Lump Sum Contributions - Where's the Catch?

westv

I know that you can make one off lump sum payments into your pension up to something like £40k a year (less what you have already paid in that year)
I also know that the Government will top up that lump sum payment based on your rate of income tax.
In addition I am know those over 55 can do (within reason) whatever they like with their pension pot subject to the rules of the scheme (I'm assuming defined contribution scheme here)
Now what's to stop someone contributing a lump sum to their scheme at, let's say 53, obtaining the additional tax benefit and then withdrawing the sum (assuming it's less than 25%) as soon as they reach 55? Thereby gaining 20%/40% extra on their funds with little effort.

maximumgardener

ok. you are proposing draw off max 25% (the tax free element)
yes, you can do that, live off that for a bit.
when you then draw on the 75% remaining you will pay tax at your marginal rate. of course
you would be be drawing this at 55 and need to be comfortable with that timing
as it may not last e.g. till your are 60 /65 depending on how fast you use the tax free money.??

westv

Well I would intend to do is this:-

In the near future I will gain a 5 figure lump sum - I intend to use this to reduce my mortgage. As I'm on a 2 year fixed rate and I will pay the majority of the lump sum in once the fixed term ends.

I will be 55 soon after the fix term ends.

So I will pay what I can of the lump sum into my pension, gain 20%/40% and then, once I am 55, withdraw an amount to into my mortgage.

I intend to carry on working and paying into a pension up to around 60ish.

dunstonh

I also know that the Government will top up that lump sum payment based on your rate of income tax.

Not quite correct. You pay the net amount. You cant pay £40,000 and have tax relief added to that as it would exceed the annual allowance.

You would make a £40k gross contribution but would write the cheque for £32,000.

Now what's to stop someone contributing a lump sum to their scheme at, let's say 53, obtaining the additional tax benefit and then withdrawing the sum (assuming it's less than 25%) as soon as they reach 55? Thereby gaining 20%/40% extra on their funds with little effort.

Nothing. However, it would typically not be a good idea as you only get one bit of tax free cash against that amount. At 65, that pension fund could be double the value but you cant get another 25% out of it tax free.

maximumgardener

From what you outline, best maybe to think it through
and discuss all your options with an IFA.?
these are important decisions and need careful consideration.

thenudeone

Remember that can can't get tax relief on any contributions over 100% of your income. There is no carry-forward or carry-back of income-based allowances any more.

kidmugsy

thenudeone wrote: »

Remember that can can't get tax relief on any contributions over 100% of your income.

Not "income"; earnings.

zaza_zaza

I am 54 now and need to continue working for another 10 years or so. from the discussion above then I could pay a total of 24k this tax year into my pension and then get 25% next year in May when I am 55 with 40% tax topup to reach the 40 k limit.


Am I missing something?

AlanP_2

To Zaza_Zaza:

You would have to pay £32k in to get it grossed up to £40k at basic rate tax by the pension provider automatically with HMRC.

You then tell HMRC that you are a Higher Rate taxpayer and have paid in £32k. They will then either send you an £8k cheque or adjust your tax code to reflect the tax refund due.

Either way you end up paying £24k net to get a £40k pension investment.

Beware of limits though - £40k annual allowance includes all pension contributions (just in case you are already paying into one). There is a carry forward facility to utilise previous years unused allowances which may help you get over that one.

You must have EARNED income greater than the amount you are paying in to a pension in the relevant tax year.

If you take any more out of the pension than the 25% TFLS then you trigger a reduction of the annual limit to £10k.

One questsion - If you have a good salary (presumed as you are talking about £40% tax) and plan to work for ~10 more years why do you want to take the 25% TFLS next May?

If you left it for the full 10 years your £40k could be worth say £60k and then your 25% TFLS would be £15k as opposed to the £10k in your plan.

Equally the market could fall over 10 years I know so could be worth less but statistically unlikely.

A more realistic scenario that you may want to consider is that you pay the money in now and come May next year your £40k is only worth £30k as we have suffered a 25% fall in the meantime.

Would that mess up any plans you had for the £10k TFLS?