One of the most recurrent questions when you want to plan your long-term savings consists of evaluating two of the most popular options:
Investment fund or pension plan?
The objective of the article is to determine which of these two options offers the highest tax and financial profitability, seeking to obtain the maximum profitability and pay the minimum taxes, always respecting current regulations.
If these two financial products were taxed the same, there would be no debate between whether we should choose pension plans or investment funds, but it is precisely the tax section that differentiates these two financial products.
We must be clear that it is impossible not to pay taxes with this type of product, but we can minimize the tax impact and maximize our profitability with correct financial planning that takes into account two fundamental factors:
- Invest in long-term profitable products
- Select the most fiscally favorable financial product
Differences between saving and investing
There are important differences between saving and investing. Although they seem very similar concepts, it is worth taking into account their main differences. We describe them below.
What is savings?
Savings is the difference between what we earn and what we spend during a certain period of time. We can summarize it in the following formula:
Savings = Income – Expenses
The most common is that the savings remain in the current account of our bank, without generating any type of profitability.
There are financial products such as savings accounts that allow us to obtain a small return if we deposit our savings for a period that can range from 6 months to several years.
The pension plans are also considered savings products, as we saving for retirement.
What is investment?
The main objective of the investment is to grow our savings in the medium and long term. When we invest we look for certain profitability assuming a certain level of risk.
The key to investing is to control risks and obtain the maximum possible return on a sustained basis over time. This is the factor that differentiates good investors from bad investors.
To understand the relationship between saving and investment, we can say that saving is the raw material for investment. Without saving there is no investment.
Investment funds
In the next section, we will talk about investment funds, and especially what you must take into account to correctly compare them with pension plans.
What is an investment fund?
An investment fund is a financial product that allows us to invest in shares of different companies and in other investment instruments in a diversified way, and with the peace of mind of being in the hands of a team of professional managers who are dedicated to investing the money of savers like us.
Thanks to mutual funds, people who want to invest in the stock market but do not have sufficient knowledge, can count on investment specialists to manage their savings in exchange for a small commission.
Advantages and disadvantages of investing in mutual funds
In this section, we will analyze the 3 most important factors that influence our investment in mutual funds.
Investment fund flexibility
Investment funds have the advantage of being able to configure highly diversified portfolios based on criteria such as the business sector (chemical, technological, industrial, automotive, energy, etc.), geographical area (United States, Europe, Asia, China, emerging countries, etc.), or by investment style (growth, value investing, stocks, fixed income, etc.).
Investment fund liquidity
One of the most important advantages of investment funds over pension plans is liquidity. The liquidity of investment funds is practically immediate.
If you have 200,000 euros in an investment fund and you need to redeem part or all of this capital the next day, you only need to sell the shares of the investment fund and you will have liquidity the next day.
Return on investment funds
The profitability of equity investment funds is usually significantly higher than equity pension plans. This happens for two main reasons:
In the first place, the commissions on pension plans, at least in Spain, are much higher than the commissions paid by mutual funds.
Second, pension plans are usually products that combine fixed income and variable income, that is, they are mixed products, and that usually leads to lower profitability as they have a lower exposure to equities, which has been demonstrated much more profitable in the long term than fixed income.
These two reasons show us another clear advantage of investment funds compared to pension plans, which offer greater profitability (if we select a good manager), and also the commissions are much lower than traditional pension plans marketed by The bench.
Pension plans
In this section, we will talk about pension plans and everything you should take into account when deciding if it is a suitable product for you.
What is a pension plan?
A pension plan is a long-term savings instrument whose objective is to make the savings profitable for the retirement age, or in the event of disability or long-term unemployment.
This type of financial product requires a commitment to periodically enter a certain amount of money, in exchange for a return that will vary depending on the pension plan chosen by the client.
Advantages and disadvantages of investing in pension plans
In this section, we will analyze the 3 most important factors that influence our investment in pension plans.
Flexibility of pension plans
Although it is true that pension plans can also be fixed income, variable income or mixed, the reality is that the offer of available products is much smaller if we compare it with investment funds, where there is a much wider offer.
Most pension plans are marketed by the main banks in the country. The banking sector in Spain is an oligopoly of few companies with a large market share, and this notably conditions both the supply and the quality of available pension plans.
Pension plan liquidity
Liquidity is the main disadvantage of pension plans since they are totally illiquid products. That means that you cannot redeem the money until you reach retirement age, or you meet some of the exceptions such as being disabled or being unemployed for a long time.
For example, let’s imagine that you are 25 years old, you have a stable job, you decide to hire a pension plan where you contribute an initial amount of €5,000, and you make monthly contributions of €100.
Well, all the money that goes into this financial product you will not see for at least 40 years, losing the ability to rescue that capital at any time in your life when you need it. This does not happen with investment funds that have immediate liquidity.
Profitability of pension plans
The pension plans have obtained average profitability of 3.7% and 2.7% in periods of 5 and 10 years respectively. These data are consistent with studies by Pablo Fernández, professor of finance at IESE, which indicate that the average profitability of 15-year Spanish pension plans is 3.03%.
If average inflation in Spain has been between 2 and 3% during the last 20 years, the returns that pension plans offer us barely allow us to overcome the increase in the cost of living.
Therefore, pension plans are not a good investment product due to their low profitability, nor do they help us to keep our purchasing power above inflation.
The taxation of investment funds and pension plans
I have left the tax section for the end because it is one of the differentiating points between the investment funds of the pension plans, and I have believed that it deserves a separate point with respect to the rest of the characteristics that we have been commenting on.
In Spain, there is a belief that pension plans have important tax advantages, and it is one of the main hooks that lead many savers to hire a pension plan rather than an investment fund.
In this section, we are going to analyze the taxation of these two financial products to accept or refute the supposed tax incentives of pension plans.
The taxation of investment funds
The person who invests in an investment fund will only pay taxes when he sells the investment fund shares and has a positive return, which will cause a capital gain that will be recorded in the taxable income of personal income tax savings.
Thus, the taxes that an investor who has sold his investment fund with a profit must pay are the following:
from €0 to €6,000 → 19%
Between €6,000 and €50,000 → 21%
More than €50,000 → 23%
That means that if we rescue an investment fund we will pay a maximum of 23% on the profit.
In addition, another tax advantage of investment funds is added, and it is the taxation of the transfer of funds.
The transfer between investment funds allows us to move our investment from one fund to another without having to pay any type of tax, in an unlimited way. We will only pay the aforementioned taxes on the profit generated when we sell the fund shares.
Example of taxation in investment funds
If we have a capital of 1,000,000 euros, we invest it in an investment fund that gives us a return of 20% per year, and we sell the fund’s shares, we will have obtained a gross profit of €200,000 on which we will have to pay taxes.
The tax burden will be as follows:
from 0 to € 6,000 → 19% = €1,140
Between € 6,000 and € 50,000 → 21% = €9,240
More than € 50,000 → 23% = €34,500
Total taxes: €44,880
Net profit = €200,000 (gross profit) – €44,880 (taxes) = €155,120
Taxation in pension plans
The taxation of pension plans is the main hook used by banks for clients to contract this type of financial products designed to save for retirement, but…
Is the taxation of pension plans as good as compared to mutual funds?
Pension plans allow contributions to be deducted, with a maximum of €8,000 or 30% of work income (taking the lower of these two amounts). However, at the time of rescuing the pension plan, the tax issue can be complicated, and a lot.
As we say, things get complicated at the time of reimbursing the money, that is when we have already retired and we proceed to rescue the pension plan. At that time we must pay taxes on all the capital that we have previously saved, and they are taxed as income from work.
Example of taxation in pension plans
To be able to compare among equals, we will analyze the tax impact that we would have on a pension plan using the example that we have made with the investment fund, where we had a capital of €1,000,0000 with which we have obtained a return of €200,000.
How much taxes would we pay with the same example we used before?
Well, let’s calculate it:
From € 0 to € 12,450 → 19% = €2,365.5
€ 12,450 to € 20,200 → 24% = €1,860
€ 20,200 to € 35,200 → 30% = €4,500
€ 35,200 to € 60,000 → 37% = €9,176
More than € 60,000 → 45% = €63,000
Total taxes = €80,901.5
Net profit = €200,000 (gross profit) – €80,901.5 (taxes) = €119,098.5.
Tax comparison between mutual funds and pension plans
If we analyze the previous data on the tax impact between mutual funds and pension plans, we obtain the following results:
Investment funds
- Total taxes: €44,880
- Net profit: €155,120
- Fiscal impact: 22.44%
Pension plans
- Total taxes: €80.901.5
- Net profit: €119,098.5
- Fiscal impact: 40.45%
Keeping the variables of initial investment, profitability and the moment of rescue stable in the comparison, we obtain the following differences:
Investing in mutual funds saves €36,101.5 in taxes, obtaining a lower tax impact of 18.01% compared to pension plans.
Therefore, investment funds allow you to save almost 50% in taxes in the case of this example, money that will stay in your pocket.
conclusion
When planning our finances, we must take into account all the products available in the market and choose the most suitable product for our personal situation.
The profitability and taxation of the product are key elements that we must assess as we have done throughout this article.
In this case, the balance clearly indicates that the smartest option to invest our money in the long term is mutual funds, since they offer us greater profitability, greater liquidity, lower commissions, and lower tax pressure compared to pension plans.
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