New Pension Drawdown Rules today.

Loughton_Monkey

JamesU wrote: »

The 55% tax on top of this on death (albeit reduced from previous rates) is excessive for 20% taxpayers and far more detrimental to them relative to 40%+ tax payers. I feel that the risk/reward/tax in-out balance has too many drawbacks and that there is little point in 20% taxpayers setting up a pension when the same investment for retirement can be achieved within a S+S ISA, with no tax on drawdown, fewer risks and uncertainty, and more control over finances. Even for 40% tax payers the benefits of a pension may be marginal.

I'm not so sure.

Even ignoring 'salary sacrifice', then each £100 Pension Contribution produces 6.25% more money than an ISA at any point in the future (assuming you take the 25% tax free lump sum and 'value' the remaining pension pot as 80% of its actual gross value).

Assuming you don't die early, then provided you draw down your pension pot 'agressively' - perhaps in the same way you would start spending your ISA fund - you remain 6.25% better off.

If you die relatively young, then your spouse still has the 'pot' without the 55% charge. If you don't have a spouse, then yes, your net estate will be smaller. But do you care?

The "ideal" case, as I see it, might be a 40% married tax payer - say 5 to 10 years off retirement - looking at "fixed" pensions of about £10K under top rate tax. He still has £10K per year left - which could go into an ISA. But put it in the pension (at 66% HMRC rebate), then at age 65 take the 25% lump sum. With the remaining pot, there is enough to draw down £10K a year - bung it into ISA - until the pot has gone. Statistically he's not going to die before the pot is empty. Even if he does, his wife can use it.

JamesU

Loughton_Monkey wrote: »

I'm not so sure.

Even ignoring 'salary sacrifice', then each £100 Pension Contribution produces 6.25% more money than an ISA at any point in the future (assuming you take the 25% tax free lump sum and 'value' the remaining pension pot as 80% of its actual gross value).

Loughton, have no reason to doubt your calculation, but do not understand how you reach it. Could you explain how you obtain the 6.25% and what this refers to, 6.25% overall/annually etc.

Loughton_Monkey wrote: »

Assuming you don't die early, then provided you draw down your pension pot 'agressively' - perhaps in the same way you would start spending your ISA fund - you remain 6.25% better off.

Query on the 6.25% as above.

JamesU

jamesd

The big bad news of this seems to have been missed: from age 55 we'll be limited to 100% of the GAD limit in drawdown instead of the current 120% limit. That'll really hurt those who need or choose to retire before state pension age because they'll get lower levels of income from a pension and won't be able to make up for the £7000 that they won't get from the state pensions by drawing at a higher rate until they start.

It's exactly the opposite of what is needed. The £20k target to draw at a faster rate is way too high - means you need to be a very well off pensioner with 27k annual income after the state pensions start. And even to get that and draw more you need to have thrown away a large chunk of your potential income by buying an annuity instead of being able to leave it invested where it's likely to grow at a faster rate and produce more income over time.

It's something that merits a significant shift away from investments within a pension for those who are trying to take care of their needs before they reach state pension age. Though it's also bad for those with pots under 20k, looks as though the limit was picked by relatively wealthy pensioners, not average pensioners with modest lifestyles. And it's bad news for those with lower than average life expectancy, like many outside workers, who won't be able to draw at a rate commensurate with their lower life expectancy.

There's another hit as well: once you've gone into flexible drawdown on any pension you can't get tax relief on any more pension contributions. So no taking a pension commencement lump sum to pay off a mortgage and continue to work and contribute to another pot to build up for retirement. That's very bad news for those with pension mortgages that have an end date before state retirement age and a plan to continue working to that age or longer. Also bad if you think you won't be able to work more and retire, only to find that your health improves and you can go back to work, but are then blocked from tax relief for the longer retirement that will follow. But since this appears to apply to only flexible drawdown (after reaching that £20k pension income requirement) this is more of a concern for wealthy pensioners rather than more ordinary ones.

It's a shame that this is actually worse then the USP/ASP combination for those with less than large pension pots. A substantial step backwards for flexible pensions IMO.

Cautious_Investor_3

jamesd wrote: »

There's another hit as well: once you've gone into drawdown on any pension you can't get tax relief on any more pension contributions. So no taking a pension commencement lump sum to pay off a mortgage and continue to work and contribute to another pot to build up for retirement. That's very bad news for those with pension mortgages that have an end date before state retirement age and a plan to continue working to that age or longer. Also bad if you think you won't be able to work more and retire, only to find that your health improves and you can go back to work, but are then blocked from tax relief for the longer retirement that will follow.

I'm not sure this is correct.

I've read yesterday's draft finance bill and saw nothing of the above mentioned.

Currently you can still pay into a pension and get tax relief (assuming you have net relevant earnings) even if you have taken benefits via USP, can you point me to some evidence to show this has changed?

The Cautious Investor

jamesd

Thanks. I think I had that wrong to a significant degree, see the corrections I made in italics.

The consultation responses and replies:

"3.30 The draft legislation includes a number of measures which are intended to prevent tax avoidance. In particular, the Government proposes that:
... individuals in flexible drawdown should not be permitted to accrue further tax-relieved pension savings, in order to prevent “recycling” of tax relief."

Taking the pension commencement lump sum without buying an annuity puts the pension into drawdown even if no income is being taken, hence the substantial adverse impact in the pension mortgage case.

However the key words there seem be "flexible drawdown" not simply "drawdown" or "capped drawdown", the new term for normal non-flexible drawdown.

While posting links, here's a link to the budget proposals page and directly to the pension income reduction proposal itself.

Cautious_Investor_3

Thanks Jamesd

If I am reading that correctly and in the same way you are that is indeed a big change.

There are a number of people who have taken the PCLS and are "recycling" income, as they have net relevant earnings which allow them to do so, to create a further PCLS and because death benefits on an unvested scheme are better than a vested scheme.

Thanks for highlighting it to us, I think most people have missed that one.

The Cautious Investor

hugheskevi

Thanks for highlighting it to us, I think most people have missed that one.

There is a connection here with the new employer duties from 2012 regarding auto-enrolment.

Even though an individual who has taken flexible drawdown at age 55 would have no reason to make pension contributions, if they remain employed their employer will keep putting them into a pension scheme every 3 years until they reach State Pension age and they will have to keep taking themselves out.

jamesd

I'm still pondering this but I think it'll cause me to shift to suggesting for many people under age 55:

1. Make no more pension contributions than required to get maximum employer matching.
2. If you're getting no employer matching, make no pension contributions at all.
3. Use S&S ISA, your own property, BTL property, VCT and EIS or outside any tax advantaged option investing until you have reached a level of income that lets you maintain our desired standard of living by drawing on this money.
4. Once you reach age 55 continually evaluate whether you can meet your income target if you accept the 100% GAD income limit of the pension. Don't make non-matched pension contributions until you can.
5. Once you can meet your contingency (undesired) and planned early retirement targets on the combination of heavily capped pension income plus non-pension income, consider increasing pension contributions if the tax advantage compared to other options makes it look like a good idea.

I've still got a good deal of thinking about this but the major killer for pensions with this plan is the 100% GAD drawdown limit before state retirement age, when even 120% made it tough to get the necessary income if a pension component was used. The huge advantage of the non-pension options is the ability to draw down the capital as rapidly as needed to meet the income target until state pensions start.

Quite a few exceptions, like those on track for more than average (18k or so) pension income levels who are cautious and might find the annuity purchase desirable for that reason. But even there, the delay seems more prudent than going for pension contributions early in life.

Still early in my thinking on this though, so I may adjust that initial inclination later. But this plan seems to have badly dropped the "use a pension" ball for anyone doing prudent lifetime contingency planning, rather than looking only at the after state retirement age picture.

wotsthat

I'm still pondering this but I think it'll cause me to shift to suggesting for many people under age 55:

1. Make no more pension contributions than required to get maximum employer matching.
2. If you're getting no employer matching, make no pension contributions at all.
3. Use S&S ISA, your own property, BTL property, VCT and EIS or outside any tax advantaged option investing until you have reached a level of income that lets you maintain our desired standard of living by drawing on this money.
4. Once you reach age 55 continually evaluate whether you can meet your income target if you accept the 100% GAD income limit of the pension. Don't make non-matched pension contributions until you can.
5. Once you can meet your contingency (undesired) and planned early retirement targets on the combination of heavily capped pension income plus non-pension income, consider increasing pension contributions if the tax advantage compared to other options makes it look like a good idea.

I've still got a good deal of thinking about this but the major killer for pensions with this plan is the 100% GAD drawdown limit before state retirement age, when even 120% made it tough to get the necessary income if a pension component was used. The huge advantage of the non-pension options is the ability to draw down the capital as rapidly as needed to meet the income target until state pensions start.

I'm not seeing the 120% to 100% reduction in drawdown as a a major killer at all. I certainly don't think it's a big enough problem to consider suggesting that people don't contribute to a pension unless they get matching employer contributions.

As state retirement age increases it's going to have an affect and, as you say, there's a lot to ponder but I'm seeing this as a big move forward and an incentive to invest in a pension rather than a disincentive because there are more advantages than disadvantages.

Loughton_Monkey

JamesU wrote: »

Loughton, have no reason to doubt your calculation, but do not understand how you reach it. Could you explain how you obtain the 6.25% and what this refers to, 6.25% overall/annually etc.

Query on the 6.25% as above.

JamesU

You put £8,000 into ISA. Now doesn't matter what period, but let's assume over the years, investment growth takes this up by 20%. So in X years, you have £9,600 in value.

I put the same £8,000 into pension - similar fund. So my £10,000 (including HMRC Contribution) grows to £12,000 over same period.

Therefore, I take £3,000 Lump Sum, leaving £9,000 in "Drawdown". Under new rules, I can draw this immediately at 20% tax. This is £7,200. So plus the £3,000 I have £10,200 - which I bang straight into an ISA. My £10,200 is exactly 6.25% higher than your £9,600.