Another pension vs mortgage query.

jamesd

GunJack said:
When your retirement income is 2xDB pensions plus SP when it gets there, being mortgage-free is very important

...and possibly why people with DC pensions look at it a bit differently??

Using DC the pension pot was the repayment method when I took out the mortgage. Aside from the non-trivial investment risk it's a fairly easy decision, made easier with salary sacrifice where the tax and NI savings provide a significant buffer against losses.

jamesd

bolwin1 said:

I'm 55 years old...
Once my place does sell, I'll be in possession of £250K cash + a £250K mortgage. Figures rounded for simplicity. ...

Current pension £600K DC + £10K DB from age 60. Confirmed full state pension at 67. Salary £90K.(recent promotion). ...

I'm currently paying £14K p.a. into company pension via salary sacrifice. This costs me £8,120 after tax & NI are considered. ...

If I increased this to £40K p.a. this would drop me out of higher rate tax & cost me £23,200 p.a. (an impact of £15,080 p.a. in my paypacket). ...

I know could salary sacrifice more with my carry forward allowance but the benefits would be a lot lower as the only benefit would be the tax free element (20% tax on the way in & 20% tax on the way out).

Am I missing anything ?

Is your employer adding any of their saved NI? I'll assume  not for now,

You can get 52% relief on much of the money. NI is calculated for each pay period, tax annually. Sacrifice down to minimum wage in a month and some of the money will be saving you 2% NI but much will be in the 12% employee NI range so you save 52% instead of 42% on your higher rate income. Concentrate into as few months as possible to maximise your gain, in the rest do no more than it takes to get employer matching.

There are limits on recycling pension tax free lump sum money into new contributions, including indirectly. Two limits are of interest here:
1. £7,500 permitted each rolling 12 month period (not tax or calendar year)
2. 30% of tax free lump sum increase in total over the two years before taking the lump sum, the tax year taken and the following two tax years. Increase is compared to what would have been expected, with things like pay rises providing expected increases that don't count.

Since you have a 600k pot already you could reduce your out of pocket cost by 7500 every 12 months by taking benefits of 30000 with 7500 tax free lump sum going to you and 22500 placed into a flexi-access drawdown account that you must not touch until about to retire. If you take anything from the flexi-access drawdown pot you trigger the money purchase annual allowance that caps pension contributions that get tax relief at 4000 a year. Alternatively, 25% of the 600k is 150k and 30% of that is 45k to use for increases in this and the next two tax years.

Overall it looks best to plan to contribute your whole higher rate pay while still working and use any  remaining annual allowance carry-forward to make as much as you can in basic rate contributions as well. Funded by other savings, higher mortgage and tax free lump sum.

The lifetime allowance is also a consideration. With 800k committed already that's 273k available at present. Pessimistically the excess cost you 55% with no income tax due. For contributions getting employer matching, you're ahead, so continue. For others:

a. 40% income tax and 12% NI costs you per £1k, £600 after income tax minus £120 saved NI. Net cost £480. In pension £1000, after charge is £450. Not profitable. If you got 13.8% employer NI added the pot would be £1138 and after 55% that's £512.10 so profitable. 50% of employee NI would give a £1069 pot, net £481.05, profitable. There's no 25% tax free amount on money above the lifetime allowance.
b. the others cut costs less so not likely to be profitable if paying 55%. 40% plus 2% costs £580. 20% plus 12% costs £680.

There is the option to pay 25% charge, place the money into drawdown and pay 20% income tax within the basic rate band. Net out for this without employer NI is £600 and that makes all scenarios in a profitable along with the b 40% plus 2% case. So for this, sacrificing higher rate pay still provides tax profit.

An option to reduce the lifetime allowance used is to take the DB earlier, with actuarial reduction. That uses 20 times the reduced payment plus any tax free lump sum. Sometimes this can be a good move and your situation looks like one. There are no restrictions on using DB  income for pension contributions. To get higher rate relief on it, calculate the sacrifice needed for higher rate pay and add the DB income to get the total sacrifice.

bolwin1

jamesd said:

Is your employer adding any of their saved NI? I'll assume  not for now,
You can get 52% relief on much of the money. NI is calculated for each pay period, tax annually. Sacrifice down to minimum wage in a month and some of the money will be saving you 2% NI but much will be in the 12% employee NI range so you save 52% instead of 42% on your higher rate income. Concentrate into as few months as possible to maximise your gain, in the rest do no more than it takes to get employer matching.

Thank you jamesd for that very detailed reply. 
My employer does add some of the saved NI (5% of my pension contributions), so it's a relatively small bonus, but I'm not complaining. 
Although I had seen the variable monthly payments suggested on another thread, I had never taken much notice of it as I had assumed the numbers were small. However, putting my figures into a rough & ready spreadsheet show an additional saving of in the region of £2.3K p.a. so thanks again.
I'll try to avoid drawing on the pension before I retire if I can, but it is useful to have it as a backstop if needed.
Very useful info on the LTA - in the 'worst' case scenario, I'll drop to 5% contributions in the last year or so as that's the max employer contribution. It would be a nice problem to have. 

jamesd

Instead of potentially cutting you might look at market downturns that take values below present ones as an opportunity. Take the tax free lump sum from part of the pot and that gets calculated as a lower amount of allowance used. Say do 10% of the pot each month it's down by at least 10%, 20% if down at least 20% and all remaining if down 30% or more.

ukdw

jamesd said:

bolwin1 said:

I'm 55 years old...
Once my place does sell, I'll be in possession of £250K cash + a £250K mortgage. Figures rounded for simplicity. ...

Current pension £600K DC + £10K DB from age 60. Confirmed full state pension at 67. Salary £90K.(recent promotion). ...

I'm currently paying £14K p.a. into company pension via salary sacrifice. This costs me £8,120 after tax & NI are considered. ...

If I increased this to £40K p.a. this would drop me out of higher rate tax & cost me £23,200 p.a. (an impact of £15,080 p.a. in my paypacket). ...

I know could salary sacrifice more with my carry forward allowance but the benefits would be a lot lower as the only benefit would be the tax free element (20% tax on the way in & 20% tax on the way out).

Am I missing anything ?

Is your employer adding any of their saved NI? I'll assume  not for now,

You can get 52% relief on much of the money. NI is calculated for each pay period, tax annually. Sacrifice down to minimum wage in a month and some of the money will be saving you 2% NI but much will be in the 12% employee NI range so you save 52% instead of 42% on your higher rate income. Concentrate into as few months as possible to maximise your gain, in the rest do no more than it takes to get employer matching.

There are limits on recycling pension tax free lump sum money into new contributions, including indirectly. Two limits are of interest here:
1. £7,500 permitted each rolling 12 month period (not tax or calendar year)
2. 30% of tax free lump sum increase in total over the two years before taking the lump sum, the tax year taken and the following two tax years. Increase is compared to what would have been expected, with things like pay rises providing expected increases that don't count.

Since you have a 600k pot already you could reduce your out of pocket cost by 7500 every 12 months by taking benefits of 30000 with 7500 tax free lump sum going to you and 22500 placed into a flexi-access drawdown account that you must not touch until about to retire. If you take anything from the flexi-access drawdown pot you trigger the money purchase annual allowance that caps pension contributions that get tax relief at 4000 a year. Alternatively, 25% of the 600k is 150k and 30% of that is 45k to use for increases in this and the next two tax years.

Overall it looks best to plan to contribute your whole higher rate pay while still working and use any  remaining annual allowance carry-forward to make as much as you can in basic rate contributions as well. Funded by other savings, higher mortgage and tax free lump sum.

The lifetime allowance is also a consideration. With 800k committed already that's 273k available at present. Pessimistically the excess cost you 55% with no income tax due. For contributions getting employer matching, you're ahead, so continue. For others:

a. 40% income tax and 12% NI costs you per £1k, £600 after income tax minus £120 saved NI. Net cost £480. In pension £1000, after charge is £450. Not profitable. If you got 13.8% employer NI added the pot would be £1138 and after 55% that's £512.10 so profitable. 50% of employee NI would give a £1069 pot, net £481.05, profitable. There's no 25% tax free amount on money above the lifetime allowance.
b. the others cut costs less so not likely to be profitable if paying 55%. 40% plus 2% costs £580. 20% plus 12% costs £680.

There is the option to pay 25% charge, place the money into drawdown and pay 20% income tax within the basic rate band. Net out for this without employer NI is £600 and that makes all scenarios in a profitable along with the b 40% plus 2% case. So for this, sacrificing higher rate pay still provides tax profit.

An option to reduce the lifetime allowance used is to take the DB earlier, with actuarial reduction. That uses 20 times the reduced payment plus any tax free lump sum. Sometimes this can be a good move and your situation looks like one. There are no restrictions on using DB  income for pension contributions. To get higher rate relief on it, calculate the sacrifice needed for higher rate pay and add the DB income to get the total sacrifice.

Thought it would be interesting to factor in child benefit savings too if they happen to be relevant - to get the maximum available pension benefit for allowable £7,500 worth of pension lump recycling for people who are still working above age 55.  Happy to be corrected on calculations.

Based on this articule

https://citywire.co.uk/funds-insider/news/earning-over-50k-you-dont-need-to-miss-out-on-child-benefit/a682507

"A family with parents earning less than £50,000 is entitled to £20.30 a week for the first child and £13.40 for subsequent children but this will be reduced by 1% for every £100 over £50,000 earned."

So it looks like there is an additional benefit of about £1750 for families with 2 children who salary sacrifice down from £60k to £50k.

Based on 40% tax relief, 12% NI savings for concentrated salary sacrifice, 5% employer NI additional contributions it looks like the net cost of this £10,500 worth of extra pension contributions would be 60% (£6k) minus 12% (£1.2k) minus £1,750 -  so £3,050 - assuming the £10.5k could be withdrawn at 20% below LTA with a 25% PCLS - then it would net £8,925 -  so a gain of 192% on the £3,050.

The remaining £4,450 of the £7.5k lump sum drawdown could then be used to fund salary sacrifice of another £9,270 (60% (£5,562) minus 12% (£1,112)) - which would yield £9733 gross after the 5% employer NI addon in the pension, or £8,273 net after 20% below LTA drawdown + PCLS.

So assuming a salary of £69,270 - then it should theoritically be possible without any additional funds to withdrawn £7,500 net from the pension as a PCLS, and then end up with £20,233 gross (£17,198 net) back in - so almost £10k of free money.

Obviously where salary is above £69,270 further additional funds (perhaps from the mortage approach suggested in this thread) would be required to bring the salary down to the £69.2k level.

In terms of practicalities I guess it would be ideal if the salary sacrifice concentration changes were made near the end of one tax year and then overlap into the start of the next tax year -  as this would mean changes would only be required once every two years.

However if this causes cashflow issues due to the £7,500 PCLS allowable recycling drawdown 12 month limit then I guess annual salary sacrifice concentration changes would be easier.

atush

With a recent promotion, do you actually need the extra money for living expenses?  Or at least all of it?