Early retirement-funding the gap

Redsox64

Secret2ndAccount said:

Yes, we are recommending you open a SIPP and pay into it.

Suppose you earn £20,000 per year. You will take home about £17,200 after tax. You can pay £16,000 into a SIPP. When you do that, the government gives you back the tax you paid. It doesn't matter exactly how much tax you personally paid - they add a quarter to whatever you pay in. So your 16k paid in turns into 20k. It's free money. You can only do this trick up to the amount you earn in any tax year. That's why I said 16k, because it becomes 20k, which is what you earned in this example. Let us know if you are a higher rate taxpayer as it gets better, although more complicated. So, yes, it's better to pay in your salary and live off your savings. Even if you don't do anything with the money in the SIPP, you have still gained from the governemnt gift. Most people choose to invest the money in the SIPP into some kind of investment. Stocks and shares tend to grow 5% or more every year, although they can go down too. Any growth you achieve inside the SIPP is free of tax - woohoo!

When you come to take the money out of the SIPP, 25% is tax free. The rest gets taxed as income. So some of the generous government gift gets taken back again. However, if you aren't earning a lot at the time, you might pay little or no tax as you still have your annual tax free alowance - the first £12000+ is free of tax. So in the years between retiring and receiving State Pension, when you have no earnings, you might be able to get it all back out of the SIPP without paying any tax at all. Let me know if you need an example to understand this. It would help, in that case, to have some idea of your annual income, and how much you need to live on.

Thank you that’s a bit clearer. I earn just over £30K working part time. I pay £500 a month into my AVC. At 60 my pension (incl an element of final salary) would be around £18K pa with a Lump Sum of around £34K, this obviously goes up the later I retire. If I defer LGPS until 65 only the CARE would be reduced.  However I would like to finish at 60 which gives me only 4 years to build up a pot. As to when I would defer to, it’s a balance between the early reduction amount and length of time I would be without a salary before drawing pension so I’m thinking defer until 63. In those 3 years I could probably live off £10K a year (no mortgage). Is this even do able? 

Dazed_and_C0nfused

If you stick to cash you would need to fund a SIPP with £24k between now and your early retirement.

The pension company, courtesy of HMRC, adds basic rate tax relief of £6k giving you a pension fund of £30k.

You can withdraw that at £10k for 3 years to bridge the gap till your other pensions start.

In tax years where you have no earnings you can only contribute £3,600 (£2,880 from you plus £720 tax relief).

Secret2ndAccount

Note that you normally aren't penalised for taking your pension early. Of course you get a smaller amount each year, but you get it for several more years. They normally try to work it out so that it balances out some time in your eighties, which is about how long an average person lives. So Ms average is neither better nor worse off - it just comes down to your choice. Take the money the way that works best for you. Looking at the numbers you've given, I would be tempted to take the pension early. You are on 30k now, and saving 6k/yr. You say you could live on 10k if you had to. Add your 18k to the state pension (9k) and you will be on 27k from age 67 to 100. Why twist yourself into a pretzel now in order to provide yourself with more than you need in your 80's?

So, continue paying the AVC's. Open a SIPP, and pay in as much as you can every year until you retire. If you earn 30k-6k AVC, that's 24k, so you can pay in 19k, which gets topped up to about 24k. You could do this from your savings, at least for one year. That still leaves you with plenty of cash in case of any unexpected misfortune. Note that the tax year expires in April, so if you get your skates on you can open a SIPP and pay into it in the next month, and get your free 5k for 2020/21.

You seem quite comfortable that you can live on 24k. Even at 60, your pension pays 18k. You only need 6k/yr or less to retire at 60. There's 24k in the SIPP by Mid 2021. Add half your lump sum and you're up to 41k. That's 6k for 7 years. So you have your 24k from age 60 to 67, with 17k lump sum, and 50k in other savings. I don't see why you couldn't retire at 60.

Keep juggling money into the SIPP and you could get up to 15k more free money by the time you were 60. Not sure you have the sources of money to achieve that though. Nice to keep a bit of cash handy, though you can always take money out of the SIPP if a big emergency arises - SIPPs can be accessed very flexibly.

I am not a financial adviser, and I don't know all the details of your personal circumstances

sevenhills

Secret2ndAccount said:

Why twist yourself into a pretzel now in order to provide yourself with more than you need in your 80's?

I think people do that. I will have more than I earn now, once I am state pension age, it's just the 8 years prior to that where I will struggle.

So timing is everything.

State pension = £9.5k

WYPF if cashed today = £4.5k

Morgage finishes in 6 years = £4k

Yearly earnings now = £17k

Redsox64

Many thanks for all the helpful comments. My understanding of SIPPs is pretty shoddy. Would I be able to ask my employer to make payments from my salary (I work for a local authority),  in addition to usual pension contributions and paying into my AVC. Could I also put in some of my savings and would HMRC top up on both scenarios. Thanks. 

AlanP_2

Redsox64 said:

Many thanks for all the helpful comments. My understanding of SIPPs is pretty shoddy. Would I be able to ask my employer to make payments from my salary (I work for a local authority),  in addition to usual pension contributions and paying into my AVC. Could I also put in some of my savings and would HMRC top up on both scenarios. Thanks. 

Your employer won't pay in to a SIPP direct from your salary.

What you need to do, if this is your preferred option, is to pay £x per month in to a SIPP from your bank account and then refill your bank account from savings if you need a bit more for noemal living costs. Over time your SIPP goes up and your savings go down but there is no direct relationship between a digital £ in your Current Account (from salary), a digital £ in your Savings Account (from previous salary payments) and a digital £ in your SIPP.

Earlier you mentioned LGPS AVCs - You are correct, they can only be taken at the same time as main benefits.

Overall gross pension contributions are limited by your salary so your SIPP contributions would be limited to (Salary - LGPS Contributions - AVC Contributions) - so you could contribute 80% of this and provider will reclaim the 20% tax break.

If you want to defer LGPS then a SIPP makes sense, if you are prepared to accept the reduced LGPS pension then upping the AVCs might be a better option but come back here if you want to explore that as there are additional tax complications to consider.

The LGPS numbers you quoted earlier (£18k at 60) - Are they reduced or unreduced?

cloud_dog

Your employer won't make personal deductions from your salary for a SIPP, you simply open one and set up a regular direct debit.

As others have mentioned you can use any of your available funds/money to deposit in to the SIPP, up to your annual allowance (already discussed on here).  All contributions will receive a 25% uplift (equivalent of 20% tax relief).

Redsox64

AlanP_2 said

Redsox64 said:

Many thanks for all the helpful comments. My understanding of SIPPs is pretty shoddy. Would I be able to ask my employer to make payments from my salary (I work for a local authority),  in addition to usual pension contributions and paying into my AVC. Could I also put in some of my savings and would HMRC top up on both scenarios. Thanks. 

Your employer won't pay in to a SIPP direct from your salary.

What you need to do, if this is your preferred option, is to pay £x per month in to a SIPP from your bank account and then refill your bank account from savings if you need a bit more for noemal living costs. Over time your SIPP goes up and your savings go down but there is no direct relationship between a digital £ in your Current Account (from salary), a digital £ in your Savings Account (from previous salary payments) and a digital £ in your SIPP.

Earlier you mentioned LGPS AVCs - You are correct, they can only be taken at the same time as main benefits.

Overall gross pension contributions are limited by your salary so your SIPP contributions would be limited to (Salary - LGPS Contributions - AVC Contributions) - so you could contribute 80% of this and provider will reclaim the 20% tax break.

If you want to defer LGPS then a SIPP makes sense, if you are prepared to accept the reduced LGPS pension then upping the AVCs might be a better option but come back here if you want to explore that as there are additional tax complications to consider.

The LGPS numbers you quoted earlier (£18k at 60) - Are they reduced or unreduced?

The £18K is the reduced calculation at 60 based upon my current salary level so it should be more.. Some suggest it might be better not to worry about deferring taking pension in which case is it worth taking out a SIPP or should I just pay into my AVC? Thanks 

chiefie

Just a thought - any avc’s you pay into Lgps can be taken tax free (as long as these avcs  amount to no more than 25% of the total pension value) at the moment. So sometimes useful to pay in some of these if you can afford it. Check with your administrator 

Secret2ndAccount

The AVC's and the SIPP serve the same purpose. They both come out of your income. They both attract tax relief (you get 25% extra). They both give you a pension. You might find restrictions on taking the AVC. For example, you might only be able to cash in part or all of the AVC when you start taking your work pension. With the SIPP, since you are over 55, you could cash it in any way, any time: take the 25% lump sum; take an income; take the whole lot in one go. Most likely though, either the SIPP or the AVC will work - meeting your needs as and when they arise. The AVC has the benefit of simplicity. By doing nothing you make a monthly contribution, it gets invested for you, and a pension comes out the other end.

Some people would prefer the SIPP because they get to choose how the money is invested, and how and when they take it out. Others might prefer the AVC's because they don't want to deal with any of that. AVC's can sometimes be used to increase the tax free lump sum when you take your DB pension.

My suggestion was to keep your AVC at the current level, but to maximise the free gift from the taxman each year by paying into a SIPP until your total pension contributions for the year are equal to your earnings. I guess if you want the simplest possible life, just double or triple your AVC's. You still get extra tax relief that way. Bear in mind what I said above though about when you can get the money out from AVC's if you suddenly need it. Also, you don't want to go so big with the AVC that your remaining salary drops below 12500 (your tax free allowance). You would then be putting money into AVC's that wouldn't have been subject to tax anyway.

So, easy life = AVC. If you are pushing it to the max, SIPP is better.