Drawdown Pension but continuing in paid employment. Advice

L9XSS

Hi looking for some advice with regards to the tax implications/PAYE scenarios. I turn 55 next year and am in paid employment, which I enjoy and plan to continue working till 60, maybe a little longer. I pay income tax at the lower rate (my salary is circa 20k per year). I have a DB pension that is payable from 65 and from my previous employers pension statements is forecast at 18.5k per annum. My state pension is £179 p/w at 67.
im thinking of accessing my DC pot from 55 and rather than taking the tax free lump sum of 25%, withdrawing my tax free allowance plus 25% tax free (I believe this is £16,666 yearly). My DC pot is 190k. The reason I’m contemplating this is to support my living costs. Am I right in thinking that HMRC would tax the salary at 20% and the pension withdrawal (£16,666) would remain untaxed as part of my annual allowance upon drawdown?

molerat

The most likely scenario is that they keep your tax code allocated to the employment and BR to the pension.  Doing it that way you can take what you want when you want, no need to be restrained by trying to work around the tax allowance, with 25% tax free and 75% taxed. They won't allocate a code to the pension until you commence taking it and trying to move your allowance to it mid year will only end in a bit of a mess to sort in the next year. It is usually best to take a small first payment so that the tax code is sorted for the second.

jamesd

Probably a bad idea to do it as described but there is an alternative way to get it done.

 When you take taxable income (an exception later) from the DC pension you'll have your annual DC pension capped at 4k allowed a year by the money purchase annual allowance (MPAA). This matters because if you're earning 20k it's best for you to make 20k of gross pension contributions since that saves you income tax on at least 25%, the part you can withdraw from a pension tax free.

The exception is the small pot rule that allows you to take all of a pot worth up to 10k, 25% tax free and 75% taxable. It must be the whole pot. You can transfer to make such a pot. Do not mix this up with UFPLS, which has the same 25:75 split but does trigger the MPAA. You can use this rule up to three times in your lifetime.

Taking just the 25% tax free lump sum from part or all of a pot doesn't trigger the MPAA as long as the 75% taxable portion is placed in a flexi-access drawdown pot for later. DB income also doesn't trigger the MPAA.

So, an alternative way to do it is to use the small pot rule once a year and top up with some tax free bit. Don't even think of taking the taxable 75% until you have no more 25% tax free left to use. Then you can accept the 4k cap and take more.

There is no extra £16,666 free of tax from a pension when still working. Your taxable income is the 20k from work plus the taxable withdrawing from the pension so your pay will use your whole personal allowance and all but the tax free 25% of the £16,666 will be taxed at 20%. That number does become true when you're no longer working and have no income other than the DC pension.

L9XSS

jamesd said:

Probably a bad idea to do it as described but there is an alternative way to get it done.

 When you take taxable income (an exception later) from the DC pension you'll have your annual DC pension capped at 4k allowed a year by the money purchase annual allowance (MPAA). This matters because if you're earning 20k it's best for you to make 20k of gross pension contributions since that saves you income tax on at least 25%, the part you can withdraw from a pension tax free.

The exception is the small pot rule that allows you to take all of a pot worth up to 10k, 25% tax free and 75% taxable. It must be the whole pot. You can transfer to make such a pot. Do not mix this up with UFPLS, which has the same 25:75 split but does trigger the MPAA. You can use this rule up to three times in your lifetime.

Taking just the 25% tax free lump sum from part or all of a pot doesn't trigger the MPAA as long as the 75% taxable portion is placed in a flexi-access drawdown pot for later. DB income also doesn't trigger the MPAA.

So, an alternative way to do it is to use the small pot rule once a year and top up with some tax free bit. Don't even think of taking the taxable 75% until you have no more 25% tax free left to use. Then you can accept the 4k cap and take more.

There is no extra £16,666 free of tax from a pension when still working. Your taxable income is the 20k from work plus the taxable withdrawing from the pension so your pay will use your whole personal allowance and all but the tax free 25% of the £16,666 will be taxed at 20%. That number does become true when you're no longer working and have no income other than the DC pension.

Thankyou @jamesd for the detail regarding the small pots rule, I wasn’t aware of that. So in summary for my situation, transfer 30k to three new SIPPs, 10k into each, utilise pot 1 taking 25% tax free (2.5k) then withdraw/exhaust pot 1 paying tax at my BR as and when I require it.
Repeat the process for pots 2 and 3 in the coming years.
The remaining DC pension still has 160k in, presuming no growth and follows the same rules of 25% tax free and the remainder taxed on drawdown. Am I understanding it correctly?

jamesd

For the three small pots the whole 10k must be taken at the same time. So one 10k from one of those each tax year.

Then take 25% of parts of the remaining 160k to cover living expenses while paying your whole gross pay as extra pension contributions so you dodge income tax on at least 25% of it.

Triumph13

Does anyone have any recommendations for SIPPs / PPs to transfer the small pots into with minimal fuss / cost?  I'm looking to go this route to shelter £30k from the LTA charge.

Scrounger

Triumph13 said:

Does anyone have any recommendations for SIPPs / PPs to transfer the small pots into with minimal fuss / cost?  I'm looking to go this route to shelter £30k from the LTA charge.

I'm using Fidelity for my small pots.  Transfers in are very straightforward.

They do insist on a telephone conversation with their retirement services who then send out a 'small pots' application form with a pre-paid envelope. 
There is an informal target of 13 working days to complete the withdrawal (though in my experience can sometimes take up to 30 days - ouch!). 

Best of all though - no charges 

I've also heard good things about HL but not tried them for small pots (as they refused to transact small pots on crystallised funds).

Scrounger

Albermarle

Triumph13 said:

Does anyone have any recommendations for SIPPs / PPs to transfer the small pots into with minimal fuss / cost?  I'm looking to go this route to shelter £30k from the LTA charge.

Some providers will not organise withdrawals under the small pot rule- Vanguard for one .
Also you want a provider with a % charge not a fixed charge , which are more suitable for larger amounts .
So means Fidelity; HL and A J Bell .

HL will take a larger pot and split it into three £10K pots . Nobody else will as far as I know as it must be a lot of cost and for sure against the spirit of the small pot rule , so might get stopped one day .

If you are still investing in pensions another route is to open up a new SIPP with one of the above and just invest directly .
So max £8K as you will get tax relief of £2K . 

Scrounger

It's a shame the small pots rule is limited to just 3 times per lifetime.

I could use it many more times than that... 

Scrounger

Triumph13

Thanks all.  I'm already over the LTA so looking to shift some existing funds to avoid £2,500 of tax a time rather than contribute new ones to gain £500.  Unfortunately I consolidated my pots before being aware of the small pots dodge so I'm going to have to transfer back again!

Here's hoping the providers don't get suspicious when I ask to transfer £9,995 and leave it in cash!

Albermarle

You will need to check your current provider allows partial transfers .

Also in the case of AJ Bell ( maybe others ?) if you transfer in and then withdraw within 12 months there is a hefty charge ( £250?)