Do I take 25% lump sum?

eric6060

Hi,

 I'm intending to retire next year and I think I'm better off taking my maximum tax free lump sum. I'd appreciate comments.

My pension provision;
I have a mixed pension provision (same company for last 36 years). I have a DB element with AVCs (the closed scheme) and  a DC element  (the current scheme). These elements are combined to calculate the 25% tax free amount I can withdraw, and in my case the lump sum can all be taken from the DC element (with a very small residue). The AVC element will convert to an annuity at a more favourable rate than the DC element. I plan to draw my pension next year (age 59), and the DB and AVC elements will take me above the personal tax threshold.
I qualify for full state pension at age 67.


My options;
I could convert the DC element to an annuity but I don't see this as good value for me.
I could move the DC element to drawdown (via a third party) and take withdrawals as required (25% tax free, 75% taxable) and retain the pension wrapper benefit. As my DB+AVC pension will put me over the personal tax threshold I'll be paying tax on each 75%.
Or I could take the tax free lump sum and invest it outside of a pension (and make withdrawals as required). This way I get a large sum tax free instead of a series of smaller taxed sums. If I take the 25% tax free lump sum then the DB+AVC elements are not reduced and a small DC residue will exist.

My thoughts;
If I take the 25% tax free lump sum then I take most of the DC element and I don't harm the (more valuable) DB+AVC element. Doing this will reduce my pension by £3000 for a lump sum of £150000.
If I were to transfer this £150000 to a third party provider for drawdown then I'd end up paying £22500 in tax (20% tax on  £112500), ignoring inflation and investment growth..
Whether I go for the 25% lump sum or drawdown, I am planning to take at least  £100000 over the first  8 years of retirement.
I'm assuming that third party drawdown and a non-pension investment will result in broadly similar investment gains/losses and my aim for this investment would be to match inflation.

I can see two reasons not to take the 25% tax free lump sum and to drawdown instead;
1) Over time, the uncrystallised part of the drawdown could increase to a level such that the total taxed withdrawals are a better deal than having an extra £22500 up-front.
2) IHT planning (which is not relevant for me).

Is this an example of where taking the whole tax free lump sum does make sense?
What additional benefit does the pension wrapper provide that I don't get from investing as a lump sum, and is it worth the £22500 extra tax?

Thanks.

TVAS

Early Retirement Factor
What is the DB scheme retirement age. Will you be suffering an early retirement penalty?

DB and AVC
Will you be able to take TFC from your AVC first before so that you have the highest possible starting DB pension?  This will depend on the commutation factor this is the rate you exchange pension for tax free cash so anything above a factor of 20 is good i.e. giving up £1 of pension for £20 tax free cash. 

DC Pension
Depending on the scheme retirement age of the DB pension are you able to take these benefits now or rather when you stop paid employment. I am thinking take TFC and use that as income and leave the rest in the fund.  

I do not understand what you are driving at however when you take your DB pension let's say 20k p.a. when you take an income payment, let's say 10k your income for that tax year is 30k. I would suggest talking drawdown income payments in Month 12 i.e. March because one will get a tax refund quicker and depending on the amount i.e. under the personal tax allowance it will be paid gross but it will be taxable. Likely that your tax code under the DB code will be adjusted to reflect the drawdown income. 

You said:
"third party drawdown and a non-pension investment will result in broadly similar investment gains/losses and my aim for this investment would be to match inflation" this is not the key difference, the key difference is if you invested in a Stocks and Shares ISA for example there is no income tax to pay in payment in juxtaposition to a pension.

The only benefit I can see is if you deplete your DC fund first then take DB fund. This will be the best way to minimise tax because you will not be taking the two pensions at the same time. When you get to age 67 you cannot avoid DB plus state pension. The latter is paid gross but is taxable. 

Linton

The £150000 tax free for  £3000 pension seems an extremely good deal, are you sure its right?  If it is I cant see how you can possibly turn it down.  If you did simply use the money to buy an annuity depending on your age you may get more than the £3K you gave up and it would be tax free.

Perhaps I am very confused but I do not understand why you will be paying tax when you draw down on the £150K.  As it is regarded as already taxed money outside a pension you would not put it into a SIPP but rather into an unsheltered investment account where only CGT would apply.  Over 8 years or less if you have a spouse with spare ISA allocance you can get it all completely sheletered in an S&S ISA.

Perhaps it would be clearer if you explained what money you have in your various pots and what happens to the £150K that is not used for the DB.  Though if your TFLS can all be taken from your non DB accounts then you wont have your pension reduced by £3K.

Secret2ndAccount

Linton, I think the OP is talking about cashing in most of his DC in one go. 150k of which 25% is tax free, and the rest attracts tax. Eric, unfortunately it's not as simple as this. You don't pay 20% on everything after the first 25% of the lump sum. The rest of the withdrawal is treated as income. If you earn 112k in one year you will be into 40% tax for most of it. What you should do is pull the money out of the DC year by year, so that you your total income just keeps you clear of  higher rate tax. You can take the tax free part up front if you have a good way to invest it, or leave it in, and it take part of it each year if you are happy with the growth and charges of your DC.

As TVAS pointed out, there is a tax efficient way to take AVC's out of your DB which you should investigate. With a DB, there are two figures for the tax free lump sum. Firstly there is the maximum amount permitted tax free by HMRC. Second, there is the lump sum offered by the rules of your scheme. These are not the same. Suppose HMRC's number would allow you to take 50k, but your scheme's PCLS is only 40k. You could cash in 10k of AVC's to take the total lump sum up to the HMRC limit. That's more of your money out tax free.

Linton

Secret2ndAccount said:

Linton, I think the OP is talking about cashing in most of his DC in one go. 150k of which 25% is tax free, and the rest attracts tax. Eric, unfortunately it's not as simple as this. You don't pay 20% on everything after the first 25% of the lump sum. The rest of the withdrawal is treated as income. If you earn 112k in one year you will be into 40% tax for most of it. What you should do is pull the money out of the DC year by year, so that you your total income just keeps you clear of  higher rate tax. You can take the tax free part up front if you have a good way to invest it, or leave it in, and it take part of it each year if you are happy with the growth and charges of your DC.

As TVAS pointed out, there is a tax efficient way to take AVC's out of your DB which you should investigate. With a DB, there are two figures for the tax free lump sum. Firstly there is the maximum amount permitted tax free by HMRC. Second, there is the lump sum offered by the rules of your scheme. These are not the same. Suppose HMRC's number would allow you to take 50k, but your scheme's PCLS is only 40k. You could cash in 10k of AVC's to take the total lump sum up to the HMRC limit. That's more of your money out tax free.

But surely all the £150K is tax free.  As I understood what was being said the AVC and DC pots can pay out the taxfree money generated by the DB pension.   Or are there 2 different £150Ks?

Secret2ndAccount

Hmm, it seems like there are two options:

1. Take the 150k as TFLS funded by the DC. Then the whole 150k would be tax free, but all other future payments from the DB+AVC would be taxable

2. Move the DC to another provider, then cash it in. 22k tax to pay (assuming withdrawal is suitably spread out), but then there would still be a PCLS available from the DB+AVC

At first look, 25% of all the money comes out tax free either way. It comes down to where the best return comes from. Does the DB have a big guaranteed annual increase if you defer drawing it? What's the cost, in the DB, of giving back lump sum for annual income, or taking more, if that option is offered. What growth are you going to achieve with the lump sum you have withdrawn, and can you protect it from tax? These are the things you are able to tinker with.