Take tax free cash and invest in ISA?

Pulpdiction

Not sure if this is a sensible idea or not, but at 55, I could start taking tax free cash from my pension, say £10k per year and put that is a stocks and shares ISA as a more tax efficient investment?

What I mean by that is that I can only take a total of 25% out of my pension tax free as a lump sum (I think that any draw down would still be subject to personal allowance - not entirely sure) and invested it in a S&S ISA then any income derived from that would be tax free, so in effect using one pot where tax will eventually apply to fund another pot where no tax will apply - under current rules.  If that makes sense.  I realise I would in effect crystalise £40k each year in doing so, but if I am not using it as I am still working then it gives me the opportunity to increase my S&S ISA - or try to max contributions in a 5 to 10 year run up to retirement where any income from that pot would be entirely tax free.

dunstonh

Not sure if this is a sensible idea or not, but at 55, I could start taking tax free cash from my pension, say £10k per year and put that is a stocks and shares ISA as a more tax efficient investment?

Except ISA is not more tax efficient.

There are some scenarios where taking the 25% out to go into an ISA makes sense but in most cases it doesn't.   Nothing you have said suggests you are one of those cases where it makes sense.

AlanP_2

Putting some numbers on it:

Take 10K out as TFLS and invest in S&S ISA with say a 10% return = £10,100 tax free after 1 year.
£30K of crystallised funds in pension with say a 10% return = £30,300

TOTAL = £40,400

Leave pension alone with say a 10% return, the £40K becomes £40,400 and you can take 10,100 tax free after 1 year (crystallising £40,400 at that time).


Where is the advantage?

Albermarle

Not sure if this is a sensible idea or not, but at 55, I could start taking tax free cash from my pension, say £10k per year and put that is a stocks and shares ISA as a more tax efficient investment?

There is no point doing this , as there is no gain . Easier just to leave it in the pension and take the tax free cash from there as and when you need it .

Pulpdiction

By transferring it I remove the 25% tax free tax limit on the ISA and in effect if I move £100k over 5/10 years and this were to compound up to £160k - I could then if I wanted take out all £160k with no tax liability whilst still drawing on my pension.  Or I could withdraw the growth, say £8k per year whilst taking my £12,500 allowance and avoid paying 20% tax on that.

As I said, not sure if it makes sense, not sure if it is a good idea, just exploring it as an option. Thanks

dunstonh

By transferring it I remove the 25% tax free tax limit on the ISA and in effect if I move £100k over 5/10 years and this were to compound up to £160k - I could then if I wanted take out all £160k with no tax liability whilst still drawing on my pension. 

It would have the same outcome as not taking the 25% until you need it.

 Or I could withdraw the growth, say £8k per year whilst taking my £12,500 allowance and avoid paying 20% tax on that.

No different to the pension.

Pensions and ISA can have the same charges and the same investments.  So, identical returns apart from tax.   The 25% is tax-free.  The ISA is tax-free.

Pensions are outside of the estate.    The ISA is not.   So, you are potentially increasing your tax liability if you move it from the pension to the ISA.

Albermarle

By transferring it I remove the 25% tax free tax limit on the ISA 

This is maybe where you are confused . There is no 25% tax free limit on an ISA.

There are rules about how much you can add to an ISA each year, but you can withdraw any amount ( including all of it at once ) at any time tax free.

The advantage of holding investments in an ISA is that there is no capital gains tax or dividend tax to pay . Same applies to a pension.

Pulpdiction

Thanks, sorry my poor grammar meant I remove the 25% on the pension as ISA returns are not taxed.  

Just an idea, if there's no point there's no point.  

dunstonh

Thanks, sorry my poor grammar meant I remove the 25% on the pension as ISA returns are not taxed.  

Pension returns are not taxed either.  Both the ISA and the pension have the same internal taxation.

If you have £400k in the pension and take out £100k to put it in the ISA (noting it would need to be over multiple years), then you are left with £300k in the pension and £100k in the ISA.

They get charged the same. They grow the same. So, let's say both double in value.  If you left it in the pension you would have £800k which would give you £200k tax-free cash (25%).  if you had taken it out to put in the ISA you would have £600k in the pension and £200k in the ISA.   So, exactly the same.

The exception on that example is that the ISA is part of your estate and potentially subject to IHT. Whereas the pension is not. 

Pulpdiction

I thought there was more of  subtlety to it than that, so under your example anything I draw down from the pension over the annual income tax, tax free allowance would be charged at 20% tax but any draw down on the ISA - eg if it was £200k I could take £10k per year, and hope it still grows, would be subject to no income tax?

So in effect if I was getting a full state pension - round numbers £10k, anything over £2.5k from my pension would get charged at 20% income tax but the ISA £10k would not be counted for income tax purposes?

I'm simplifying it and ignoring any tax free allowance left in the pension, although if I've taken 25% of the value to put in the ISA in your example there wouldn't be any would there?

The ISA £10k would be available year in year out, but any tax free 25% from the pension would only last until it were all 'crystlised' and then I run into the 20% tax scenario?

Apologies if I have this all wrong, but these things are complicated as you know.

 

bostonerimus

Pulpdiction said:

By transferring it I remove the 25% tax free tax limit on the ISA and in effect if I move £100k over 5/10 years and this were to compound up to £160k - I could then if I wanted take out all £160k with no tax liability whilst still drawing on my pension.  Or I could withdraw the growth, say £8k per year whilst taking my £12,500 allowance and avoid paying 20% tax on that.

As I said, not sure if it makes sense, not sure if it is a good idea, just exploring it as an option. Thanks

It's swings and roundabouts