Commutation & Higher Rate Tax

benz

I'm 61, about to retire and will be receiving a final salary pension. I have AVC's which I will take as a lump sum, but this doesn't reach 25% of the total amounts. I could take the maximum lump sum but it would mean taking £88,700 cash from my final salary pension and a loss of income of £6700 (Commutation rate 13.3) If I did this my pension would be just under the 40% bracket

My question is, how does higher rate tax affect the calculations as to whether to take a maximum lump sum or not?

ermine

A spreadsheet like Excel will be your friend

You can probably expect to live about another 20 years. There's also the question of what you would do with the 88,700 cash. F'rinstance, if you save it with NS&I (you can't at the mo and not all that lot at once) so it is RPI inflation-proofed you get to pay yourself £4,400 pa in today's real terms if you run it down linearly, whereas you'd get 4020 from the post-tax income (you may also get hit by losing some personal allowances, but you are a long way into that so it is probably no different either way).

Personally I'd run with the pension there incase you outlive your 20 years, however if you have debts like a mortgage that need paying down or want to live large in your earlier, younger years then that could swing things for the lump sum. Nobody can tell you that answer to those questions, these are judgement calls you have to make for yourself.

gadgetmind

Yes, the tax does make a different, and can make up for that lowish commutation rate.

You could invest that £88700 into something that generates dividends, which are taxed at lower rates than income, and also start moving it across to ISAs, which will give you tax free income.

Play with the numbers and decide for yourself.

benz

Thanks Ermine and Gadgetmind for your input.

I also worked out that 20 years is the balancing point. I'm tending toward taking the whole pension as it's RPI proofed up to 5%.

It's quite finely balanced and as you say it is a judgement call................

jamesd

RPI protection should swing it in favour of taking it rather than commuting. The government currently has a policy of using fiscal drag to lower the higher rate tax threshold so you're likely to be caught by it even if you do reduce your income.

No mention of the state pensions so I assume also that you're going to get at least £5,000 of extra income there to push you thoroughly into the 40% band.

You can make pension contributions of £3600 gross a year while retired. So you can do that to get another 25% lump sum and some ongoing drawdown or annuity income. The 40% tax relief should make this a very attractive option.

If they are suitable for you, you could look into some use of venture capital trusts. Some of those expect to generate 5% income tax free and with no CGT on any gains, both for life. 30% tax relief, capped at the amount of tax you actually pay, to be repaid if you sell within five years. Relatively high risk investments though the income generators are less than some, not really something for more than 5-10% of investments but given your final salary pension you might go a bit higher because you won't depend on them for core income. Just be sure to diversify what you use.