Pension/ISA contribution split

peterg1965

I am about to restart ISA and pension savings in earnest, having stopped for a year or two. I was considering £750/month to ISA and £475/month to my SIPP (in fact I am already paying this amount into the SIPP). £475 to the SIPP is the minimum necessary to keep my personal allowance as my income is greater than £100K pa. This would have a net cost to me of £1107/month after I take off the HRT relief. I can afford to invest more per month. My SIPP currently has £99000 in it and I will have 38% of the £1M LTA left over after my final salary (AFPS) pension starts next week. I also have an occupational DC PS which currently has 10% of my salary going into it (just started) which will increase to 14% next April (16).

My goal is to retire in 6 /7 years having maxed out LTA and also having saved a tidy sum into my ISA(S&S).

I could afford to save (or at least transfer from another savings account) another £500 or so per month. An alternate thought was to increase SIPP contributions to £1200/month (£1500 after basic Tax Relief) and this would increase my net monthly saving 'cost' to £1650 if I continue to pay £750 into my ISA.

Question, does this make sense and should I consider putting even more into the pension pot at the expense of the S&S ISA getting more tax relief? Getting the balance right seems to be a hard call for me and I don't wish to be caught out by further Govt tinkering with pension rules. I also want to keep some money in a more accessible wrapper should I need it over the next 6 years.

I am 49 and want to fully retire by the time I am 56/57

FatherAbraham

peterg1965 wrote: »

Question, does this make sense and should I consider putting even more into the pension pot at the expense of the S&S ISA getting more tax relief? Getting the balance right seems to be a hard call for me and I don't wish to be caught out by further Govt tinkering with pension rules. I also want to keep some money in a more accessible wrapper should I need it over the next 6 years.

I am 49 and want to fully retire by the time I am 56/57

Tax-wise, your balance may the wrong way around. The money you're putting into the ISA has been taxed at 40%, but funds in the pension will be taxed in the future at no more than 30% if drawn down at a reasonable rate, or annuitized (since, even if you're a 40% taxpayer in retirement, you can take a quarter of the funds tax free).

Of course, cash-flow considerations may override this, but the tax advantages of pensions are worth paying close attention to.

Warmest regards,
FA

peterg1965

With the potential rise in the HRT threshold to £50k by 2020, I am planning on drawing from the SIPP/Company PP to ensure that I only pay basic rate tax. My final salary pension will be about £37-£38k by the time I am 56/57 so will drawdown to achieve £50k. If I have a combined pension pot of £400k that would be 4-5% drawdown after I have taken the 25% tax free.

FatherAbraham

peterg1965 wrote: »

With the potential rise in the HRT threshold to £50k by 2020, I am planning on drawing from the SIPP/Company PP to ensure that I only pay basic rate tax. My final salary pension will be about £37-£38k by the time I am 56/57 so will drawdown to achieve £50k. If I have a combined pension pot of £400k that would be 4-5% drawdown after I have taken the 25% tax free.

If you're only going to pay basic-rate tax in retirement, then that'll be an effective rate of 15% (only three-quarters of the money will be liable to 20% tax, thanks to the tax-free lump sum).

So, you can put money into the ISA, having paid 40% tax on it, or put it into the pension, paying tax at 15% in the future. That tilts the game strongly in favour of the pension, all things being equal.

Warmest regards,
FA

atush

FatherAbraham wrote: »

Tax-wise, your balance may the wrong way around. The money you're putting into the ISA has been taxed at 40%, but funds in the pension will be taxed in the future at no more than 30% if drawn down at a reasonable rate, or annuitized (since, even if you're a 40% taxpayer in retirement, you can take a quarter of the funds tax free).

Of course, cash-flow considerations may override this, but the tax advantages of pensions are worth paying close attention to.

Warmest regards,
FA

I have to say I agree that not withstanding your very early retirement plan, i'd be grabbing more of that 40% tax relief

jamesd

Given your high income and existing assets I suggest skipping the ISA use for now and switching to VCTs instead, at least for a while. There's a wide range available from lowish risk 100% secured lending like that done by the Albion VCT all the way through to early state startup investing.

You get the VCT 30% tax relief early, either in higher tax code or a reclaim after the end of the tax year, no need to wait as you do for a pension or get no initial relief as in the ISA. That can make it considerably easier to fund the VCT purchases than pension contributions because the short term effect on income is lower - you get that 30% back into your pocket quickly. The ongoing tax free income also helps with this.

You have to repay the 30% if you sell within five years. After that you can sell and buy something else, or wait six months and buy the same thing, and get another 30% relief. The 30% is capped at income tax payable in the tax year of purchase. No CGT on VCTs. So unlike the pension you don't need to wonder about tax rates on the way out, there isn't any.

Many VCTs pay most of their returns in the form of dividends, which are tax free for everyone in VCTs. Expected dividends of the Albion VCT are 10.02% with one they run with less asset backing called Crown Place expected to pay 11.16%. Both of those rates are after allowing for the effect on the purchase price of the 30% refund.

Choice of VCTs is a bit limited at the moment because the main VCT issuing season doesn't start until September and October.

VCTs do not preserve personal allowance so you'll probably want to keep using pension contributions to achieve that.

One of the mistakes that I made was not switching from ISAs to VCTs as early as I should have done, I slacked on learning more about them earlier. They could also be quite interesting as a way to arrange a tax free ongoing income in retirement.

Looking beyond this year, we'll presumably finally see peer to peer ISAs introduced and with some P2P paying 10-12% that could prove interesting.

There are today also a limited number of SIPPs that allow P2P, perhaps of interest for those who want to do serious diversifying out of equities and bonds due to the relatively high valuations of some of those markets at the moment. Unfortunately the current SIPP providers offering this don't become economic until at least £50,000 and better £200,000+ is invested with them due to fixed annual charges, though there are no ongoing charges beyond that in those I've looked at, so they could be a good buy for those with larger SIPPs who transfer their non-P2P investments as well.

peterg1965

Thanks James. Not convinced VCTs are for me.

I am going to go down the route of increasing contributions to my SIPP and optimise tax relief. Given that I am about to start my final salary pension, would this raise issues with recycling? I am not adding a lump sum to the SIPP and I would consider that monthly contributions are coming from earned income not the pension?

jamesd

It is a potential recycling issue if you get a tax free lump sum because it's an increase in pension contributions in the two tax years before taking the lump sum, the tax year of taking it and the two following tax years. I'm unsure how HMRC would regard a year or two of no contributions at all within that window.

If the amounts now are on the same pattern as you used two years ago or are lower my guess is that it'll be OK. Guess because it's up to HMRC to decide. Eliminating loss of your personal allowance is easy to understand, particularly if you've only just reached the income level where that happens. It also seems easy to show that you are funding the contributions from your income, not the lump sum.

I wasn't sure about VCTs either until I learned more about them. Don't use them unless you're comfortable with them, though. Nobody needs the headaches of worrying whether they did the right thing or not.

peterg1965

Thanks James, it's a bit of a worry really, and I know there is not a definitive answer regarding recycling. My contributions, up until Mar 13 were up at the £1600/month level (inclusive of basic rate relief) so I will be marginally below this.

if challenged by the HMRC I can show them that it is not the lump sum from my final salary pension that is being recycled and also not the monthly pension that is being used to fund the SIPP, although that is a little more subjective as the pension goes into my current account with my salary and is also the account where my direc debit for the SIPP comes from.

atush

Will taking his DB pension mean his AA is lowered to 10K per annum?

jamesd

peterg1965 wrote: »

My contributions, up until Mar 13 were up at the £1600/month level (inclusive of basic rate relief) so I will be marginally below this.

that's good news because it means that it is unlikely that the total extra will be more than 30% of the lump sum.

peterg1965 wrote: »

not the monthly pension that is being used to fund the SIPP, although that is a little more subjective as the pension goes into my current account with my salary and is also the account where my direc debit for the SIPP comes from.

Well, recycling pension income isn't restricted in any way so that extra bit of taxable income tends to both provide a reason for starting higher contributions and part of the funding source.