Protecting personal allowance & our plan

Workerbee999

Hi

My total taxable benefits will soon increase to be £124k pa (£110k salary, plus car allowance, and other P11d benefits).

I want to avoid the 60% marginal tax trap so intend to put roughly £24k in my pension. Company contribution is 15% of £110k so it would mean I would be putting in the full £40k annual allowance.

With the employers pension contribution my total income would be £140k, so under the new £150k for tapering pension tax relief. I don't have any other sources of income. It's salary sacrifice but the scheme has been in place for years.

In this situation is there anything you can think of that would be a better option than this, other than if I need access to it before I turn 55 (I'm 46 so hopefully this will still be the date).

The things I have considered are:

1) I would be putting in the full allowance each year all at higher rate tax relief and my taxable income would be down to £100k.

2) I don't expect to reach the LTA as I would start drawing it @ 55. Ideally I would stop work at 52 and leave it to build for 3 years. My current DC pot is £165k, plus I have a £20k DB from 60. I'm aiming to build a DC pot of around £0.5m, and the DB would be valued at £400k. SP at 67 of £7k.

3) OH has his own DB of £24k from 55. So we will cover our personal allowances. I will take the 25% TFLS and then withdraw each year the max I can, staying within the 20% tax bracket. If that is £43K, the pot should provide around £43k pa to start with (excluding the lump sum), and then top up the DB to get the same amount later.

4) I'm hoping there is enough margin in the growth to cover inflation effect on the DC.

5) Currently no savings (but lots of redundancy / sickness etc. cover). But only 3 years left on the mortgage where we are paying £3,500 pm. We will then save that in ISAs etc. to build up a pot to live on from 52-55.

6) Sometimes I might get a bonus (max 15%), and the only option I can currently think of is using up some existing carry forward of unused pension allowance.

I would be interested in anybody's views on if I have missed anything?

Thanks

neilvw

This is a bit of a brainteaser for a Friday night :-)

If you got a bonus of £16.5k (15% of pre-sacrifice salary) and wanted to put it into a pension, I assume you would be sacrificing it directly into the employer's scheme?

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Pre-bonus
=======

£86k salary (post-sacrifice) + £14k P11d = £100k total income
+ £16.5k ER contribution
+ £24k extra ER contribution (sacrificed salary)
= £140.5k adjusted income, less than or equal to £150k, taper does not apply

[Threshold income* = £100k, less than or equal to £110k, taper does not apply]

Pension input of £40.5k, would require £500 of carried-forward allowance on these figures

Post-bonus (£16.5k bonus sacrifice)
=======

£86k salary (post-sacrifice) + £14k P11d = £100k total income
+ £16.5k ER contribution
+ £40.5k extra ER contribution (sacrificed salary & bonus)
= £157k adjusted income

Threshold income = £100k, less than or equal to £110k, taper does not apply

Pension input of £57k, would require £17k of carried-forward allowance on these figures

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The taper is not going to be a problem; the limiting factor will be how much unused annual allowance you have available to carry forward. Worth bearing in mind that 2013/14, the earliest year you can use to carry forward to the present year, had an annual allowance of £50k, the last year before it fell to £40k. Assuming it isn't tapped out, that is the one you would be using next if you exhaust 2016/17.

* Threshold income (total income minus personal contributionss) has to be more than £110k for the taper to be activated.

jamesd

A few things missed:

1. Unused pension annual allowance for 2013-14 tax year is now a use it or lose it one so why aren't you planning to use it?
2. Throwing away money and early retirement time on the mortgage overpayments, should be maxing pension contributions with that money then planning to clear after 55 when you will have received tax relief on your mortgage capital payment. OH might hit 55 before you if you dislike waiting.
3. Start learning about VCTs, you're a prime candidate for using them. 30% initial tax relief from HMRC, tax exempt dividends, no CGT means you can think of the lower risk ones as a way to save a lot of income tax if you can defer some of your income for the five year minimum holding period. Will also let you draw DC money faster if desired by getting rid of the tax cost of that.
4. Is the home you're paying the mortgage on your long term home in retirement? If no need for it, relocating or downsizing sooner than you might otherwise do might be a good move.

Workerbee999

Hi. Thanks for the replies.

1st question about bonus. Yes it would be salary sacrifice and my employer would add 5% to split the NI benefit. The numbers you quoted neilvw make sense to me. It seems to work fine until the possibility of getting a bonus that takes me back over the thresholds again! Not a relatively bad position to be in obviously, I am very fortunate, but equally I want to be smart with it. However bonuses are not guaranteed (none this year).

Due to a very recent promotion I will now be in the position to be able to max out my pension input to the 40k going forwards. Up until now around 26k pa has been going in based on mine and the companies contributions.

So you are right Jamesd there is some missed opportunity there in the past due to overpaying the mortgage where we have not been smart. The same is true for OH, who has a great final salary deal which seems to have a far smaller pension input amount attached to it, so we could have put more there. It has been the topic of a number of our discussions but OH is very risk adverse and it has always been important to him to clear the mortgage first, for personal rather than financial priorities. While both well paid our jobs have not been that stable in the past and there have been a few scares. Besides we have some other plans on how to spend the 25% TFLS - sensibly helping our son onto the property ladder, or wildly blowing it on a boat to sail the Med! ��

We are both the same age so plan to run from the rat race at the same time. We are not in our forever home yet, but that will involve moving from the area. When we turn 52 our son might have flown the nest to start university, so the family aspects will dictate the right time to move.

In terms of using 13-14 carry forward, I don't think I am going to be in the position this year to go over the 40k (no bonus this year and promotion only just happened) . Unfortunately we can't change the mortgage payments either as we changed the term, rather than overpaying.

So I think I can only make sure we make the most of everything going forwards. We might also look at maxing out OHs annual allowance with an additional personal pension - I need it to be my pension to avoid losing the personal allowance, but I don't want to put too much in that means I pay 40% when I take it out, if OH would only pay 20%. It's a balancing act.

I am interested in VCTs and have seen them mentioned on here sometimes but I don't really understand them. Can you recommend where I could research? The trouble is I don't want much risk, so would be happy with something that just gave the tax relief, as 30% is a great return in itself compared to paying HMRC. How do they allow me to draw DC money faster?

Thanks

theoldgreychap

A couple of thoughts - are the commutation factors on your DB schemes fair value? If not then are there options other than using them to generate capital sums, eg reconsider other uses for higher regular income instead? I'm considering funding early pension contribs for my kids rather than property ladder help for instance - which would also align well to any future monthly 'surplus' income
When you start to build savings don't overlook P2P. Will see them increasingly available via Innovative Finance isa's.
Final thought - it may be worth looking at scenarios featuring actuarial reductions on DB schemes to access earlier (if early access allowable under scheme rules). May give options for smaller savings targets.

Workerbee999

Sorry, I don't know what you mean by commutation factors on the DB being fair value, please can you explain? We just plan to take these pensions when they are due to avoid actuarial reduction. By the time we are 60 we would prefer to have 44k DB forever with the protection of 50% spouse pension and inflationary increases, and then use the DC pot to fill the gaps between when these start.

I will need to research P2P also - I don't know what that means

The TFLS I mentioned taking would only be from the DC pot, so that we can have the max DB pension. If I can build a DC pot of 500k, I can take out 125k.

theoldgreychap

The commutation factor is simply the amount of annual income you surrender from your DB scheme in exchange for every pound of your tax free lump sum (i.e. divide your potential lump sum by the associated reduction in annual pension) . You can then see how long you have to live beyond your NRA for you to 'win' or 'lose'.

For instance I have 2 deferred DB schemes (and another DC scheme into which I actively contribute into) - one with a commutation factor of around 12 which is poor value to my mind (but seemingly quite common according to those other very knowledgable people on this forum!) and one with a commutation factor of around 23 which is clearly much better value and may feature in my plans depending on the precise scenario in question.

I expect to be a HR tax payer in retirement so will be looking to minimise the total tax I am likely to pay - so reducing annual income (via commencement lump sums) and/or stretching pension in payment across a longer period (via early access with associated actuarial reduction) are considerations.

Clearly if you are only considering using the DC scheme to provide a commencement lump sum then the 'commutation factor' is not a relevant factor!

You will be pretty close to the LTA (although this may increase between now and your planned early retirement date) so keeping a close eye on this will be important too.

Looks to me like you are in a good position with potential to be very well set heading into the future!

jamesd

To use easy numbers, say you drew 30k taxed at basic rate and 30k taxed at higher rate from a pension. You could buy 60k of VCT and get 30% income tax relief on it, the same as the tax payable, so you just withdrew taxable 60k from the pension with no net tax cost at all. The Albion VCT that I have used most anticipated paying about 10% a year tax exempt on the net 42k so that's another 20.8k during the five year holding period. Initial charges of about 3%, anticipated capital drops of about 1% a year and about 6% sale loss after five years cost around 14% of the 60k, about 8.4k. So after five years when you sell the 60k the anticipated result is no income tax and about 12.4k of investment gain on your money. Numbers not guaranteed, just from an independent analysis of their financials and my own expectation.

If you're happy to pay 20% income tax you could take out more. One interesting thing is that you could start doing this now to cut your 40% income tax bill and have the five years end at a useful time.

Your OH should remember that the money off the mortgage is useless to you for paying bills since it's not available to spend on bills and expenses. Savings and investments are, in general, since most don't have that five year VCT holding period.

But you've done something even worse by changing the term. Now you have to find that full 3500 regardless. At least with overpaying you can choose to drop back to the normal payment if in need.

Your OH got it badly wrong in thinking the mortgage payments were reducing risk. By increasing the mandatory payments and depriving you of savings that has greatly increased your overall risk level. As an additional penalty you don't have the savings to use with VCTs to cut your effective tax rate a lot and save yourselves even more money.

If you really want to reduce risk you should be looking for a long mortgage term to cut the minimum mortgage payment level, then if desired overpaying on that, though it'll waste a lot of tax saving potential if you do.

I'm doing something similar with an interest only mortgage. High pension contributions and VCT buys that eliminate most of my tax bill and much of my employee NI. I can pay off my mortgage whenever I want from savings and investments but I don't because it'd cost me more than it saves. I'll eventually pay it off at no real cost to me since it'll all be some of the tax and NI relief I've had. I don't expect to pay much tax in retirement courtesy of continued VCT buying that will make most of my taxable income tax free by deferring it for five years.

If you use the forum advanced search for my username and either VCT or P2P you can find a fair bit of discussion about those topics. I currently favour the raw interest rate of 12-14% P2P via Ablrate and MoneyThing. About 10% is what I expect after tax deductible bad debt. Well, what I allow for, I expect less.

jamesd

Theoldgreychap, nicely done.

You should also investigate CETVs, which can be far more generous than commutation factors even after allowing for the cost of the mandatory transfer advice. That 12:1 commutation factor one might have a CETV of 35 times income!

12:1 is the standard commutation factor of the public service for schemes and it's poor value for those with normal life expectancy for those in good health.

jamesd

You'll find that much of what you read about VCTs mentions high risk or high charges. VCT risk varies a lot, from highly speculative new technology firms to adding money to stable businesses that started years ago. The Albion one I've used most has recently been building three new care homes and as well as those the rest of what it's doing also has physical assets as security. Such things as hotels and hydro power that aren't allowed any more for new investments because they are too low risk, and independent schools. It's towards the lower end of the VCT risk range, which is what I was looking for.

Performance fees tend to be the charges that get most attention[STRIKE] but that can be misguided because VCTs tend to pay out most gains in tax exempt dividends. The performance fee is based on the value of the VCT, called the net asset value (NAV), and is higher the greater the gain in NAV. For VCTs that anticipate paying most gains in dividends the NAV won't grow or might decrease, reducing or eliminating the potential performance fee. Albion is in this category.[/STRIKE]

The numbers I gave earlier are after all fees, except the initial charge one I mentioned.

jamesd

Your sailing the Med plan opens up some interesting opportunities. Did you know that it's entirely legal to take the whole of a DC pension pot tax free and pay no income tax if the circumstances fit? No evasion or scams involved.

Britain has tax treaties with many countries which say that pension income is to be taxed in the country of residence, not the country it's paid from. Portugal has a scheme that you can opt in to that makes the tax rate on foreign pension income zero. The 75% of a pension pot that is taxable is income, so is taxable at 0% under that scheme. So you could take out a 25% tax free lump sum and also a 75% taxable sum taxed at 0% after you have made Portugal your country of tax residence.

The Portugese scheme is intended to encourage well off foreigners to relocate there. I can think of far worse countries of tax residence for those cruising the Med!

Other places have lower tax rates than the UK and a similar tax treaty.

To prevent the use of this by those just leaving the UK for a short time as a tax dodge, if you return permanently for several years after taking out the money you will be taxed as if you took the money in the UK in the year you return to the UK for long enough to become tax resident.That would mean 45% and 40% on most of it. Places like Ireland, where UK nationals have a right of abode not linked to EU membership, the Channel Islands and Isle of Man can be useful ways to stay out of UK tax residence if required.

If the circumstances fit, a DC pension can get you 40% tax relief on not only your boat but also your whole mortgage capital payment.