Pension Planning - use of AVCs

JJWW

Hello - I plan to retire in 10 years at the age of 60 and would like to build up a lump sum. I can afford to save £600 per month in LGPS AVC's which would bring me back down to basic rate rate tax. As I see it, the tax advantages of doing this essentially mean that this is more efficient than utilising ISAs. I calculate this will bring me a lump sum in the region of £100k. My latest pension forecast comes out at £31k PA at age 65 although this will be reduced by 5/60s because I will leave at 60. I do not intend to draw on this pension until 65 but use the lump sum.

Am I right in thinking that I would be able to draw the AVC fund as a lump sum because my notional pension pot would be 20 x 31 + 100 = £720K meaning that I could draw up to a notional 25% ie. £180K. I have assumed a 6% growth rate in an index linked AVC provided by the Prudential. Are my assumptions correct or do I need to rethink?

My partner would like to work half-time at this point (she is 15 years younger than me) and at this point she would have 23 years contributions also in LGPS having purchased extra years when she was still able to do so. The mortgage on our main residence will be paid in 7 years (if all goes to plan) and it is at an affordable fixed interest rate - would we be better off starting another AVC fund in her name or look to paying into our ISA rainy day fund that has been all but static? She currently earns £40K PA so the tax advantage would be less but I still feel this represents better value although we will have to accept that she will not be able to access this until she is 60. The ISA fund currently stands at £20K.

Sorry this is a long post but there is a lot to think about and we would like to have some quality time together before I am no longer capable!

Your thoughts would be appreciated.

Many thanks

jem16

JJWW wrote: »

Am I right in thinking that I would be able to draw the AVC fund as a lump sum because my notional pension pot would be 20 x 31 + 100 = £720K meaning that I could draw up to a notional 25% ie. £180K. I have assumed a 6% growth rate in an index linked AVC provided by the Prudential. Are my assumptions correct or do I need to rethink?

Only if your scheme allows you to draw the 25% solely from the AVC pot - not all schemes do. I believe the LGPS is one scheme that does allowa it but I have seen it vary from council to council so best check.

Also best to check if you can take the lump sum without drawing on the pension. This would not normally be possible except for those pension pots in drawdown which I'm not sure applies to final salary pensions.

would we be better off starting another AVC fund in her name or look to paying into our ISA rainy day fund that has been all but static? She currently earns £40K PA so the tax advantage would be less but I still feel this represents better value although we will have to accept that she will not be able to access this until she is 60. The ISA fund currently stands at £20K.

Again depends on the scheme rules re AVCs and lump sum.

For your partner it's not so clear cut re pension vs ISA as she is not a higher rate taxpayer.

jamesd

You each need to check your schemes to verify that you can use the AVCs for the lump sum. If you can then what you are planning is a good deal. Also need to check on drawing the lump sum before the income.

A 6% growth assumption is a bit low so that's cautious enough. You might investigate better investments than just a FTSE tracker if you have those other options available to you, though.

There's also the personal pension option. That gets the same tax relief but has a lump sum and income that can be taken from age 55. It's not as good until you can take the lump sum from AVCs because avoiding the reduction in pension income enhances the benefit.

For your wife part of the issue is how long she'll continue to work. She's very close to higher tax rate that starts at £42,475 at the moment. It seems likely that for a while over the next ten years she will be paying higher rate income tax on part of her income. Those years will be the ideal ones for her to use AVCs. For her it currently seems best to use investments within a S&S ISA until she can get higher rate pension tax relief. If plans change I assume that she can put almost her whole income into basic rate AVCs for a year or two to get the AVC level to where it would have been if she hadn't waited.

The ISA route has the big advantage that you can draw on the capital at any rate you like. That makes ISAs very useful for maintaining a level income before the state pensions start. You can draw down the ISA pot to zero to provide the spending money that the state pension will subsequently provide.

You're planning on taking a 5/60ths reduction in income. What happens if you plan on using ISA money instead to live for five years and take no reduction? How does the gain from that compare to the gain from not reducing the pension income level to get the lump sum?

To bridge the five year gap you could also consider some mortgage borrowing, repaying it out of the higher income level.

Do you actually need the lump sum or could saving from a higher income achieve your objective?

You wrote that your mortgage is at a low interest rate so I'm hoping that you're not overpaying it when you can make more money from investments than overpaying saves in interest. The ideal time to repay mortgage capital is likely to be out of the after tax relief pension lump sum - tax relief on your mortgage capital repayment is hard to beat. That's probably too far away in your case for the current mortgage. It's not too far away to do it if you look at bridging the last five years - you can borrow and then repay out of the after tax relief lump sum.

What I've been looking for here is in part ways for you to avoid taking the long term drop of 5/60ths of your pension income.

kidmugsy

I speak from ignorance, but I'd be pretty surprised if a Final Salary scheme let you withdraw what is effectively a joint lump sum from your AVC before you activated the main pension - for a start, how could they calculate the amount you would be entitled to when they couldn't be sure exactly when you would activate the main scheme pension?

As for your wife: in your shoes I'd be reluctant to encourage her to tie up money in a relatively age-inflexible pension without the extra incentive of avoiding higher rate tax. ISAs are wonderfully flexible and, moreover, effectively freeze current income tax rates- in her case 20%. If the standard rate of income tax should happen to be 30% in twenty-five years time, how would she feel about having avoided 20% tax on her pension contributions but paying 30% on her pension?

jem16

jamesd wrote: »

What I've been looking for here is in part ways for you to avoid taking the long term drop of 5/60ths of your pension income.

He won't have any choice in that if he leaves before age 65 as he will have 5 years less contributions if he retires at age 60.

It's not the actuarial reduction he is looking at as he is planning on not touching the pension until age 65.

jamesd

jem16, you're right, I was thinking of actuarial reduction, not earning for fewer years, so accumulating fewer sixtieths.

kidmugsy

OP, have you checked what happens to your widow's pension if you take the AVC as tax free lump sum and take the LGPS pension without a lump sum. Does this increase her eventual pension too, or just yours?

JJWW

Thank you everyone for your thoughtful and thought provoking replies - I have been away for a few days but when I can catch up I will certainly do a lot more research. In brief though I have the following immediate reflections:

a) I will look to not over-paying our main mortgage (fixed for term at at 3.9%) with a view to full repayment from lump sum (although this to me is counter-intuitive, I can see the logic behind this);

b) Survivor's pension should not be an issue, calculated at x/160s of final salary for my partner although we could look to maximising the lump-sum draw down from my pension (i.e. LGPS lump sum entitlement + AVC pot within the total 25% allowance) to cushion this should it be an eventuality;

c) We will look at using further S&S ISA saving for my partner then dramatically increasing AVC payments ten years hence (noting also that when she hits 40%, a tax minimisation strategy into AVCs would work well) - I can see the flexibility benefits of ISAs but still have an underlying concern about pension reform and the relief not being available at a later date;

d) Just to note that I did not intend drawing the lump sum from LGPS but from the AVC pot only (I was calculating the maximum allowable), although I will check on this and look to deferment of the regular pension income for five years, if not possible then I will look to deferring state pension to reduce tax liability;

e) Just as a quick off the wall musing, our savings / investments have always been in some kind of wrapper, should the tax-free benefits of dividends play any part in this planning should we decide to make some direct investments in "safe" companies?

Thanks once again - I realise it's a long time off but it has given us cause for thought and would certainly put both our minds at rest once we have a strategy in place.

kidmugsy

"should we decide to make some direct investments in "safe" companies?"

While one of you is a payer of standard rate tax, she could hold equities outside a "wrapper" while you use your wrappers for, say, bonds that would have their income taxed if held outside a wrapper.

Some of the Investment Trust savings schemes provide a pretty economical way to buy and hold equities.

kidmugsy

I've just come across this interview, which implies a neat way to use a wrapper to protect income from tax, while taking capital gains outside.

http://www.citywire.co.uk/money/investment-trusts-a-good-manager-is-more-important-than-asset-allocation/a494602?ref=citywire-money-latest-news-list

jamesd

What means do you think it is implying?

That investment trust can do it within the single IT company by moving income and capital around but individuals are not companies.