LTA Basics

jamesd

Lump sum 55% charge has no subsequent income tax. Income 25% is used when you place the LTA subjected part into flexi-access drawdown for possibly taking future income that is subject to income tax when take; it's usually the better deal.

Once the money is in flexi-access drawdown there is an additional charge on just the growth in value at age 75 and that's normally avoided by withdrawing sufficient income to ensure no growth or growth only within the lifetime allowance.

A lifetime allowance calculation can be triggered by taking a tax free lump sum and this freezes the lifetime allowance used for the pot providing the lump sum at the value at that time. Given his situation he appears to be in one of the cases where taking the maximum lump sum as soon as he is able would be a good move, since it'll safeguard his ability to usefully make more pension contributions.

The 25% tax free lump sum is only available up to the lifetime allowance. You can crystallise into flexi-access drawdown on portions above the lifetime allowance if you want to trigger the calculation or you can wait until age 75 when those will be checked automatically. Triggering and withdrawing growth is likely to minimise the bill if in that situation.

jamesd

Because national insurance is calculated for each individual pay period he can save more NI by concentrating his sacrifice down to minimum wage in as few months as possible. This way he'll get the 12% employee NI saving instead of the 2% on some of his contribution, while still getting 40% income tax saving on the annually calculated portion that would be subjected to income tax at 40%.

Because carry-forward is available for annual allowance he can also do things like low-high years of say 10k sacrifice in one year and 70k in the following one. This sort of thing can be used to maximise the NI saving with inflexible employers that don't allow changes in sacrifice during the year. Remember to include the employer matching and any employer NI portion of the pension contribution in this calculation.

jamesd

With lifetime allowance charge salary sacrifice is clearly beneficial in the following regions:

1. for the part getting a 100% employer match.
2. for the part of pay above 100k where there is also recovered income tax personal allowance
3. possibly where child benefit is restored

Beyond that the the best possible non-match case below 100k on £100 of employee sacrifice with basic rate tax on the way out is:

a. if it's within 12% NI band there is immediate saving of £12 in NI, £2 if not.
b. you get 100% of the saved employer NI on the contribution. £113.80 in the pension
c. pay 25% income LTA on the £113.80 leaving £85.35 in drawdown
d. pay 20% income tax on the £85.35 leaving take home £68.28
e. net received is £68.28 + £12 or £2 so £80.28 or £70.28

This compares to 2% NI and 40% income tax leaving take home of £58 in the 2% NI range.

You can do similar calculations for the specifics of how the individual scheme works on employer NI and whether sacrifice is into the 12% NI range or not.

cfw1994

If growth is low then he might not go over LTA by much. 

The flip of this is that if growth is ‘normal’ or ‘high’, he could go over the LTA…perhaps by a lot.

Of course, none of us have crystal balls, and the pessimists here will point out how we are always due a market crash which could make your musings all completely moot points…
…but IMHO (& it is just an opinion!), I think he may easily hit the LTA within a few years.

One think to consider: in his shoes, I would crystallise some lumps once he reaches 55, even if it is to “only” siphon into your ISAs, and effectively still have them invested in S&Ss as they are today within his pension.  

Yes, that is outside his pension and therefore taxable on death….but it will give you tax-cash to access when you want, and take up some % of the LTA.  Over the following years, you’ll probably see that grow…but safely in the drawdown part of the pot.

it has taken quite a lot of talking to bring him round to early retirement at all. He does not love his job - he just wants to make sure that we can do what we want to in retirement (travel mainly) and not be financially constrained. I'd go as soon as I thought we had enough - he will always be the 'one more year' type. He does also have pessimistic days when he focuses on the 10x salary life insurance he gets while still working - worth more dead than alive sort of thing.

We all shuffle off sometime: the trick is to enjoy what time we have 😉
If he doesn’t love his job (I know some do, and may never quit), then remind him that failure to plan is planning to fail, & OMY syndrome is an affliction that can be cured 🤣

I gave up a 4x death in service benefit earlier this year: was never a major consideration for us.  Time together doing stuff we want is far more important!

MallyGirl

jamesd said:

With lifetime allowance charge salary sacrifice is clearly beneficial in the following regions:

1. for the part getting a 100% employer match.
2. for the part of pay above 100k where there is also recovered income tax personal allowance
3. possibly where child benefit is restored

Beyond that the the best possible non-match case below 100k on £100 of employee sacrifice with basic rate tax on the way out is:

a. if it's within 12% NI band there is immediate saving of £12 in NI, £2 if not.
b. you get 100% of the saved employer NI on the contribution. £113.80 in the pension
c. pay 25% income LTA on the £113.80 leaving £85.35 in drawdown
d. pay 20% income tax on the £85.35 leaving take home £68.28
e. net received is £68.28 + £12 or £2 so £80.28 or £70.28

This compares to 2% NI and 40% income tax leaving take home of £58 in the 2% NI range.

You can do similar calculations for the specifics of how the individual scheme works on employer NI and whether sacrifice is into the 12% NI range or not.

Brilliant- thanks for the nice clear breakdown. 

All his Sal sac is in the 2% NI band but he does get 100% of the 13.8% employer NI as well.
No child benefit as our only offspring is at uni.
I woke up to early retirement as a possibility a couple of years ago so we don't have any carry forward from previous years - I suspect that low/high years might fry his brain a bit too much I do flex my contributions over the year but he wouldn't 'mess about' like that.

MallyGirl

cfw1994 said:

If growth is low then he might not go over LTA by much. 

The flip of this is that if growth is ‘normal’ or ‘high’, he could go over the LTA…perhaps by a lot.

Of course, none of us have crystal balls, and the pessimists here will point out how we are always due a market crash which could make your musings all completely moot points…
…but IMHO (& it is just an opinion!), I think he may easily hit the LTA within a few years.

One think to consider: in his shoes, I would crystallise some lumps once he reaches 55, even if it is to “only” siphon into your ISAs, and effectively still have them invested in S&Ss as they are today within his pension.  

Yes, that is outside his pension and therefore taxable on death….but it will give you tax-cash to access when you want, and take up some % of the LTA.  Over the following years, you’ll probably see that grow…but safely in the drawdown part of the pot.

I think that crystallising some from 55 (next year) seems an obvious step and one he can get his head round. It will give a fixed position on the % LTA used and reduce the amount that can grow further and affect that 2nd test at 75. Yes there may be a subsequent crash which would have been a better time to do it but, as you say, there are no crystal balls.

I do appreciate that it is a very nice 'problem' to have to puzzle out.

Albermarle

 He does also have pessimistic days when he focuses on the 10x salary life insurance he gets while still working - worth more dead than alive sort of thing.

This is an issue rarely mentioned in this forum when talking about early retirement . Many jobs ( usually at managerial level but not necessarily just senior managers ) have a number of valuable perks attached that have to be given up at the same time as the salary stops. Life insurance is just one , there is commonly also family private medical insurance, income protection maybe, possibly a fully expensed company car, free mobile and broadband , expensive  laptop supplied etc.

In this case your expenditure goes up when you retire, as you have to buy all/some of these things yourself and the whole package makes it that bit more tempting to do One More Year , or two.....

zagfles

jamesd said:

With lifetime allowance charge salary sacrifice is clearly beneficial in the following regions:

1. for the part getting a 100% employer match.
2. for the part of pay above 100k where there is also recovered income tax personal allowance
3. possibly where child benefit is restored

Beyond that the the best possible non-match case below 100k on £100 of employee sacrifice with basic rate tax on the way out is:

a. if it's within 12% NI band there is immediate saving of £12 in NI, £2 if not.
b. you get 100% of the saved employer NI on the contribution. £113.80 in the pension
c. pay 25% income LTA on the £113.80 leaving £85.35 in drawdown
d. pay 20% income tax on the £85.35 leaving take home £68.28
e. net received is £68.28 + £12 or £2 so £80.28 or £70.28

This compares to 2% NI and 40% income tax leaving take home of £58 in the 2% NI range.

You can do similar calculations for the specifics of how the individual scheme works on employer NI and whether sacrifice is into the 12% NI range or not.

You're double counting in e if you're comparing with the £58 in the next sentence. 

It's correct to add £10 in e for the part of the sal sac below the NI UEL if you take lumpy pay to get 12% employee NI saving, because you're moving income from the 12% band to the 2% band so getting an extra £10 take home pay. But on an income approaching £100k you'd be forced to sal sac a significant amount within the 2% NI band, over half probably, so that would only apply to part, likely less than half even if optimised.

So the comparison should be £68.28 plus maybe £4 or so from NI optimisation (which OP doesn't seem too bothered about), compared with £58.

Also worth comparing with higher rate tax in retirement, which is a possibility if investments do well to avoid getting hit with the second LTA test at 75, then it's £51.21 (ex NI opt) so it's negative compared with the £58.

So basically with the employer NI saving it's worth max'ing pension conts provided you don't end up paying higher rate tax in retirement. That's a hard call that does require a crystal ball!

However it may be a good hedge, if using reasonable assumptions eg inflation + 3% for equities based on historical averages, if that doesn't put you into higher rate tax then it'll only happen if investments do better, in which case you will pay more tax than you could have, but you'll be better off than you modelled so does it really matter?

jamesd

zagfles said:

jamesd said:

With lifetime allowance charge salary sacrifice is clearly beneficial in the following regions:

1. for the part getting a 100% employer match.
2. for the part of pay above 100k where there is also recovered income tax personal allowance
3. possibly where child benefit is restored

Beyond that the the best possible non-match case below 100k on £100 of employee sacrifice with basic rate tax on the way out is:

a. if it's within 12% NI band there is immediate saving of £12 in NI, £2 if not.
b. you get 100% of the saved employer NI on the contribution. £113.80 in the pension
c. pay 25% income LTA on the £113.80 leaving £85.35 in drawdown
d. pay 20% income tax on the £85.35 leaving take home £68.28
e. net received is £68.28 + £12 or £2 so £80.28 or £70.28

This compares to 2% NI and 40% income tax leaving take home of £58 in the 2% NI range.

You can do similar calculations for the specifics of how the individual scheme works on employer NI and whether sacrifice is into the 12% NI range or not.

You're double counting in e if you're comparing with the £58 in the next sentence. 

It's correct to add £10 in e for the part of the sal sac below the NI UEL if you take lumpy pay to get 12% employee NI saving, because you're moving income from the 12% band to the 2% band so getting an extra £10 take home pay. But on an income approaching £100k you'd be forced to sal sac a significant amount within the 2% NI band, over half probably, so that would only apply to part, likely less than half even if optimised.

So the comparison should be £68.28 plus maybe £4 or so from NI optimisation (which OP doesn't seem too bothered about), compared with £58.

I was trying to examine the marginal best possible case for an extra £100 of sacrifice. The best possible cases is it going down into 12% NI so that's what I used.

Of course I agree with you that in this practical situation there's going to have to be some NI at 2% even if sacrifice is concentrated into as few months as possible. It appears that he may not be willing even to do quite minor tweaks to get down to the 12% range so in his specific case 2% might be all that's available.

jamesd

MallyGirl said:

All his Sal sac is in the 2% NI band but he does get 100% of the 13.8% employer NI as well.
No child benefit as our only offspring is at uni.
I woke up to early retirement as a possibility a couple of years ago so we don't have any carry forward from previous years - I suspect that low/high years might fry his brain a bit too much I do flex my contributions over the year but he wouldn't 'mess about' like that.

I don't know or want to know his pay but lets pretend that he can sacrifice so that half of the sacrifice is at 12% and half at 2%. That's 10% or £20,000 or £2,000in NI to be saved.

Is he really so reluctant to avoid having an extra £2,000 in his bank account instead of HMRCs?

Maybe, but putting numbers to it can help to make it more real to him...