Maxing tax free drawdown

SomeMadeUpName

Hi
Quick question:
I've seen on here mention a few times of maxing tax free drawdown by taking (at this years allowance rates) £16,666 pa. The idea being that £4,166 is tax free, the remaining £12,500 is taxable but fits within the personal allowance. Happy days, You've got £16,666 to spend, your pot goes down by £16,666.
BUT
Could you draw £21,466 whilst continuing a pattern of paying £2,880 into your fund. Result being £5,366 is tax free, the remaining £16,100 is taxable and results in a tax bill of £720. The £2,880 contribution receives a £720 boost within the pension thereby effectively recovering the tax. Also Happy days, you've got £17,866 to spend, your pot goes down by £17,866.

There are a ton of assumptions built in to the scenario, like nil other taxable income, or that you wouldn't be making a £2,880 contrib anyway even if you drew only £16,666 (which would be even better efficiency, but maybe hard to afford) etc etc.
However setting all that aside am I missing something about the example. Or might it fall foul of the recycling rule I've seen mentioned on here?

NedS

Leaving aside the £16,666 as that's a done deal, what you are describing is additionally paying £2880 net (£3600 gross) into the pension and then taking that £3600 back out again leaving the overall size of the pension pot unchanged?

So you've paid in £2880 net cost to you, and taken out an additional £3600, 25% of which is tax free (£900) and the remaining £2700 is taxed at your 20% tax rate (£540 tax due) leaving you with £3060 after tax, meaning you've gained an additional £180 for your troubles making your total net income £16,666 + £180 = £16846 for the year.

This is not classified as recycling due to the small sums involved (less than £7500).

dunstonh

Could you draw £21,466 whilst continuing a pattern of paying £2,880 into your fund. 

It depends on what income you need.

I was just speaking to someone this week that is taking the £16666 and paying in the £2880 without drawing extra on the pension.  If you need to draw more to be able to be able to afford it then so be it.

At the end of the day, tax wrappers can be used based on individual circumstances.  If it works then use it.

SomeMadeUpName

NedS said:

Leaving aside the £16,666 as that's a done deal, what you are describing is additionally paying £2880 net (£3600 gross) into the pension and then taking that £3600 back out again leaving the overall size of the pension pot unchanged?

So you've paid in £2880 net cost to you, and taken out an additional £3600, 25% of which is tax free (£900) and the remaining £2700 is taxed at your 20% tax rate (£540 tax due) leaving you with £3060 after tax, meaning you've gained an additional £180 for your troubles making your total net income £16,666 + £180 = £16846 for the year.

This is not classified as recycling due to the small sums involved (less than £7500).

Nope, what I am describing is taking the £16,666 plus £3,600 plus another £1,200. The £3,600 you are taxed on but then recover that by paying the net £2,880 back into pension and getting £720 auto added back on. The £1,200 is an additional tax free amount you get by virtue of drawing the extra £3,600 of taxable.

SomeMadeUpName

dunstonh said:

Could you draw £21,466 whilst continuing a pattern of paying £2,880 into your fund. 

It depends on what income you need.

I was just speaking to someone this week that is taking the £16666 and paying in the £2880 without drawing extra on the pension.  If you need to draw more to be able to be able to afford it then so be it.

At the end of the day, tax wrappers can be used based on individual circumstances.  If it works then use it.

Oh, agreed. The ideal is draw £16,666 then still pay £2880 in. That way you are not just level on tax you are £720 ahead.
I'm just making my comment in the context of the oft used suggestion of drawing £16,666 to live off as optimal for tax efficiency.

Whilst £16,666 less £2880 might be tight to live on, if you had unwrappered savings you could use those to make it doable and be really smug about your tax efficiency.

pensionpawn

This exact idea came to me only the other day as an extension on doing something similar with passing 10% of your tax code between couples, which could be combined with this for an even larger 'tax neutral' annual UFPLS drawdown.
I ran the numbers using April's personal allowance of £12570 and came up with a withdrawal of £21560, which after paying £720 tax (refunded into your SIPP) and paying £2880 into your SIPP leaves you with £17960pa / ~£2500pm tax 'free' (neutral) income.
Now should you also receive 10% personal allowance credit (£1257) from your husband / wife then this means you can afford to pay £1977 (£720 + £1257) tax as this will be refunded to you. The annual UFPLS withdrawal to incur this tax payment would be £29940. From this amount £1977 tax would have to be subtracted plus a further £2880 to pay into your SIPP, a total of £4857. This leave a final annual 'tax neutral' net figure of £25083 pa / ~ £2090 pm.
It is worth noting that the donating husband / wife will correspondingly lose £1257 of personal allowance and would have to reduce their drawdown accordingly or pay £251 in tax. That said, £36396 (£25083 + £11313) tax free / neutral pa (£3033 pm) is a fairly decent pension for most couples!
A final thought, you will have to have a fairly hefty pot to sustain £30k pa withdrawals and these numbers don't survive post SPA.

Dazed_and_C0nfused

Now should you also receive 10% personal allowance credit (£1257) from your husband / wife then this means you can afford to pay £1977 (£720 + £1257) tax as this will be refunded to you. 

In 2021:22 a Marriage Allowance recipient will be entitled to a tax deduction of £252.

In a very simple pension income only scenario this means they could have taxable pension of £13,830 before any tax would actually be payable.  Making a UFPLS withdrawal of £18,440 possible.

But you have lost me with the £1,977 tax refund bit.  

There is no direct link between the tax an individual pays and the basic rate tax relief which can be added to a relief at source pension and I just cannot see how you could take a UFPLS withdrawal of £29,940 and get a tax refund of £1,977??

SomeMadeUpName

pensionpawn said:

This exact idea came to me only the other day as an extension on doing something similar with passing 10% of your tax code between couples, which could be combined with this for an even larger 'tax neutral' annual UFPLS drawdown.
I ran the numbers using April's personal allowance of £12570 and came up with a withdrawal of £21560, which after paying £720 tax (refunded into your SIPP) and paying £2880 into your SIPP leaves you with £17960pa / ~£2500pm tax 'free' (neutral) income.
Now should you also receive 10% personal allowance credit (£1257) from your husband / wife then this means you can afford to pay £1977 (£720 + £1257) tax as this will be refunded to you. The annual UFPLS withdrawal to incur this tax payment would be £29940. From this amount £1977 tax would have to be subtracted plus a further £2880 to pay into your SIPP, a total of £4857. This leave a final annual 'tax neutral' net figure of £25083 pa / ~ £2090 pm.
It is worth noting that the donating husband / wife will correspondingly lose £1257 of personal allowance and would have to reduce their drawdown accordingly or pay £251 in tax. That said, £36396 (£25083 + £11313) tax free / neutral pa (£3033 pm) is a fairly decent pension for most couples!
A final thought, you will have to have a fairly hefty pot to sustain £30k pa withdrawals and these numbers don't survive post SPA.

Hi, yep combining the two would add flexibility if one partners pot was bigger than the others.

I think though that as the post above intimates you've gone adrift on the £1957, imo it should be £972 (£720+£252), as moving the tax allowance of £1257 only results in a tax saving of £252.

NOw as you sugest all we need to do is build pots big enough to support these efficient drawdown ideas 

zagfles

For tax efficiency, just follow 2 simple rules. Don't waste allowances, and pay max pension contributions within the various limits (tax relief limit, AA, LTA, recycling). Transferring the marriage allowance is no benefit unless you'd otherwise waste personal allowance. Getting tax relief that exactly matches the tax you pay may look nice but so what, you get tax relief through RAS regardless of whether you've paid tax.

pensionpawn

Well spotted! Just like (the old maths joke) you shouldn't drink and derive, in an attempt to post before hitting the sack the wheels fell off my fiscal brain at the witching hour lol. I just applied the allowance to the actual tax calculation even though I have posted the correct tax amount (£251) further down the post. I did think the number rather large which underlines "post in haste, recalculate in leisure" lol.
The calculation should read:
Now should you also receive 10% personal allowance (£1257) credit (£251) from your husband / wife which means you can afford to pay £971 (£720 + £251) tax as this will be refunded to you. The annual UFPLS withdrawal to incur this tax payment would be £23233. From this amount £971 tax would have to be subtracted plus a further £2880 to pay into your SIPP, a total of £3851. This leave a final annual 'tax neutral' net figure of £19382 pa / ~ £1615 pm.

SomeMadeUpName

I guess my point was this:

Suppose someone is retired and pre SPA, no other income streams so dependant on pension drawdown for lifestyle.
They might pitch drawing at £16,666 as they have been advised this is most tax efficient (sticking to this years allowance levels for illustrative purpose). However they find that a little 'tight' to live on, and they are certainly not paying back into pension on that income (some might be able to, but this example individual is not).

So instead they draw £18,000 as they feel they will be ok with that. £4,500 (25%) is tax free, £13,500 is taxable and results in a £200 tax bill, meaning they end up with £17,800 to support lifestyle and are happy enough with that.

Counter intuitively they would be better off drawing more.
If they drew £21,466 instead. £5,366 is tax free, the remaining £16,100 is taxable and results in a tax bill of £720. They pay £2,880 into pension and get £720 back in tax. They have £17,866 left after tax and pension contrib to support lifestyle (so a few [£66] quid more. There pension pot has only dropped by £17,866 as opposed to £18,000 (so a few [£134] less).

They are then better off to the tune of £200 by drawing more. Not a lot admittedly, but if you did it every years from 57 to 67 years old then £2k (before growth) for doing nothing effectively.