Question on flexible drawdown tax free amounts

GazzaBloom

Hi, I have a question on how the 25% tax free amount that can be drawn down from a DC pension pot. I'm going to use some hypothetical numbers below to help ask my question.

If I didn't take the 25% tax flee lump sum in one go, up front, but instead commenced a 5% drawdown each year in monthly instalments, I gather than 25% of the monthly amount drawn down would be tax free, is that correct? What happens in year 2, if the remaining funds grow 5% and I decide to take another 5% of the total pot as monthly drawdown, is the 5% tax free amount 25% of the new annual amount, or is it based on the value of 25% of the starting pot in year 1? Or dies it recalculate monthly, each time I drawdown?

Ie: Pension pot at start of drawdown £500,000
Year 1 drawdown 5% - £25,000
Year 1 tax free amount (25% of £25K) - £6,250

Year 2 - remaining pot of £475,000 has gained 6% (for arguments sake) by remaining invested so now equals - £503,500
Year 2 drawdown 5% - £25,175
Year 2 tax free amount?? is it 25% of £25,175 (£6,293.75) or £25% of the original drawdown amount of £25,000 (£6,250)

Ie does the 25% tax free amount recalculate based on the pot value, if so or is it fixed at 25% of the opening pot at the time drawdown begins?If it does recalculate, how often? is it annually or monthly in the above scenario?

Is that too confusing? I know I am!

garmeg

GazzaBloom said:

Hi, I have a question on how the 25% tax free amount that can be drawn down from a DC pension pot. I'm going to sue some hypothetical numbers below to help ask my question.

If I didn't take the 25% tax flee lump sum in one go, up front, but instead commenced a 5% drawdown each year in monthly instalments, I gather than 25% of the monthly amount drawn down would be tax free, is that correct? What happens in year 2, if the remaining funds grow 5% and I decide to take another 5% of the total pot as monthly drawdown, is the 5% tax free amount 25% of the new annual amount, or is it based on the value of 25% of the starting pot in year 1? Or dies it recalculate monthly, each time I drawdown?

Ie: Pension pot at start of drawdown £500,000
Year 1 drawdown 5% - £25,000
Year 1 tax free amount (25% of £25K) - £6,250

Year 2 - remaining pot of £475,000 has gained 6% (for arguments sake) by remaining invested so now equals - £503,500
Year 2 drawdown 5% - £25,175
Year 2 tax free amount?? is it 25% of £25,175 (£6,293.75) or £25% of the original drawdown amount of £25,000 (£6,250)

Ie does the 25% tax free amount recalculate based on the pot value, if so or is it fixed at 25% of the opening pot at the time drawdown begins?If it does recalculate, how often? is it annually or monthly in the above scenario?

Is that too confusing? I know I am!

For year 2 the tax free PCLS is 25% of £25,175 = £6,293.75.

To clarify, 25% of each withdrawal is tax free at the time it is withdrawn, whether annually, monthly, whatever.

I am ignoring LTA here as hopefully irrelevant.

DairyQueen

The 25% tax free amount is a factor of how much you withdraw at the point of withdrawal. It is not a factor of the value of the pot at the point of withdrawal unless you crystallise the whole pot by taking the max 25% upfront.

The value of the pot will vary on a daily basis and you intend to make monthly withdrawals. You could either withdraw 0.4167% (5%/12) of the pot (a variable amount) each month, or £2083.33 (£25,000/12) - a fixed amount each month for the first year. In the latter case you could increase/decrease the fixed withdrawal in subsequent years depending on factors like how the fund performs over the preceding year.

There is therefore potential to increase the amount of TFC taken over the total period of withdrawals.

As an aside, 5% is a relatively high withdrawal rate and may not be sustainable over the course of retirement. Plenty of discussion and advice on here (and elsewhere) about SWR (safe withdrawal rate) and drawdown strategies designed to manage the risk of running out of money (or dying with an excess).

dunstonh

If I didn't take the 25% tax flee lump sum in one go, up front, but instead commenced a 5% drawdown each year in monthly instalments, I gather than 25% of the monthly amount drawn down would be tax free, is that correct? 

yes

What happens in year 2, if the remaining funds grow 5% and I decide to take another 5% of the total pot as monthly drawdown, is the 5% tax free amount 25% of the new annual amount, or is it based on the value of 25% of the starting pot in year 1? Or dies it recalculate monthly, each time I drawdown?

It depends on what you set the 5% figure on.   If you are still using 5% of the original "opening" value then it is the same amount. If you decide to increase the withdrawal then it will be 25% of the revised amount.  The rate of return is irrelevant as the whole pot is made up of uncrystallised funds.    Uncrystallised funds have 25% tax free available to them.

Each withdrawal stands in isolation of any other when drawing from uncrystallised funds.

GazzaBloom

DairyQueen said:

The 25% tax free amount is a factor of how much you withdraw at the point of withdrawal. It is not a factor of the value of the pot at the point of withdrawal unless you crystallise the whole pot by taking the max 25% upfront.

The value of the pot will vary on a daily basis and you intend to make monthly withdrawals. You could either withdraw 0.4167% (5%/12) of the pot (a variable amount) each month, or £2083.33 (£25,000/12) - a fixed amount each month for the first year. In the latter case you could increase/decrease the fixed withdrawal in subsequent years depending on factors like how the fund performs over the preceding year.

There is therefore potential to increase the amount of TFC taken over the total period of withdrawals.

As an aside, 5% is a relatively high withdrawal rate and may not be sustainable over the course of retirement. Plenty of discussion and advice on here (and elsewhere) about SWR (safe withdrawal rate) and drawdown strategies designed to manage the risk of running out of money (or dying with an excess).

Thanks for confirming, that makes sense.
 
I was just using 5% as an example to demonstrate my question as the maths is easier!

My tentatively planned withdrawal rate will vary, higher in the early years until state pensions kick in then reduces significantly. Average withdrawal rate over 35 years would be quite low, below 3% depending on returns through the course of retirement. I'm 53 and several years from retirement drawdown at present so just trying to increase my understanding.

Albermarle

Drawdown, tax free amounts etc can be confusing but I found that once I fully grasped the idea of crystallised and uncrystallised pots then it all became much more clearer.