Pension & drawdown query

Watsy

I started a pension quite late in life whenever workplace pensions became a thing but after having a chat in work yesterday could someone confirm I've got this exactly correct.

Say I retire early at 60 with a pension pot of £100k and don't have any other income. Am I correct in thinking I can put that money in drawdown (I'll pretend  that value stays static although I know there will be market fluctuations) and I could withdraw £10k each year tax free due to it being below my tax income threshold? Once I started receiving state pension 7 or 8 years later I could use the remainder (£20k-£30k) to top up my state pension until I reached the tax income threshold? 

I would need to add personal contributions to reach the £100k figure but I never realised any money I contribute gets 20% tax relief added so due to having extra savings not doing much I hope to add lump sums to my pension every so often as it seems to make far more sense than sitting in a low interest account. I won't be putting all my savings in as I realise it becomes tied up and unaccessable so I'll still have a cash savings pot to dip into for any family/personal finances that need addressed.

Is there anything I've written there that is wrong, particularly the £10k a year tax free part due to no other income? 

zagfles

You can get more out without paying tax because of the tax free 25%, plus the personal allowance is £12570. So you could get up to £16760 with no tax, or alternatively an initial tax free lump sum of £25k then £12570 a year.

Note there are limits on contributions, you can only get tax relief on your "relavant earnings" eg if your gross earnings after any workplace pension contributions are taken off is £20k then you can only get tax relief on £20k gross, ie £16k net to a SIPP etc.

There's also the annual allowance if you're putting large amounts in.

Dazed_and_C0nfused

It's actually 25% of what you contribute that is added, which equates to 20% of the gross contribution.

Say you contribute £400 then £100 is added in tax relief leaving you with £500 in your pension fund.

That assumes you are making "relief at source" contributions.  If your scheme is "net pay" you would only have £400 in your pension fund (but may have paid less personal income tax).  And contributing via salary sacrifice would also mean you only had £400 in the pension fund.

You really need to be 100% certain what method you are using before you do anything else.

Watsy

Thanks you very much zagfles, I didn't know about the 25% tax free part, is that 25% applicable every year? Appreciate the explanation on the contributions as well. 

Dazed_and_C0nfused

Two common options are to take 25% TFLS at the beginning. Everything else withdrawn is then taxable.

Or take 25% TFLS as part of each withdrawal (the £16,760 option would be an example of this).

If you don't really need 25% TFLS upfront then it's generally better not to take it then as if you do it means you will probably pay more tax later.

For example £100k pot.  £25k TFLS taken up front means 100% of the remainder is taxable.  Say that £75k grows to £95k then all £95k is taxable, you cannot take another TFLS as you took it upfront.

Watsy

Dazed_and_C0nfused said:

It's actually 25% of what you contribute that is added, which equates to 20% of the gross contribution.

Say you contribute £400 then £100 is added in tax relief leaving you with £500 in your pension fund.

That assumes you are making "relief at source" contributions.  If your scheme is "net pay" you would only have £400 in your pension fund (but may have paid less personal income tax).  And contributing via salary sacrifice would also mean you only had £400 in the pension fund.

You really need to be 100% certain what method you are using before you do anything else.

Thanks for the reply. I'm currently on a salary sacrifice scheme so if make a £400 contribution from my savings I'll see £400 added to my pension pot but my weekly wage will be up slightly due to tax relief? I appreciate this by the way, it's very alien to me though and maybe not as straight forward as I thought.

Dazed_and_C0nfused

Salary sacrifice means you aren't contributing to the pension. You are agreeing to a lower salary in return for your employer contributing more to your pension and there is no pension tax relief due on employer contributions.

You are saving tax and NI by having a lower salary so the £400 you end up with in your pension fund might only cost you £272 in reduced take home pay as you not paying 20% tax or 12% NI on the salary you sacrificed.

The above assumes you aren't paying higher rate tax

Watsy

Dazed_and_C0nfused said:

Salary sacrifice means you aren't contributing to the pension. You are agreeing to a lower salary in return for your employer contributing more to your pension and there is no pension tax relief due on employer contributions.

You are saving tax and NI by having a lower salary so the £400 you end up with in your pension fund might only cost you £272 in reduced take home pay as you not paying 20% tax or 12% NI on the salary you sacrificed.

The above assumes you aren't paying higher rate tax

This was the part that really confused me when we switched to salary sacrifice from whatever it was previously. I get paid an hourly rate and when we switched to salary sacrifice my hourly rate stayed the same so I wasn't sure what I was actually sacrificing. Our pension advisor at the time told us it was pretty much a "no brainer" so we all jumped on board and apparently we're better off for it. 
Honestly, how it works is difficult for me to get my head round and I could make someone feel as if they're banging their head on brick wall very handy. I really appreciate the advice you've given. I'll make a small contribution from my savings as planned and hopefully when I see when I see my pension pot or wages adjusted it'll help me come to terms with how it works. Ideally I'd hoped if I added say the £400 to my pension pot then the tax relief would have been adjusted there rather than in my weekly wages. 
Again, anything you've written is appreciated, thank you. 

QrizB

Watsy said:

I'll make a small contribution from my savings as planned and hopefully when I see when I see my pension pot or wages adjusted it'll help me come to terms with how it works. Ideally I'd hoped if I added say the £400 to my pension pot then the tax relief would have been adjusted there rather than in my weekly wages.

If you are earning enough to still pay income tax, it would be better to increase your salary sacrifice by £500 then top up your spending money from your savings, rather than pay the £400 into your pension from your savings.

By increasing your salary sacrifice you will save on NI as well as on income tax.

tacpot12

Watsy said:

... so due to having extra savings not doing much I hope to add lump sums to my pension every so often as it seems to make far more sense than sitting in a low interest account. I won't be putting all my savings in as I realise it becomes tied up and unaccessable so I'll still have a cash savings pot to dip into for any family/personal finances that need addressed....

This is very sensible - put what you can into your pension but make sure that you still have enough for day to day living and to enjoy your life.

Watsy

tacpot12 said:

Watsy said:

... so due to having extra savings not doing much I hope to add lump sums to my pension every so often as it seems to make far more sense than sitting in a low interest account. I won't be putting all my savings in as I realise it becomes tied up and unaccessable so I'll still have a cash savings pot to dip into for any family/personal finances that need addressed....

This is very sensible - put what you can into your pension but make sure that you still have enough for day to day living and to enjoy your life.

I think it's one of those lessons that I'm learning a little bit late but still some time to try and correct that.