views on the folly of active investing - Monevator

Leave a Reply