Avoiding the LTA?

jamesd

MrBobbins said:

Yet another person here in a similar situation. My DC workplace pension is currently sitting at around £920K, I'm Salary Sacrificing around £25K p/a, but I'm not 55 until next Sep. I'm a high rate tax payer (though considering bumping up my contributions by the necessary £2.1K to drop myself into standard rate next tax year).

I reckon I'll have around £970-980 in my pension when I hit 55, so I guess I should be ready to go then if I am going to crystallise! I don't have any children, so not too concerned about IHT implications, just more concerned about taking a fairly large sum out of the income/capital gains tax protections!

Of course growth could take you over the LTA but if below it the easy thing to do is crystallise immediately you're able to, perhaps telling the pension firm in advance that you want to crystallise on your 55th birthday for LTA mitigation.

Money taken using the small pot rule is exempt from the LTA so you could take three pots of 10k each to get a bit more room, 75% is taxed at 20%. You can use transfers to create the small pots.

If you're not concentrating your sacrifice into as few months as you can at minimum wage you should consider that. It'll increase your NI saving by getting you 12% instead of 2% on some of the money, due to NI being calculated for each individual pay period rather than annually.

MrBobbins

EdSwippet said:

MrBobbins said:

I reckon I'll have around £970-980 in my pension when I hit 55, so I guess I should be ready to go then if I am going to crystallise! I don't have any children, so not too concerned about IHT implications, just more concerned about taking a fairly large sum out of the income/capital gains tax protections!

It looks that way. Crystallising everything would leave you around £100k remaining LTA, so four years of future pension contributions at your current rate. Maybe less if there's a worthwhile employer match and/or employer NI uplift.

How much longer do you plan to work. If fewer than three or four years then you could perhaps be a bit more relaxed on this. If more than that though, once you've used up your LTA then pensions are no longer a tax saving strategy (and could, depending on your income in retirement, be a tax-losing one), in which case you'll need to either investigate other tax saving options, or just retire earlier than planned (like me!).

As for taking out the PCLS, simplest is to invest it in the same assets as before, just outside the pension. Move as much as possible into ISAs, but even without the ISA wrapper, remember that you have a £12k/year or so capital gains tax allowance and a £2k/year dividend tax allowance that you can use to mitigate tax on gains on the reinvested PCLS money.

Thanks very much for that - very informative.

I was planning on retiring at some point between 55 and 60, just haven't narrowed it down! Had decided to maybe let LTA be the deciding factor, but my main concern is I don't really have much lined up to occupy my time!

I had wondered about (at least while I'm still working), crystallising just enough to take 20/40K tax free each year so I can put in an ISA(s), but you make the good point about the allowances. 

jamesd

In your case the lifetime allowance is going to make crystallising pretty much the moment you can a good move, assuming you're still not over that limit.

Of course this is completely unrelated to when you actually retire, since you can carry on paying into pensions until your 75th birthday and don't have to actually spend any money that you're taking out just for tax optimisation.

MrBobbins

Thinking some more about this....

If I'm going to be crystallising, and therefore getting a big cash injection, fairly soon, I guess it would now make sense to bump up my pension contributions to the full £40K, and start dipping into my savings, as I know I will soon be able to replenish that money from the tax free lump sum. Does that make sense?

MallyGirl

Yes - sounds like a plan

EdSwippet

MrBobbins said:

Thinking some more about this....

If I'm going to be crystallising, and therefore getting a big cash injection, fairly soon, I guess it would now make sense to bump up my pension contributions to the full £40K, and start dipping into my savings, as I know I will soon be able to replenish that money from the tax free lump sum. Does that make sense?

It's an option. Money is fungible, after all. But ...

In a previous post you mentioned bumping up contributions by £2.1K to drop into standard rate tax. The implication there is that of your possible £40k contribution, some £13k or so of that would only be saving you 20% tax. And you would be using up your LTA headroom faster, which may matter if you plan to work more than just two or three years longer.

In pure tax efficiency terms, and assuming you will be working next year and in higher rate tax again, would it not be better to save up that additional £13k or so for next year, so that you can gain 40% tax relief on it as a pension contribution?

jamesd

MrBobbins said:

Thinking some more about this....

If I'm going to be crystallising, and therefore getting a big cash injection, fairly soon, I guess it would now make sense to bump up my pension contributions to the full £40K, and start dipping into my savings, as I know I will soon be able to replenish that money from the tax free lump sum. Does that make sense?

It makes perfect sense for your planning but there is a potential issue: the restrictions on tax free lump sum recycling into new pension contributions. I think you'll be OK on that but here's how I worked that out:

1. You mentioned sacrificing around 25k and I'll assume that this has been true for as long as the allowance has existed, so it's a clear and indisputable pattern. This means that your expected contribution before receiving the lump sum will be 25k for the last two tax years before you take the lump sum, the year you take the lump sum and, if still working, the following two tax years.
2. This means that an increase to 40k for five years could potentially be regarded as 5 * 15k of additional contributions due to receiving the lump sum, a total of 75k more.
3. The relevant limit in increase over the five year period is 30% of the total value of the lump sums taken, so with 75k more you'd need to take a lump sum of 75k / 0.3 = 250k.
4. 250k is the tax free lump sum for a total pot size of a million and you recon you'll have 970k-980k when you reach 55, so close enough for this rough calculation.
5. Except, at least one of the two previous tax years is going to be 2020/21 and you didn't make any increase in that year, so it's 15k is available for future years, meaning you can really only possibly do an increase of 60k if sticking to the 40k annual allowance without using any of the carry-forward you have available.
5. You're considering retiring at 55 so the last two years of the five year period may really see no increase at all, given that you'd cut to 2880 or nil depending on your LTA situation. The tax year of taking the lump sum might also see no increase if you stop work before getting 40k paid in.

So, the plan looks OK but you might need to pay a bit of attention to the last two years of the five year period to stay within the recycling limit based on the exact numbers you happen to end up with.

What to do, then? This year and next year maximise your sacrifice and use any available carry-forward of unused annual allowance that makes sense. Keep any eye on that very rough 75k of total increase potential within the recycling limits and do a double-take if your plans would put you over that level over the relevant five years. It seems unlikely that they will, particularly if you do retire in the year you take the tax free lump sum, which means that none of the increase will be in the second year before or the two  years after, so the roughly 75k within the limit will be split over just two years. 75k of increase over two years is quite a lot of room.

The recycling rules specifically cover depleting savings and replacing them with the lump sum as well as borrowing and repaying with the lump sum, so you can't dodge by doing those things, but must include the relevant amounts into the increase calculation.

cfw1994

MrBobbins said:

EdSwippet said:

MrBobbins said:

I reckon I'll have around £970-980 in my pension when I hit 55, so I guess I should be ready to go then if I am going to crystallise! I don't have any children, so not too concerned about IHT implications, just more concerned about taking a fairly large sum out of the income/capital gains tax protections!

It looks that way. Crystallising everything would leave you around £100k remaining LTA, so four years of future pension contributions at your current rate. Maybe less if there's a worthwhile employer match and/or employer NI uplift.

How much longer do you plan to work. If fewer than three or four years then you could perhaps be a bit more relaxed on this. If more than that though, once you've used up your LTA then pensions are no longer a tax saving strategy (and could, depending on your income in retirement, be a tax-losing one), in which case you'll need to either investigate other tax saving options, or just retire earlier than planned (like me!).

As for taking out the PCLS, simplest is to invest it in the same assets as before, just outside the pension. Move as much as possible into ISAs, but even without the ISA wrapper, remember that you have a £12k/year or so capital gains tax allowance and a £2k/year dividend tax allowance that you can use to mitigate tax on gains on the reinvested PCLS money.

Thanks very much for that - very informative.

I was planning on retiring at some point between 55 and 60, just haven't narrowed it down! Had decided to maybe let LTA be the deciding factor, but my main concern is I don't really have much lined up to occupy my time!

I had wondered about (at least while I'm still working), crystallising just enough to take 20/40K tax free each year so I can put in an ISA(s), but you make the good point about the allowances. 

The ‘threat’ of LTA was one factor in my decision from 55 to start crystallising much of my DC pot. 

Compounded for me in that I have 2 smaller DB pot to take into consideration, which don’t kick in until 60 & 65….

That said, I would strongly suggest you delve into the infinite world of “what could you do if your time was 100% your own” 🤪

For my part, I have lots going on, but I am aware of one friend (not a close one) who retired and within 2 *weeks* was struggling with what to do with himself 😳
I half joke that he demonstrates a severe lack of imagination, BUT at the same time, I do realise many people are very much defined by their work….& planning for the point where your time is your own does require serious thinking….it isn’t all about the money!

MrBobbins

EdSwippet said:

MrBobbins said:

Thinking some more about this....

If I'm going to be crystallising, and therefore getting a big cash injection, fairly soon, I guess it would now make sense to bump up my pension contributions to the full £40K, and start dipping into my savings, as I know I will soon be able to replenish that money from the tax free lump sum. Does that make sense?

It's an option. Money is fungible, after all. But ...

In a previous post you mentioned bumping up contributions by £2.1K to drop into standard rate tax. The implication there is that of your possible £40k contribution, some £13k or so of that would only be saving you 20% tax. And you would be using up your LTA headroom faster, which may matter if you plan to work more than just two or three years longer.

In pure tax efficiency terms, and assuming you will be working next year and in higher rate tax again, would it not be better to save up that additional £13k or so for next year, so that you can gain 40% tax relief on it as a pension contribution?

That is a good point. Wow, so many angles to consider...