Flexible drawdown SIPP and GMP scheme

fbrj

I am 60, retired and in receipt of a defined benefits final salary scheme pension. I have just transferred a defined contribution scheme fund (from a different previous employer) to a SIPP; this is currently valued at approx £45,000 and includes an element of protected rights (I am aware that this distinction will be abolished this April).

I have another pension, which is payable when I am 65, and is 100% comprised of a GMP - indexed at 8.5% - to provide approx £3400pa (at 65). I will also be eligible for a state pension (again at 65) of approx £6000 at current values.

I currently have about £6000+ "unused" of the 20% tax rate band (all my investment income - about £8000pa is held in ISAs) and am considering converting my SIPP to flexible drawdown to make best use of my basic tax rate band. Depending on the underlying performance (!) the SIPP could all be extracted between 5-7 years at a 20% tax rate (having initially extracted a 25% TFLS). I could also consider deferring my state pension.

My question relates to the setting up of a flexible drawdown SIPP and my GMP pension. As I understand it I have to confirm that I am not an active member of a separate final salary pension scheme or, relating to that scheme, there is no further accrual of benefits under that pension scheme. I assume I am a "deferred" member - rather than "active" (I left in 1981).

My GMP is "accruing" a benefit but it is all indexation (at 8.5%). Does the existence of this prevent me from setting up a flexible drawdown SIPP? I would much prefer to leave the GMP untouched at this stage - if possible - rather than transferring it to a SIPP, to meet the requirements for flexible drawdown.

jamesd

Deferring the state pension by about three years then taking extra income is the sort of deferment that's expected to be optimal for males, three to five for females, assuming good health. Since you seem to have plenty of available income you might go for a longer deferment to reduce investment risk for high inflation cases in the later part of life, which could more adversely affect other pensions.

I think that it's a waste of pension benefits to enter flexible drawdown for the fairly small sums of money and time period that you're considering. Better to continue to make pension contributions and use capped drawdown and recycling of higher rate income up to £3,600 a year. You can do this for perhaps 25-40 years, not just five to seven.

I don't know the GMP answer about drawdown eligibility.

You might also consider making some use of VCTs with 30% upfront tax relief then zero tax on income for as long as you hold them. With a significant chance that you will be a higher rate tax payer this offers potential benefits long term, potentially greater than the pension benefits on which you'd be getting 20% tax relief then maybe paying 40% income tax on withdrawing. You might consider doing this if you want to get money out of flexible drawdown pots at 40% income tax then 30% tax relief, stopping at whatever percentage of investment in VCTs is appropriate for your risk tolerance. It's also something that you could do now with some of your existing final salary pension income, some £20,000 or so invested would eliminate all of your basic rate tax. Tax relief on VCTs is capped at the value of tax you actually pay during the year.

The accumulated pot of pension money that you're drawing down from as fast as you can, while adding more contributions each year, then forms an emergency pot that you can get 100% of in flexible drawdown if you ever need that. Say for care needs later in life, which may cost some £30,000 a year.

So my inclination:

1. Capped drawdown.
2. Pension and other income recycling into a pension of £3,600 a year, topping up income as necessary to use that, getting 40% tax relief eventually. Take benefits and recycle again every three to five years from the new pot into which money is being paid. Sooner if you want a GAD recalculation - new money added to drawdown pot triggers one.
3. VCTs to get 30% tax relief then ongoing 0% tax income.
4. Accumulating drawdown income pot used as emergency fund with flexible drawdown if ever needed.

Your existing plan is a good one but I think this approach offers you more benefits long term, particularly if some use of VCTs is within your risk tolerance.

fbrj

jamesd - first of all thank you so much for taking the time to produce such a comprehensive reply.

I quite like the idea of VCTs that you suggested. However, as a general principle, I want to keep matters reasonably simple and as flexible as possible. As I understand it, investments in a VCT need to be for a minimum of 5 yrs (to retain the tax reliefs). Also I believe they are "higher risk"; it is all very well obtaining tax relief but not so good if I lose my shirt on the underlying capital - and there is no relief on VCT losses!

At the moment I am not a higher rate tax payer but I will be (at the margin) as soon as my state pension kicks in (but that can be deferred - as you say for perhaps 3 years or so) and will probably be close to being so when my GMP starts (my principal pension is RPI linked but income tax allowances are CPI linked), if I defer my state pension.

This brings me to my existing SIPP - if I don't touch it for a few years, then all income/capital from it will be hit with 40% tax (ie coinciding with state/gmp pensions). You say : Better to continue to make pension contributions and use capped drawdown and recycling of higher rate income up to £3,600 a year......but isn't there a great danger that not being a higher rate taxpayer for another 4 years+ I will end up with getting 20% relief on the £3600pa going in - only to have about £2000 of it taxed (later) at 40% on the way out? I think the capped drawdown would only produce an immediate income (pre tax ) of about £1650pa.

The 40% rate would not only apply to the balance of the £3600pa investments (ie the part not extracted under a capped drawdown) but then to the entire pot! Is this only avoided if I have VCT contributions simultaneously?

You also said: I think that it's a waste of pension benefits to enter flexible drawdown for the fairly small sums of money and time period that you're considering. What I was proposing was to start a flexible drawdown fairly soon and utilise my lower rate tax band over the next few years before I become a 40% payer - roughly TFLS of £11250, followed by about 5yrs of £6500, less 20% tax - ie about £37000 cash in total; this could either be spent or invested into ISAs (remember one of my priorities is to remain as flexible as possible) ..... not sure I would call those "fairly small sums"!

Thank you once again.

jamesd

VCTs can be quite high risk or can be more moderate. You might want to take a look at the Northern and ProVen offerings to see whether they appeal. A bit lower down the risk scale are some fixed exit time VCTs. At the high end are some investing in speculative high technology.

At the moment you have low to very low risk income - final salary pension and state pensions, so you have considerable lower risk side to average out the risk with some use of higher risk items. But it does have to be whatever you're comfortable with, if anything.

I expect that fiscal drag will be used on the higher rate threshold to gradually push you further into it, while the chance of making pension contributions can help to keep you out of it.

Yes, there's a risk that you'll be putting money in with 20% tax relief then getting taxed at 40% on the way out for part of it. The saving part there is the lump sum and ability to recycle income into pension contributions on which you get 40% tax relief. The money you take out overall is the 25% tax free lump sums so you end up getting full tax relief. If the pension contributions turn out not to be sufficient to keep you out of higher rate tax you can than consider a little VCT use.

The 40% tax rate is applied only to what you take out. If you used flexible drawdown to take it out very rapidly then yes, it'd be applied to the whole pot. But I envision using capped drawdown not taking it all out except in an emergency. The VCT contributions reduce the effect of any 40% tax you pay, down to nominal 10%.

Take a look at your plan to use the 20% tax range you have. £45,000 less 25% leaves £33,750 to take out. That's about 6 years with £6,000 a year to use and saves you £6,750 of higher rate tax while you pay that much in basic rate.

Lets say you're at a point where the possible capped drawdown money is all getting taxed at 40% and look at the pension recycling at that point. Pay £3,600 in for six years and have zero investment growth, so you have £21,600. Take a 25% lump sum out so that's £5,400 tax free, saving you both basic and higher rate tax on it, a total of £2,160 tax saved.

£6,750 / £2,160 = 3.125 so about that many times to be better off with the recycling, so say 19 years onwards you're better off in tax terms if it's all taxed at 40%. The initial period has basic rate tax relief and income tax so it's not quite as favourable but close enough.

If you get investment growth the picture shifts more in favour of the pension because the 25% is on the after growth and tax relief money, so you get out a quarter of the growth tax free.

What I'm describing saves you tax long term, what you're contemplating maximises your flexibility. There are good reasons for either approach.

If appropriate VCTs can be used whichever way you do it.

The fairly small sums are the tax differences, not the capital. Your tax saving in what you propose is about £6,750 over six years in which you get paid perhaps £216,000 (assuming £36,000 pension income) and have the pension pot, so about a quarter of a million, of which £6,750 is about 3%. Not insignificant, but not too big in the grand scheme of your income level.

fbrj

jamesd - once again....thank you! You have certainly given me plenty to think about and I have now had a look at VCTs in greater detail. Although I can see the tax advantages I will really need to get my head round having no access to the capital for 5 years - maybe ok if I was at least a decade younger but not so easy when you are already 60!

As with most things in life - you pays your money and you takes your choice! I can now see what you have been driving at and, at the heart of it, is maximising tax efficiency but at the expense of flexibility and, it has to be said, reduced access to capital. I have been saving for the "long term" for as long as I can remember - but I suppose I have always thought that "long term" would be when I retired - ie now!

I suppose I am viewing the SIPP as a vehicle for providing "lump sum" type expenditure rather than being dribbled out over many years (in a maximum tax efficient manner) to provide extra income. I only provided the details I thought relevant to my original question - but apart from my pension and investment income, my wife will have tax free pension income of £8500pa and already has £12000pa of ISA income.

So my priorities have changed but you have certainly given me some food for thought - thank you!