Investing after LTA?

Albermarle

Just to point out (the obvious) that a SIPP of £1.2m and growing will on its own likely generate returns that will exceed the basic rate allowance when you put it into drawdown

For a higher rate taxpayer , £100 in the pension costs £60 . When you take £100 as income under LTA , you lose 25% first and then 20% income tax on the remaining £75 , so you are left with £60. If the employer contribution is reasonably OK then still worth going ahead ( just ) .

One possible way around the growth issue  , is to dial down the risk/growth investments in the pension . By going for growth you are risking more LTA tax if successful, and potentially bigger losses if markets turn nasty . Instead you can concentrate the higher risk/growth investments outside the pension.

caveman8006

Albermarle said:

Just to point out (the obvious) that a SIPP of £1.2m and growing will on its own likely generate returns that will exceed the basic rate allowance when you put it into drawdown

For a higher rate taxpayer , £100 in the pension costs £60 . When you take £100 as income under LTA , you lose 25% first and then 20% income tax on the remaining £75 , so you are left with £60. If the employer contribution is reasonably OK then still worth going ahead ( just ) .

One possible way around the growth issue  , is to dial down the risk/growth investments in the pension . By going for growth you are risking more LTA tax if successful, and potentially bigger losses if markets turn nasty . Instead you can concentrate the higher risk/growth investments outside the pension.

The point I was making is that the income from a £1.2m SIPP will very likely be above the higher tax band, so you would be taxed at 40% on the £75 left after the LTA penalty tax ie. £45.

Albermarle

The point I was making is that the income from a £1.2m SIPP will very likely be above the higher tax band, so you would be taxed at 40% on the £75 left after the LTA penalty tax ie. £45.
That is of course possible, but a safe withdrawal rate from a £1.2m pot would be about £40K pa + state pension etc , so maybe get away with it.

zagfles

Albermarle said:

The point I was making is that the income from a £1.2m SIPP will very likely be above the higher tax band, so you would be taxed at 40% on the £75 left after the LTA penalty tax ie. £45.
That is of course possible, but a safe withdrawal rate from a £1.2m pot would be about £40K pa + state pension etc , so maybe get away with it.

You would presumably take max PCLS so £1.2M SIPP would be £900k after PCLS and LTA charge, so £36k taxable even if using the "optimistic" IMO safe withdrawal rate of 4%. So well below higher rate band even with full state pension on top.

jamesd

Yes, VCTs can be good, do diversify.

The punchline: it appears that taking £95,500 from the drawdown pension pot a year from age 55 until 75 will be prudent.

So far as the LTA goes the two issues are tax-efficient handling of the amount above the LTA and the additional LTA on drawdown growth at age 75. Drawdown usually beats lump sum LTA because you can use VCT buying to mitigate the income tax cost.

While zagfles is right about 4% SWR income that's a very bad case and more will be needed to be confident of not having a bill at 75. At a minimum, using the full basic rate band every year.

With VCT buying the basic rate only case is (50k - 12.5k) * 20% = 7,500 income tax. Divide by 0.3 for the VCT relief and that's 25,000 of VCT buying to cover it.

Starting out drawing more to try to get ahead of the growth you might take 18,750 at higher rate ( half of (50k - 12.5k)  ). Extra income tax on that is 7,500 for a total tax bill of 15,000. Divide by 0.3 and you buy 50,000 of VCTs. After tax income is (50k - 12.5k) * 0.8 + 18,750 * 0.6 = 30,000 + 11,250 = 41,250 to cover much of the buying cost, then a tax refund of 15,000. Deducting that 8,750 shortfall leaves you with 7,250 positive cash flow.

That sort of thing is best done early when tax free cash is available and can't all be put into a tax wrapper at once and because of the minimum five year holding time of VCTs and to start getting their tax exempt dividends. Say use 45,000 at higher rate on a five year plan. That's covered by 60,000 of VCT buying on top of the basic rate's 25,000 for a total buy of 85,000. at 95,000 gross income. Five years of that rapidly takes 450,000 out of the pot and seems to make age 75 safe from the LTA charge - until you look at the numbers more closely, as I do later. The 425,000 VCT holding would be expected to pay 5-6% dividends for 21,250 or 25,500 tax exempt a year.

425k in VCTs is a bit high so maybe cut back to a ten year plan where you recycle the money from the first five years to halve the VCT exposure, the 50k buy on 68,750 gross income from the last paragraph with 250,000 peak and 12,500 to 15,000 in dividends.

But...

At 1.2 million in the late 40s, say we assume growth of 5% plus inflation for seven years, taking the pot from 1,200,000 to 1,688,000 rounded. Since this is plus inflation we use today's allowance of £1,073,100. That's 268,275 tax free and 804,825 in drawdown. The excess is 606,900 and after an income lifetime allowance charge of 25% is paid this adds 455,175 to the drawdown pot, taming it to 1,260,000. The age 75 test is on nominal not real growth so assuming 2% growth we need to average 88,200 of withdrawing a year to expect to avoid it. That 68,750 gross ten year plan isn't enough and the 95,000 gross income one is only slowly pulling ahead once we make it a ten year plan.

The personal allowance taper starts at 100k and a bit more margin is desirable. VCT buys are normally in 1k chunks and each 1k covers 1000 * 0.3 = 300 of tax which is that on 750 of higher rate income. So add 4,500 to make it a 99,500 gross income plan that can run for all of the 20 years from 55 to 75 if needed.

Once we allow for say 25k of dividends the person may need to be on £125k a year initially just to avoid more LTA charge before we even consider other investments. Remember that we get the VCT buy money back after five years of deferral.

A person in this situation who's really keen to continue helping small companies to grow could do that sort of income for life with no net income tax bill again, unless they encounter a seriously bad sequence of returns. Of course VAT at 20% on that is 25k so they would still pay a lot of tax.

kinger101

Although you do get very good advice on this forum, in your position, I'd probably be speaking to an IFA.

zagfles

jamesd said:

Yes, VCTs can be good, do diversify.

The punchline: it appears that taking £95,500 from the drawdown pension pot a year from age 55 until 75 will be prudent.

So far as the LTA goes the two issues are tax-efficient handling of the amount above the LTA and the additional LTA on drawdown growth at age 75. Drawdown usually beats lump sum LTA because you can use VCT buying to mitigate the income tax cost.

While zagfles is right about 4% SWR income that's a very bad case and more will be needed to be confident of not having a bill at 75. At a minimum, using the full basic rate band every year.

With VCT buying the basic rate only case is (50k - 12.5k) * 20% = 7,500 income tax. Divide by 0.3 for the VCT relief and that's 25,000 of VCT buying to cover it.

Starting out drawing more to try to get ahead of the growth you might take 18,750 at higher rate ( half of (50k - 12.5k)  ). Extra income tax on that is 7,500 for a total tax bill of 15,000. Divide by 0.3 and you buy 50,000 of VCTs. After tax income is (50k - 12.5k) * 0.8 + 18,750 * 0.6 = 30,000 + 11,250 = 41,250 to cover much of the buying cost, then a tax refund of 15,000. Deducting that 8,750 shortfall leaves you with 7,250 positive cash flow.

That sort of thing is best done early when tax free cash is available and can't all be put into a tax wrapper at once and because of the minimum five year holding time of VCTs and to start getting their tax exempt dividends. Say use 45,000 at higher rate on a five year plan. That's covered by 60,000 of VCT buying on top of the basic rate's 25,000 for a total buy of 85,000. at 95,000 gross income. Five years of that rapidly takes 450,000 out of the pot and seems to make age 75 safe from the LTA charge - until you look at the numbers more closely, as I do later. The 425,000 VCT holding would be expected to pay 5-6% dividends for 21,250 or 25,500 tax exempt a year.

425k in VCTs is a bit high so maybe cut back to a ten year plan where you recycle the money from the first five years to halve the VCT exposure, the 50k buy on 68,750 gross income from the last paragraph with 250,000 peak and 12,500 to 15,000 in dividends.

But...

At 1.2 million in the late 40s, say we assume growth of 5% plus inflation for seven years, taking the pot from 1,200,000 to 1,688,000 rounded. Since this is plus inflation we use today's allowance of £1,073,100. That's 268,275 tax free and 804,825 in drawdown. The excess is 606,900 and after an income lifetime allowance charge of 25% is paid this adds 455,175 to the drawdown pot, taming it to 1,260,000. The age 75 test is on nominal not real growth so assuming 2% growth we need to average 88,200 of withdrawing a year to expect to avoid it. That 68,750 gross ten year plan isn't enough and the 95,000 gross income one is only slowly pulling ahead once we make it a ten year plan.

The personal allowance taper starts at 100k and a bit more margin is desirable. VCT buys are normally in 1k chunks and each 1k covers 1000 * 0.3 = 300 of tax which is that on 750 of higher rate income. So add 4,500 to make it a 99,500 gross income plan that can run for all of the 20 years from 55 to 75 if needed.

Once we allow for say 25k of dividends the person may need to be on £125k a year initially just to avoid more LTA charge before we even consider other investments. Remember that we get the VCT buy money back after five years of deferral.

A person in this situation who's really keen to continue helping small companies to grow could do that sort of income for life with no net income tax bill again, unless they encounter a seriously bad sequence of returns. Of course VAT at 20% on that is 25k so they would still pay a lot of tax.

Oh really? "Very bad case"? Wade doesn't think so, it looks to be a very good case internationally https://retirementresearcher.com/4-rule-work-around-world/

I'd much prefer the risk of a tax bill at 75 to the risk of running out of money.

VCTs may be suitable for some but as they say, don't let the tax tail wag the investment dog. VCTs are risky and illiquid.

BTW I notice you don't bang on about P2P any more, why is that?

Albermarle

VCTs may be suitable for some but as they say, don't let the tax tail wag the investment dog. VCTs are risky and illiquid.

After looking at VCTs , I came to the quick conclusion that they were not suitable for a non professional investor ( like me ) and just paying LTA if necessary would be a more sensible ( and easier ) option. 

Croeso69

Albermarle said:

VCTs may be suitable for some but as they say, don't let the tax tail wag the investment dog. VCTs are risky and illiquid.

After looking at VCTs , I came to the quick conclusion that they were not suitable for a non professional investor ( like me ) and just paying LTA if necessary would be a more sensible ( and easier ) option. 

I agree. I work in financial services and i struggled with what @jamesd was trying to explain.

jamesd

zagfles said:

jamesd said:

...
While zagfles is right about 4% SWR income that's a very bad case and more will be needed to be confident of not having a bill at 75. At a minimum, using the full basic rate band every year.

Oh really? "Very bad case"? Wade doesn't think so, it looks to be a very good case internationally https://retirementresearcher.com/4-rule-work-around-world/

Yes and the page you linked to is of the worst cases for many other countries. In each case it's the highest withdrawing rate that would have worked in the worst sequence of investing conditions in the previous century or so. Not merely very bad, but actual worst.

Presumably you'll agree that the worst sequence in around 125 years for the US that set its safe withdrawal rate qualifies as a "very bad case" and that 4% rather than 3.7% for the UK is also very bad, if not quite the worst.

What you've done is mix up several different things:

1. a safe withdrawal (spending) rate, which is for the worst returns sequence in a century or so. On the part tax free and part taxable £1,528,275 projected for this case 3.7% (UK SWR before costs for a common mixture) would be £56,546 while the comparable variable Guyton-Klinger 5.5% (I usually use 5% after costs) would be £84,055. Though note that 3.7% is for 30 years and 5.5  for 40 so 30 in particular looks too short for an age 55 plan start.

2. what a safe withdrawal rate is, which is very well explained by Kitces in The Extraordinary Upside Potential Of Sequence Of Return Risk In Retirement , where he observes that "taking a 4% initial withdrawal rate has an equal (10%) likelihood of leaving all the retiree’s principal left over at the end of retirement… or leaving 6X the starting account balance remaining instead". Understanding this is important for 3...

3. the rate at which money needs to be withdrawn from a pension for tax efficiency, with the amount above the SWR reinvested outside the pension. This one needs to use reasonably likely return plus a safety margin, well above the SWR worst sequence. Tax thresholds like basic rate band and loss of personal allowance also matter.

I'd much prefer the risk of a tax bill at 75 to the risk of running out of money.

You can and normally should act on both. You withdraw money from the pension at the tax efficient rate 3 and spend according to the safe withdrawal rules that you're using 1.

VCTs may be suitable for some but as they say, don't let the tax tail wag the investment dog. VCTs are risky and illiquid.

In this case our original poster is already considering VCT investing in a sensible choice, Octopus Titan, though they might want to consider Proven and Albion as well for diversification; I anticipate buying £25,000 combined of all three myself this year.

VCTs are collective investments like investment trusts and funds that invest in younger and smaller businesses than most funds, though there are some micro-cap conventional funds around. That can make their prices more volatile than say a small cap fund, in part because younger businesses held in the VCT are more likely to fail. The underlying investments (businesses) start out almost totally illiquid because they are spending the money to grow. But mature VCTs have a mixture of new and old investments and the gradual maturing and selling provides internal liquidity. But for investors, VCTs are shares traded on the stock market so you can sell or buy (no initial 30% tax relief but still exempt from tax on dividends). Trading can be thin so it's routine for VCTs to buy back their own shares. Ordinary deals have the usual settlement three days after the trade like any other UK share deal.

It's worth remembering that everything except cash in pensions is also risky and some, like property funds, can be illiquid at the direction of the FCA for a year or more. A basic fund covering the UK stock market can expect periodic 40-50% drops with the potential for 80%.