Take tax free cash and invest in ISA?

dunstonh

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?

The 25% tax free cash you draw at any time is tax free   Only the taxable element (75%) is subject to 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?

No.  

Any withdrawal from the 25% tax free cash segment would be tax free.  Anything you draw from the 75% segment would be taxable at 20%.   Or you could use the UFPLS method which each payment taken is made up of 25% tax free and 75% taxable which would equate to 15% tax.

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?

But its not gaining anything by taking it from the pension to put it in the ISA and is potentially increasing later taxation (IHT).

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?

No different to the ISA.  The amounts are identical.

MrPercent

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.

I'm thinking of doing this, as with my employers, and my contributions over the next 7-10 years, I'll smash through the LTA. My reasoning is, I can take  the tax free lump sum and put it into an ISA. This will reduce the growth in my pension , giving me more headroom under the LTA. I will need to manage the drawdown pot, ensuring I spend the growth there before the 75 LTA check.

If I prioritise (when I retire) drawing from the ISA and the drawdown growth,  I can mitigate the loss of the IHT advantage.

Does this make sense?

lisyloo

I was going to ask the same.
isnt there an advantage for someone trying to avoid hitting LTA?

Albermarle

lisyloo said:

I was going to ask the same.
isnt there an advantage for someone trying to avoid hitting LTA?

It can bring some advantage . As Dunstonh said There are some scenarios where taking the 25% out to go into an ISA makes sense

However if you only take out £20K each year to put in an ISA, the effect on LTA will not be that great. Normally it is advised to take it all out , presumably around £200K/£250K and put it in a GIA account and then feed the ISA from there each year.

Two disadvantages are
 Some admin /paying tax associated with a GIA account .
The money is now in your estate for IHT purposes. So it can be save LTA tax and get hit with IHT instead, depending on the rest of your circumstances/finances.

waveydavey48

I'm no expert and defer to wiser heads but isn't there a chance a future (skint) government might reduce or remove the 25% TFLS facility? 

Albermarle

waveydavey48 said:

I'm no expert and defer to wiser heads but isn't there a chance a future (skint) government might reduce or remove the 25% TFLS facility? 

Highly unlikely - for many low/middle income earners it is seen as the main benefit of a pension - a kind of retirement cash bonus. Also removing the TFLS removes any tax benefit of pension saving , which the government wants to encourage , especially amongst the less well off of society .
Many easier / better targets like higher rate tax relief , beneficiary pensions avoiding IHT etc 

cfw1994

Albermarle said:

lisyloo said:

I was going to ask the same.
isnt there an advantage for someone trying to avoid hitting LTA?

It can bring some advantage . As Dunstonh said There are some scenarios where taking the 25% out to go into an ISA makes sense

However if you only take out £20K each year to put in an ISA, the effect on LTA will not be that great. Normally it is advised to take it all out , presumably around £200K/£250K and put it in a GIA account and then feed the ISA from there each year.

Two disadvantages are
 Some admin /paying tax associated with a GIA account .
The money is now in your estate for IHT purposes. So it can be save LTA tax and get hit with IHT instead, depending on the rest of your circumstances/finances.

I think for those approaching or likely to hit the LTA, it makes a lot of sense to take it all out, even with those disadvantages noted. It will obviously depend on how each individual views it.

When dunstonh said There are some scenarios where taking the 25% out to go into an ISA makes sense: what are the other scenarios that might make sense?

dunstonh

I'm no expert and defer to wiser heads but isn't there a chance a future (skint) government might reduce or remove the 25% TFLS facility? 

If you look at the changes in legislation that have happened over the last 25 years, the travel has been to increase the availability of tax free cash.  Not reduce it.   Plus, the ability to draw taxable lump sums has resulted in a significant improvement to the treasury.    The tax free cash is frequently used by people to pay off mortgage or debt.   Things that are baked in with planning often decades in advance.   There is nothing to suggest that the TFC will go away.  Especially when you consider other tax wrappers, like ISA, where the again, the limits have been consistently increased over time.

When dunstonh said There are some scenarios where taking the 25% out to go into an ISA makes sense: what are the other scenarios that might make sense?

LTA management. 
Or where someone has no taxable income currently but will do in future tax years.  They can do a UFPLS and get out some taxable and tax free cash without paying any tax and stick that in the ISA making it available later on without tax. (its a variation but it involves movement from pension to ISA).

I think for those approaching or likely to hit the LTA, it makes a lot of sense to take it all out, 

It can do certainly but you also need to remember BCE 5A is going to come along at 75.   So, timing, your future draw rate and how you invest are going to come into play.  Along with IHT considerations. Taking it out to reduce one tax but then increasing another may not be a good idea.  Considerations can be about having split portfolios where you reduce the high growth assets in the pension but increase them in the ISA/GIA until age 75 and then switch around.
The planning often needs to be a bit more than just crystallising the pot to avoid LTA.

dharm999

Pulpdiction said:

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.

Someone at work’s wife is looking at doing what you are thinking about, but her situation is different.  She isn’t working and has no plans to go back to work.  She’s in her late 50s and has a decent DB teachers pension.  She is thinking about taking it early, to utilise her single person’s allowance, and then put the money in to an ISA,  as they don’t need it.  They will never be in a situation where IHT is a consideration, so that disadvantage of an ISA, versus a pension, isn’t relevant for them.  They need to find out how much lower her pension would be by taking it early compared to waiting till the normal age she can access it, and then doing the maths.  

Albermarle

dharm999 said:

Pulpdiction said:

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.

Someone at work’s wife is looking at doing what you are thinking about, but her situation is different.  She isn’t working and has no plans to go back to work.  She’s in her late 50s and has a decent DB teachers pension.  She is thinking about taking it early, to utilise her single person’s allowance, and then put the money in to an ISA,  as they don’t need it.  They will never be in a situation where IHT is a consideration, so that disadvantage of an ISA, versus a pension, isn’t relevant for them.  They need to find out how much lower her pension would be by taking it early compared to waiting till the normal age she can access it, and then doing the maths.  

THe OP has a defined contribution pension , so it is a different scenario to a defined benefit one.