Personal Pension into Sipp

fairleads

atush wrote: »

Your original hypothesis did not mention part time work using up the personal allowance so is therefor invalid to my argument. Any good experiment lays out such factors in the beginning, you may not change the parameters of an experiment midway. You have to start a new experiment.

In any case, and investments made in an ISA can also be made within a pension. Therefore, a pension is a wise move, esp in this day and age where an employer must contribute too. No one will contribute to your ISA but you.

But, savings in ISAs outside the pension are also a wise move. An investor is always better having both.

Strange though it may seem, this " experiment" and ensuing arguments are for the benefit of the op, not so? ( or do you have an alternative agenda?) After all, the op is self employed.

atush

Will he always remain so? And was said experiment based on self employment or general 20% BRT?

I have no agenda, apart from disliking your sweeping, illogical statements and snide comments.

jamesd

fairleads wrote: »

one can trade within an Isa and make taxfree gains. This applies up to and after retirement.

One can do the same with the money including tax relief inside the pension.

fairleads wrote: »

Whereas 75% of pension gains will be subject to tax in retirement.

The money will have had tax relief on the way in and unless tax rates are higher the tax relief on the 75% will compensate for the tax on the way out. Meanwhile the 25% had tax relief on the way in and no tax on the way out, so that's a tax gain for the pension choice.

fairleads wrote: »

Further, in drawdown, income is adjustable only every three years.

Drawdown income from a pension can be adjusted every month if desired. The cap on how much can be taken must be recalculated at least every three years before age 75, every year after, but can normally be done each year before 75 if desired. But that's the cap, not the actual income level.

fairleads wrote: »

Pensions are not for BR tax payers unless of course, their employer at least matches the individual's contribution.

Because of the combination of tax relief on the way in, tax free lump sum and personal allowance on the way out, pensions provide a useful gain for basic rate tax payers.

fairleads wrote: »

I'm addressing my post to the savvy investor. Pointing out that there is more to life than pensions.After all, the much vaunted 25% taxfree PCLS will, for many pensioners, be less than the total value of their contributions. So many end up paying tax in retirement on some of their own capital.

Of course they end up having to pay tax on some of their own capital, since for a basic rate tax payer only 20% of the capital was tax relief and the lump sum is 25%. It's really not hard for a prospective investor to follow:

Pay £80 into a pension.
End up with £100 in the pension after basic rate tax relief.
Ignore all investment growth for simplicity.
Take out £25 tax free lump sum.
Take taxable income on £75.
Easy to follow: £80 went in, tax is being paid on £75's income, so the person is ahead on the tax front.
Optionally put the 25% into ISA or other investments to produce tax free income if desired.
Optionally take the pension income at 55 and recycle it into more pension contributions to get another chunk of tax relief and tax free lump sum.

If the person hadn't put the money into a pension they'd have £80 instead of £100. Easy enough to see that the income after tax on £25 untaxed and £75 taxed is likely to be higher than on £80 tax free when the tax rate is 20%:

£80 of income in an ISA is £80 after tax.
£25 tax free plus £75 taxable = £25 + £60 after tax = £85.

That combination of tax relief on the way in and tax free lump sum gets the basic rate tax payer an extra 6.25% income after tax. And that's before the personal allowance is allowed for, which means that more of the pension income is likely to be untaxed.

You should at least be able to get things like the ability to change drawdown pension income at any time or the ability to have tax free growth in both a pension and a S&S IS right. You're not doing yourself or non-IFA advisers in general any favours by getting such basic things wrong.

The S&S ISA approach has things in its favor. How about pointing out its real advantages (all of the capital available, not affected by any future increases in tax rates) and disadvantages (no tax relief on the way in, won't gain from any reduction in tax rates, vulnerable to bankruptcy unlike a pension before age 55) instead?

At least that won't make it look like you don't know your own FA job, which is what asserting that you can only change drawdown pension income every three years does. You can do better than that. Please try.

BettySpofkins

"Optionally take the pension income at 55 and recycle it into more pension contributions"

You can't actually do that, of course.

atush

Yes you can if you have other income elsewhere that the pension could have been paid with.

Linton

BettySpofkins wrote: »

"Optionally take the pension income at 55 and recycle it into more pension contributions"

You can't actually do that, of course.

Unless I'm confused you can recycle income without any problem. Its recycling the tax free lump sum which HMRC may object to.

fairleads

jamesd wrote: »

One can do the same with the money including tax relief inside the pension.

The money will have had tax relief on the way in and unless tax rates are higher the tax relief on the 75% will compensate for the tax on the way out. Meanwhile the 25% had tax relief on the way in and no tax on the way out, so that's a tax gain for the pension choice.

Drawdown income from a pension can be adjusted every month if desired. The cap on how much can be taken must be recalculated at least every three years before age 75, every year after, but can normally be done each year before 75 if desired. But that's the cap, not the actual income level.

Because of the combination of tax relief on the way in, tax free lump sum and personal allowance on the way out, pensions provide a useful gain for basic rate tax payers.

Of course they end up having to pay tax on some of their own capital, since for a basic rate tax payer only 20% of the capital was tax relief and the lump sum is 25%. It's really not hard for a prospective investor to follow:

Pay £80 into a pension.
End up with £100 in the pension after basic rate tax relief.
Ignore all investment growth for simplicity.
Take out £25 tax free lump sum.
Take taxable income on £75.
Easy to follow: £80 went in, tax is being paid on £75's income, so the person is ahead on the tax front.
Optionally put the 25% into ISA or other investments to produce tax free income if desired.
Optionally take the pension income at 55 and recycle it into more pension contributions to get another chunk of tax relief and tax free lump sum.

If the person hadn't put the money into a pension they'd have £80 instead of £100. Easy enough to see that the income after tax on £25 untaxed and £75 taxed is likely to be higher than on £80 tax free when the tax rate is 20%:

£80 of income in an ISA is £80 after tax.
£25 tax free plus £75 taxable = £25 + £60 after tax = £85.

That combination of tax relief on the way in and tax free lump sum gets the basic rate tax payer an extra 6.25% income after tax. And that's before the personal allowance is allowed for, which means that more of the pension income is likely to be untaxed.

You should at least be able to get things like the ability to change drawdown pension income at any time or the ability to have tax free growth in both a pension and a S&S IS right. You're not doing yourself or non-IFA advisers in general any favours by getting such basic things wrong.

The S&S ISA approach has things in its favor. How about pointing out its real advantages (all of the capital available, not affected by any future increases in tax rates) and disadvantages (no tax relief on the way in, won't gain from any reduction in tax rates, vulnerable to bankruptcy unlike a pension before age 55) instead?

At least that won't make it look like you don't know your own FA job, which is what asserting that you can only change drawdown pension income every three years does. You can do better than that. Please try.

Pensions and drawdown
If the income cap for a 55 yr old pensioner is set at 5.3% of their capital, and the income yield on their portfolio is 6 % how much income can they draw from a 400K portfolio?
If ¾ of the income yield comprises dividends, will that portion of the income be tax free?
If at age 58 the cap is increased to 5.6 % and the market, including the portfolio, suffers a 15% drop in price just before the cap is set, and the income yield on the portfolio is now 6.9%, how much income can the pensioner draw?
On the other hand, If, between the age of 58 and 59 the pensioner realizes an extra-ordinary capital gain, say 20%, how much of the gain can the pensioner take - in that year, in total - over and above the 5.6% income cap? And how much of that gain will be tax free?
However, as regards Isas, all I can say is that income and gains, from inception to expiration are tax free, and nothing, but nothing, beats financial independence.
And to repeat, a spouse inherits the balance tax free. As do the beneficiaries of the joint estate.
I suppose it just comes down to an individual choice of where in life one chooses to take the tax free benefits.
Ps. No connection with financial services, unless one includes income tax in that field.
Pps. Please remember the OP is a young self employed individual, and my original comment /reply was in response to, and based upon, their situation.
Ppps. As to your calculations, they aren’t a true reflection of a practical situation. In addition, there are similarities between your post, and of those by a few other contributors, here on MSE, that remind me of the fable about the emperor with no clothes.

jamesd

BettySpofkins wrote: »

"Optionally take the pension income at 55 and recycle it into more pension contributions"

You can't actually do that, of course.

There is nothing that prevents recycling of pension income into new pension contributions up to £3,600 gross if not working, or the lower of earned income and £50,000 a year otherwise.

In addition, recycling of pension lump sums is permitted either with limits on how much is recycled, or to an amount unlimited except by the lifetime allowance and annual £50,000 limit if it wasn't planned in advance.

However, in general, I'd probably favour fully using ISA investing and perhaps also using VCT investing, which can generate tax free income, instead of recycling a pension lump sum. Depends in part on the balance of needs between capital and income. For very early retirement keeping the capital available may well matter more than the extra pension tax relief.

It is fairly commonly written that recycling of pension lump sums isn't allowed but that's not actually true.

jamesd

fairleads wrote: »

If the income cap for a 55 yr old pensioner is set at 5.3% of their capital, and the income yield on their portfolio is 6 % how much income can they draw from a 400K portfolio?

They can take a 25% lump sum to have £100,000 outside the pension that they can reinvest in wrappers producing tax free income, and £300,000 inside it. They can then take:

5.3% of £300,000, £15,900 before tax, £12,720 after
Plus that 6% on the £300,000 tax free, £6,000
Total after tax income: £18,720

Had they instead used ISA investing they would have only £300,00 to start and their tax free income would be 6% of £300,000 or £18,000.

Use of the pension has increased the available income after tax. And that's without allowing for the personal allowance, possibly higher rate tax relief, possibly employer contribution matching and possibly NI saving by salary sacrifice.

For the GAD limit you appear to have used a result which corresponds roughly to a 2.5% gilt yield and 120% multiplier in the calculation, which produces a limit of 5.28%. At a more normal gilt yield of 4.5% that'd be 6.96%. For long term planning it's worth remembering that we're in exceptional circumstances at the moment and the limits we're seeing today aren't really likely to apply to someone in their 20s.

fairleads wrote: »

If ¾ of the income yield comprises dividends, will that portion of the income be tax free?

Both within and outside the pension it'll be taxed as usual, with tax taken and, outside the pension or ISA, a potentially usable tax credit available.

fairleads wrote: »

If at age 58 the cap is increased to 5.6 % and the market, including the portfolio, suffers a 15% drop in price just before the cap is set, and the income yield on the portfolio is now 6.9%, how much income can the pensioner draw?

As much as desired using the savings account and tax free lump sum investments that they are sensibly using to protect them from variations like that.

The effect of the GAD limit will be a combination of increase due to age and decrease due to the capital value drop and the effect on the maximum income from the £300,000 still in the pension is a decrease of the cap from £15,900 to £14,280. Which is very easily covered by the money outside the pension.

fairleads wrote: »

On the other hand, If, between the age of 58 and 59 the pensioner realizes an extra-ordinary capital gain, say 20%, how much of the gain can the pensioner take - in that year, in total - over and above the 5.6% income cap? And how much of that gain will be tax free?

On the portion that has been moved out of the pension, all of it. On the portion within it, they may have the option to get a new GAD calculation but if not that cap won't change. If they want to take the money as higher income they'd need to use the money moved outside the pension to do it. The amount that is untaxed would depend on how much of their personal allowance is used in other ways.

fairleads wrote: »

However, as regards Isas, all I can say is that income and gains, from inception to expiration are tax free, and nothing, but nothing, beats financial independence.

Well, I'd say that there are many things that beat financial independence but agree with you that in the finance world, financial independence is a wonderful thing, an objective that, without as much safety margin as I want, I've recently achieved, should I choose to stop working, or be forced to.

fairleads wrote: »

And to repeat, a spouse inherits the balance tax free. As do the beneficiaries of the joint estate.

No inheritance tax for any of them to pay? For the pension a spouse can also inherit the part remaining in the pension tax free, outside the estate. Other beneficiaries, except some financial dependents, would have either the pension tax charge to pay on the portion within the estate or possibly inheritance tax on the portion outside the pension. Whether the effect of the pension tax charge ends up greater than the reliefs that boosted the money in the pension would depend on the tax rate going in.

fairleads wrote: »

I suppose it just comes down to an individual choice of where in life one chooses to take the tax free benefits.

Or a blend. I use both approaches, trying to exploit the benefits of each, like uncapped drawdown from the ISA combined with employer matching, higher rate and NI tax reliefs on the way into a pension pot. In my case I'm also using an interest only mortgage and investing via a pension since I have both mortgage pay off and retirement income needs, so I'm effectively getting tax relief on my mortgage capital repaying, with the whole mortgage ending up paid off by the tax relief. I also have an expectation of paying only basic rate tax in retirement, on an income that may well leave more than half of my total pension income covered by the personal allowance, for an effective pension income tax rate that may end up being just 10%. Though my safety margin target might take me into higher rate if things go exceptionally well.

But I also make heavy use of ISA investing, using the full allowance every year I've been able to do so.

I don't think that it would in general be wise to rely solely on money within capped drawdown to provide a smooth income, in part because of the legislative and capital value fluctuation risks to the smoothness of the income stream. Better a mixture with at least quite significant savings outside the pension, perhaps using part of that tax free lump sum.

It's also potentially interesting, perhaps at state pension age or after a few years of deferral, for the person in your example to consider going for flexible drawdown if it's desired to get rid of the GAD limit. Or perhaps to use a scheme pension instead of capped drawdown, particularly if their life expectancy is lower than usual.

fairleads wrote: »

Ppps. As to your calculations, they aren’t a true reflection of a practical situation. In addition, there are similarities between your post, and of those by a few other contributors, here on MSE, that remind me of the fable about the emperor with no clothes.

Perhaps you'd care to say in what ways you think they are not a true reflection of a practical situation? For simplicity in this post I've ignored say the time taken to move money into the ISA tax wrapper, though that wouldn't be an issue for the amounts given with the VCT one, if appropraite for the risk tolerance.

xmodz

thanks for your help guys