Retiring in 6 months, can we add to our pension now (e.g AVC's)?

joe06

My mum retires in 6 months on a final salary pension.
She is a high rate tax payer (<5k).

• Is there any way she can use this to reduce her tax?
• AVC's? Is there a cost to these?
• Increasing her contributions? is this possible in a final salary scheme?
• Any other ideas

Sorry for my ignorance but unfortunately i am more clued up than her about this stuff (gulp)

Thanks for your help!!!!

jamesd

Her scheme managers will tell her whether there's any option in the scheme.

AVCs might be available in the scheme. Sometimes a lump sum can be taken from the AVCs instead of the main body of the pension and that can be a good deal. Lump sums taken from the pension itself are usually a bad deal.

She could make contributions to a personal pension. She'd get 25% of what she pays in added automatically (the 20% basic rate tax adds 25% when HMRC pays it into the pension a month or so after the contribution is made). She'd tell HMRC about the contribution to get the higher rate tax back.

Will she really be £4,000 into higher rate tax after 7.5 months of pay in this tax year? That implies that she's on something over £70,000 a year. If she's on more like £45-50,000 then you've probably forgotten that she'll only work part of the year so will be entitled to a refund of any higher rate tax paid. Her pension income will be taxed under PAYE and HMRC should provide the pension payer with an appropriate notice of coding telling them how much to deduct from the pension. If she estimates how much she'll get in gross pay before retiring and how much from the pension after retiring in this tax year she can tell HMRC and they can start to adjust her tax code now.

Daniel_Elkington

It may be possible to make massive contributions to buy added years, but they would have to be fairly large at the level of benefits she may be getting.

If it is a final salary scheme then PAYE will apply and she will receive a payslip that looks a lot like a normal payslip. It should, theoretically, be the same department paying out, especially if it is a form of public service pension.

She may not need to do anything, but as said above, it's worth enquiring.

She could make payments to a personal pension, but if she can get added years it is unlikely to be worth it.

I would assume that she doesn't want to take any risk at all so investment ISA's are probably out.

joe06

risk isn't out of the question, however our real aim is to reduce the amount of tax she will pay both now and in 6 months when she retires.

Also she is retiring at 55, so can she use that fact to her advantage in any way?

jamesd

She certainly can use being 55 soon and a higher rate tax payer or even basic rate tax payer to advantage.

Say she paid £5k gross into a personal pension all at 40% income tax. Her cost after tax and NI would be £2900 of foregone income. She'd have £4,000 in the pension and a £1,000 refund from HMRC when she claims that.

At 55 she can take a 25% lump sum, so £1,000 tax free. Now her net costs is down to £1900 and she has £3000 left in the pension pot, 58% more than it cost her, with no investment risk at all required. You can get 4-6% income from investments with income drawdown, say 5%, from a capital sum. That's about £150 a year. There's about £25 in costs to pay via a £75 charge once every three years from one provider, I'll use Hargreaves Lansdown as an example. £25 from £150 is 16.7% so it's not particularly efficient on charges. That leaves £125 gross, less 20% tax in retirement so it's £100 net a year for life. (There's a minor error in this calculation, I didn't deduct the NI from the money going into the pension but the effect isn't significant in this case)

Compare to paying the £1900 into a S&S ISA where she'd get tax free £95 from the same investments.

The charges for drawdown have a significant ongoing impact and she might be better off buying an annuity. Or she can pay more into the pension, getting basic rate instead of higher rate tax relief.

Say she paid in £30,000 more, net cost after tax and NI (20% plus 12% this time instead of higher rate 40% and 2%) is £20400 and she'll have £20400 * 1.25 = £25,500 in the pension pot after basic rate tax relief (this time I did handle the NI part of the calculation). At 55 she takes a 25% tax free lump sum so she now has a net cost of £20400 - £6375 = £14025 and has £19125 left in the pension pot to produce ongoing income. That's 36% more than her net cost. Now she takes 5% income so £956 a year in ongoing income for life in drawdown. After 20% income tax that's £765. If she'd paid the £14025 net cost into a S&S ISA she'd get £701 tax free a year.

The £25 a year cost of drawdown is now more minor.

That's an illustration of how you can swap capital for income if you want to. It's better with higher rate tax and better still in salary sacrifice schemes for higher or basic rate (basic rate gains most).

I've ignored the GAD limit that will cap the amount of pension income she's allowed to take. It might limit her a bit short term but long term it's not going to. I've mostly ignored buying an annuity because drawdown provides a 100% pension for a spouse with no added cost - you inherit her drawdown pension pot tax free.

Whether there's a desire to swap capital for income is another question. I don't know if you're interested in doing that.

Why is there a desire to reduce the tax when she retires? Are you expecting extra high tax charges of some sort?

If AVCs are available by salary sacrifice out of gross pay then she might be able to use those and transfer them (ask, it's not particularly likely that she can transfer). For the basic rate this can save the 12% employee NI and boost the benefit of the basic rate pension case.

If you were considering using a lump sum to pay off a mortgage the pension and income approach is going to be more efficient as a way to do it.

joe06

James, wow, thank you so much for your time, there is some great information in your post.
You are correct that i had failed to account for the fact that she wont work a full year and therefore wont be a high rate tax payer.

Having read you post i still think that she could benefit from:

• open a new personal pension ASAP and pay all salary into it to avoid 20% tax now and take a 25% lump sum at 55.
• Leaving her work pension and salary alone as she has a final salary pension
• Leave AVS's as is? (i'm not sure how they fit in?)

Where we invest the lump sum is another matter but I have more experience in non-pension investments

Does that make sense to you?
Have I missed anything?

jamesd

That makes sense if you don't need the capital to be accessible. Pension and non-pension investments can be pretty much the same, it's just a tax wrapper like a S&S ISA.

Finding out how her scheme treats AVCs - what you can do with them and whether they are done with salary sacrifice, more efficient than a personal pension, matters.