Pensions recycling query

caronoel · 27 August 2017 at 7:06PM

How does the recycling rule apply where the total pension pot exceeds the LTA?

I am in my mid-40s now, and am fast approaching the lifetime cap of £1m. I currently put in about £700 pcm via salary sacrifice, and my employer puts in about £1,300. This totals to £2k per month.

I estimate my pension pot will be about £1.3m by age 55.

My aim is to keep working until 60ish, but I'd like to start drawing down about £40k per annum from age 55.

I understand that I will have to pay 55% tax on the excess above £1m.

My question is, once I start drawdown at 55, can I keep contributing at my current level of £2k per month, including employer contribution, without falling foul of recycling rules?

jamesd · 27 August 2017 at 8:06PM

The recycling restriction only applies to the tax free lump sum. That is normally 25% but when a person has more than the lifetime allowance, no tax free lump sum is payable on the excess. So a maximum of £250,000 tax free lump sum however big your pension pot is.

The lifetime allowance charge is 55% if you take it as a lump sum but you can take it as income and pay 25% instead, plus your income tax. You can do things like buying VCTs to reduce the income tax cost.

Since you want to continue to make pension contributions above £4,000 you will need to avoid triggering the money purchase annual allowance. You do that if you use pension flexibility to take either money from the taxable 75% (or more if over the LTA) or use an uncrystalised funds pension lump sum (UFPLS). So I'll assume that you'll be drawing 40k of tax free lump sum.

The recycling restrictions only apply to increases in pension contributions beyond those that would be expected. The increase in pension contributions potentially attributable to that lump sum is considered over the two tax years before taking it, the tax year you take it and the two following tax years. If you were doing the full 40k annual allowance already there would be no increase, so also no recycling restriction on you. If you were already doing £2k a month and stayed at £2k a month there would be no increase, so nothing to wonder about, it's fine.

If you take benefits from £160,000 a year to get £40k of tax free lump sum and leave the rest in a drawdown account with no income being taken that'll be a 40k tax free lump sum that year. As well as the five year aspect of the calculation the amount needs to be a total increase over the five years of more than 30% of the value of the tax free lump sum to be affected. You have an easy way to avoid that: just take a bigger tax free lump sum.

In your situation you can increase as much as the annual allowance will permit and still be fine just by adjusting how much tax free lump sum you take. Even if the increase happens within the five year window. And you can increase your contributions before the five year window to establish a new baseline for the expected contribution level, so planning ahead to do that for say a couple of years is another approach.

jamesd · 27 August 2017 at 8:12PM

You should also learn about VCTs. Not learning about them sooner was one of the mistakes I made. They offer 30% initial tax relief capped at your income tax payable in theyear of purchase. You have to repay it if you sell within five years. Dividends are tax and capital gains tax exempt. I tend to suggest the Albion VCT for newcomers and it has an expected dividend of 7% of the purchase price a year. There's no age restriction on taking money out of VCTs.

For those who can afford it buying VCTs can be a good way to reduce or eliminate their income tax bill, provided they can afford to defer much of the income for five or more years. The 30% they get and they get the dividends during those five years, so it's not a case of waiting for all of it. Building up a pot to do this may be more efficient for you than pension contributions for a while since you can get the 30% relief repeatedly by selling then buying back again.

Only for a while. You're getting an excellent deal on the salary sacrifice. So a potential approach is to eventually be doing pension contributions to get that salary sacrifice gain, with ongoing VCT recycling to get rid of much of the rest of your income tax burden. Which probably means a plan of at least five years of heavy VCT buying to accumulate enough in the VCTs if you don't already have enough in savings and investments outside a pension to do it.

jamesd · 27 August 2017 at 8:20PM

If you have a mortgage don't forget to factor that into your calculations. It'd be pretty silly to overpay on a mortgage and save 2% interest a year when you can save 30% plus over five years with VCT buying. If you can stomach the investing, withdrawing overpayments is likely to be more profitable, to fund pension contributions, VCTs or both.

Extending the term of a repayment mortgage is also likely to be a good move. Lower capital repayments, so more money to invest and make a higher amount of money than saved interest.

caronoel · 31 August 2017 at 4:57PM

Thanks again for this JamesD. The VCT concept is an interesting one, particularly given the tax incentives.

I am strongly considering putting in £100k or so over each of the next five years to put a dent in my PAYE bill and to bring in a bit of tax free income.

A couple of questions for you:
1) Is there a “best buys” list of VCTs, based on dividend yield and total return over 5 years? I struggled to find anything that was more recent than 2014
2) How many of them retain their original value – I presume that the exit price at the end of 5 years would be lower than the original input value.

bigadaj · 31 August 2017 at 9:14PM

Most vct information is available on trustnet, as it is for oeics, unit trusts, investment trusts etc

You may not be able to sell after five years, that's the minimum holding period to qualify for the tax relief.

Some vct firms offer buybacks at a particular discount but they are often fairly illiquid, there are options for fixed life vct as well which are wound up after a set period.

jamesd · 31 August 2017 at 9:19PM

You can often find public copies of Tax efficient Review opinions on VCTs, often used to promote VCTs during VCT season which starts around October/November with new VCT offers for the current tax year normally first becoming available then.

Exit prices depend on the VCT. You usually sell at a discount of between 5% and 20% of the net asset value at the time, depending on the buyback policy of the VCT. The NAV includes growth since your purchase. Lower risk VCTs in particular tend to pay out most gains as dividends because those are tax exempt. Usually there's either gain or for low risk ones a small drop to neutral but it may be paid out rather than retained in the NAV.

Dividend policies also vary and you can usually find those in prospectuses. For example, the Elderstreet VCT that's currently available has a policy of 3-4 pence per share of dividends per year, equivalent to 6%-8% yield based on the original offer price, 3p is 5.6% at the current price.

Of the currently open offers I bought some of the Elderstreet, rejected Foresight on performance grounds and rejected Downing four healthcare on prospects grounds compared to the generalist, some of which I bought but it's no longer available. None of these is exceptionally good, just what's around/was around, at the times.

Generally regarded as good examples include Northern and Proven but that's reflected in difficulty buying because they sell so fast.

caronoel · 1 September 2017 at 6:56AM

How have fixed life VCTs payout record fared against others?

jamesd · 1 September 2017 at 11:23PM

Total returns tend to be significantly lower than the best at medium to high ranges of the VCT spectrum (Northern and Proven types). They seem to do reasonably compared to the lower risk end like Albion (AAVC). A good choice for those who want to exit in a fairly predictable time, viewing it as a way of deferring income to save tax. Given the amounts you're considering it'll probably make sense for you to make some use of these unless you want to go for a pure investment rather than tax saving view. Even then, they tend to be at the lower risk end of the VCT spectrum and it's nice to have some of that in a mixture.

The fixed exit types are also probably high on the "stop this" agenda at the Treasury and HMRC because that's not really the primary objective of the VCT program. In general over the years the rules have been changed repeatedly to limit the lowest risk end of what can be invested in. But never retroactively for those who have already invested.

Pensions recycling query

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