Minimising tax paid in run up to retirement

DBdoobydoo

I have decided to aim at retiring in 4 years when my partner will be 60 & I will be 69. I am currently still working & earn about £60K plus I am drawing a £10K DB pension plus a UK state pension of £7K. From my current job I am accruing a DB pension that in four years will be worth £10K. So my total pension income will be about £27K which while it would be nice if it were higher should be sufficient as we will be looking to downsize our house to ensure that the last of the mortgage is paid off & there are savings for holidays etc.



My current total income is £77K. I make pension contributions in my current job of about £7K/year but there is no possibility of increasing this amount. By my reckoning I am paying tax at 40% on £20K & I would like to look at ways of minimising my tax over the next few years with the full knowledge that I will no longer be paying higher rate tax once retired. I assume a private pension of some sort is going to be the most efficient vehicle.


AIUI if I paid £12K into a private pension I could reclaim the £8K tax I paid so that there would then be £20K in the pension pot. Then if I do this for the next four years & ignoring any growth in the pot I will have a total of £80K of which I can take £20K as a 25% TFLS then draw down the remainder at a rate that keeps my total income below £50K so that I only pay 20% tax on the remaining £60K so my total from the pension pot after tax would be £20K + £48K = £68K rather than the £48K if I hadn't laundered the money through the pension. Likewise if I worked extra & was able to double up what I stuffed into the pension to £40K/ year after four years I could end up with £136K after tax.



So I have a few questions.


Is the plan above feasible or is there something I have missed? TBH it sounds too good to be true that just by washing my income through a pension that instead of paying 40% income tax I effectively only pay 15%.


What is the maximum that I could pay into a pension over the next four years? I think that I read there is a £40K per annum maximum but it's possible to go back several years & take up unused allowance. I would be prepared to work extra to maximise my pot if I knew the effective tax rate were 15% rather than 40%.

Linton

You understanding is incorrect regarding personal pension contributions. Only the basic rate tax is refunded to the pension. The HRT component is returned to you. It can get confusing, but confusion is minimised if you think in terms of a gross contribution. If you want £20K to end up in your pension you should contribute 80%=£16K. HMRC would pay £4K basic rate tax into the pension and refund £4K higher rate tax to you. The net effect is as you describe but the mechanism is a bit different.


It does sound too good to be true - dont complain too loudly!


There are two limits as to how much you can put into a pension in any one tax year and get tax relief.
1) You cannot pay in more than your earned income in any one tax year. There is no carry over from previous years.
2) The total going into your pensions in any one tax year, including employer contributions, cannot exceed £40K. But there is carry over of the unused allowance from the 3 previous years providing you were a member of any pension scheme during that period.


One question - why are you taking your State Pension and paying Higher Rate Tax on it? Were you to defer it, your SP would increase by 1% for the rest of your life for each 9 weeks deferred (it works out as 5.8%/year).

Albermarle

To basically repeat what has already been said the process would be :
Add £12 K to the Personal Pension or SIPP and the pension provider will add £3K ( which they calim back from HMRC ) Depending on the provider the £3K will be added straightaway or you may have to wait a couple of months .
Then either by way of a self assessment tax return or by a direct call to HMRC , you inform them of your gross contribution during the tax year and they will refund you another £3K to your bank account .
They will make the assumption that you will add the same amount to your pension the following year and adjust your tax code for the next tax year . This will mean you get a higher net pay each month but no refund at the end of the tax year.

£68K rather than the £48K if I hadn't laundered the money through the pension.

Only if you put the £3K tax refund back into your pension . Not sure 'laundered' is quite the appropriate expression , as it is all perfectly legal and claiming 40% relief and only paying 15% on the ay our is why for a HRTaxpayer , pensions are by far the best investment .

DBdoobydoo

Linton wrote: »

One question - why are you taking your State Pension and paying Higher Rate Tax on it? Were you to defer it, your SP would increase by 1% for the rest of your life for each 9 weeks deferred (it works out as 5.8%/year).

My plans changed. I wasn't intending to be a pensioner paying higher rate tax.


By my calculations if I wash my state pension through a pension scheme for the next four years for an effective tax rate of 15% then the advantage of deferring my pension for four years then subsequently paying 20% tax would be pretty minimal over my lifetime.

DBdoobydoo

jamesed provided an excellent worked example over on my other thread.

jamesd wrote: »

Pension contributions are very interesting because you can pay in then rapidly take a tax free lump sum. Say you pay in net 24k at higher rate tax. 25% is added inside the pension to give you 20% basic rate relief taking the pension to 30k. You tell HMRC and they adjust your tax code to give you higher rate relief of 6k. You take a 25% tax free lump sum of 7.5k from the pension and put the 75% taxable into a flexi-access drawdown pot that you take nothing from until you stop work or are about to reach 75. So:

24k net in
13.5k out: 6k from HMRC and 7.5k out in lump sum
22.5k in drawdown pot for later

That 22.5k only cost you 10.5k so before tax on the way out you've more than doubled your money. Assuming you draw at basic rate it's 18k after tax for a cost of 10.5k.

7.5k of tax free lump sum is a specific number. There are restrictions on recycling pension lump sums and HMRC might think you're doing that. One thing explicitly permitted is 7.5k of tax free lump sum every rolling 12 months (not tax year).

The question now is where is it best to put my money? I currently have a very small NEST pension pot that was set up when I did a short term freelance job. Is the simplest way of saving just to put money into that pension? or is there a better vehicle?

With an effective 15% tax rate I would be prepared to undertake some extra freelance work which could easily earn me another £30K/year which I would just pay in to the pension or rather I would pay in £24K/year to get the £6K added but not take the 25% tax free lump sum of 7.5K until after I actually retire so that it wouldn't be viewed as pension recycling.

jamesd

If you can afford it, bettter to put gross into the pension your whole gross pay, subject to the annual allowance llimit.

7.5k tax free out is allowed even if HMRC thinks the recycling limits would be breached. No reason not to take it if you can use the money productively.

Nest is quite bad on both initial charge and investment choices.

DBdoobydoo

jamesd wrote: »

Nest is quite bad on both initial charge and investment choices.

What would be a good alternative? As the pension is basically a vehicle to minimise income tax & the money will be drawn down fully over 4-5 years the most important elements are that it be low cost & risk free. I basically just want to hold the money in a deposit account while the pension magic washes away the income tax. If growth kept up with inflation that would be nice but isn't essential.

sandsy

You need to be aware of the pension input amount on the DB scheme you are still accruing or you may face a pension annual allowance charge. Looks like the amount could be around £20k.

DBdoobydoo

sandsy wrote: »

You need to be aware of the pension input amount on the DB scheme you are still accruing or you may face a pension annual allowance charge. Looks like the amount could be around £20k.

My current pension is increasing by about £1K/year so AIUI it's using about £16K of my £40K annual allowance. Without doing any extra paid work if I were able to pay in £24K this tax year I would be happy. Even if I undertake extra paid work I don't think that I'm ever going to be able to exceed the annual allowance as I can take advantage of the unused allowance going back up to three previous tax years so that's currently (£40Kx3)-(£16Kx3)=£72K on top of the £24K allowance still unused this year. It looks like I should be able pay in £48K per year for the next three years without penalty thereafter dropping to £24K per year. If I could manage to pay in that much I would be grateful (& amazed).

Albermarle

What would be a good alternative? As the pension is basically a vehicle to minimise income tax & the money will be drawn down fully over 4-5 years the most important elements are that it be low cost & risk free. I basically just want to hold the money in a deposit account while the pension magic washes away the income tax. If growth kept up with inflation that would be nice but isn't essential.

To be risk free, you would have to hold the pension in cash . You could not do this with NEST as far as I know and you would have to open a SIPP. However the cash accounts in SIPPS pay no/minimal interest so you would lose out to inflation.
Most pension holders are invested in funds which means a certain amount of stock market related risk/volatility ( some funds are more risky/volatile than others ) This is the best strategy as long as you have a long time scale to work with .Ideally 10 years minimum as in this case you should be able to rise out any volatility and see a return above infaltion. Over a short time scale ( < 5 years ) investing in funds is not as good an option , as you might get caught out with a market downswing.
Due to the tax benefit I guess you could live with some inflation losses on cash, in retrun for the safety?
Here are some links to SIPP comparisons.
https://monevator.com/compare-uk-cheapest-online-brokers/
https://moneytothemasses.com/saving-for-your-future/pensions/the-best-cheapest-sipps-low-cost-diy-pensions

DBdoobydoo

jamesd wrote: »

If you can afford it, bettter to put gross into the pension your whole gross pay, subject to the annual allowance llimit.

I'm now confused about the £40K annual allowance. If I pay in £24K the pension company adds 20% (£6K) of tax paid then if I withdraw £7.5K as a TFLS so there is £22.5K left in the pension pot how much of my annual allowance have I used? Is it £24K or £30K or £22.5K?

As I have been contributing to my DB pension for the last few years & it's been growing by about £1K/year AIUI I've been using about £16K of my annual allowance so I have £24K/year unused allowance for each of the last three tax years.

My pensions total £17K & my gross salary is £60K. I could earn up to another £30K if I took on extra work but I would only do this if I am able to minimise the tax that I pay & I certainly don't want to take on extra work & be hit with 40% income tax. What is the maximum that I can contribute from my salary into my pension pot in each of the next 3-4 years without exceeding the £40K annual allowance?