Avoiding 60% marginal tax rate

Jeremy535897

EdSwippet said:

Pat38493 said:

I have to admit I'm not too clear on why "scheme pays" or not makes any difference - wouldn't I end up paying the same amount of tax either way, either through my tax return or through the scheme - I'm obviously missing something there.

Scheme pays reduces the amount in your pension, so there is less to tax on withdrawal.

Suppose you don't use it. You put £100 into your pension and pay £40 in tax from other (post-tax!) money. On withdrawal, basic rate tax and below the LTA, you receive £25 tax free and 80% of £75, giving you £85. However, you now need to subtract the £40 you paid directly in AA tax from this, leaves you £45. That is less than the £51 you obtain from using 'scheme pays'. For higher rate tax, the result is £30, compared to £42 with 'scheme pays'.

Now add in LTA complications. Over both the AA and LTA, no scheme pays, and higher rate tax on withdrawal. Contribute £100 and pay £40 in tax. Withdrawal of this £100 is taxed at 55%, returning £45. Subtract the £40 paid in tax to make that contribution leaves you £5 out of the £100 you began with. An effective 95% tax rate.

From the above, you can now see how to construct a 100% tax case. (Hint: there is a tax bracket above 40%.)

Having been told earlier by another poster that OP would at least get tax relief on the excess contribution made, doesn't that need to be factored in? I confess I have never studied this in any depth, as it was my understanding that it is simply a crazy thing to do.

Pat38493

EdSwippet said:

Pat38493 said:

I have to admit I'm not too clear on why "scheme pays" or not makes any difference - wouldn't I end up paying the same amount of tax either way, either through my tax return or through the scheme - I'm obviously missing something there.

Scheme pays reduces the amount in your pension, so there is less to tax on withdrawal.

Suppose you don't use it. You put £100 into your pension and pay £40 in tax from other (post-tax!) money. On withdrawal, basic rate tax and below the LTA, you receive £25 tax free and 80% of £75, giving you £85. However, you now need to subtract the £40 you paid directly in AA tax from this, leaves you £45. That is less than the £51 you obtain from using 'scheme pays'. For higher rate tax, the result is £30, compared to £42 with 'scheme pays'.

Now add in LTA complications. Over both the AA and LTA, no scheme pays, and higher rate tax on withdrawal. Contribute £100 and pay £40 in tax. Withdrawal of this £100 is taxed at 55%, returning £45. Subtract the £40 paid in tax to make that contribution leaves you £5 out of the £100 you began with. An effective 95% tax rate.

From the above, you can now see how to construct a 100% tax case. (Hint: there is a tax bracket above 40%.)

So the bottom line is that it might be worthwhile doing this if I am going to make sure I am a zero rate or basic rate taxpayer and I am sure that I won't go over the LTA.  I would then end up in the long run with a 9% better rate than by simply stumping up the 60% now.  I guess this could also be impacted by when I will draw the money out and what kind of growth it experiences in the meantime.  

I am not really planning to be a higher rate taxpayer in retirement.  I am also not really expecting to bust the LTA although I guess higher than expected returns could change that.

Grumpy_chap

Pat38493 said:

So the bottom line is that it might be worthwhile doing this if I am going to make sure I am a zero rate or basic rate taxpayer and I am sure that I won't go over the LTA.  

Except, if you are a >£100k salary earner, those criteria will result in a substantial drop in standard of living when you retire.  Unless you will top-up whatever you draw as pension by other assets that you will just spend down.

In fact, for a >£100k salary earner, maintaining a life-style comparable ("2/3rd income" was the rule of thumb my Father used, based on how final salary pensions worked) you need a retirement spend pot of around £70k.  If all of that is to be met from the pension, then LTA will be an insufficient level of fund.

EdSwippet

Pat38493 said:
... and I am sure that I won't go over the LTA.  ...  I am also not really expecting to bust the LTA although I guess higher than expected returns could change that.

So not completely sure, then. :-) Don't forget the possibility that even if your funds don't grow to above the LTA, the LTA could shrink to below what you hold.

Pension savers have been blindsided, multiple times, by government "commitments" to raise the LTA with inflation, swiftly followed by freezes (reductions in real terms) or outright and overt cuts (reductions in both real and nominal terms).

How close are you to (a) the LTA, and (b) the age at which you can start crystallising some or all of your pension(s)?

EdSwippet

Jeremy535897 said:
Having been told earlier by another poster that OP would at least get tax relief on the excess contribution made, doesn't that need to be factored in? I confess I have never studied this in any depth, as it was my understanding that it is simply a crazy thing to do.

For simplicity (and because they're likely real in this case), I'm assuming either 'net pay' or 'salary sacrifice'. For these, there's no additional tax relief to be added by the pension provider. Rather, tax is computed only after pension contributions have been made by the employer. That's where the tax relief is.

A good salary sacrifice scheme, for example one that refunds some or all of the employer NI, would flatter the numbers a little compared to net pay. However, like you my view of this is that any potential gains on this are in general likely not worth the considerable political (never mind market) risks. Shrinking LTA, volatile tax rates, frozen allowances, and so on. I suppose there may be edge cases that might be worth considering, but it would take a braver person than I am to stake real retirement assets on them.

Pat38493

Grumpy_chap said:

Pat38493 said:

So the bottom line is that it might be worthwhile doing this if I am going to make sure I am a zero rate or basic rate taxpayer and I am sure that I won't go over the LTA.  

Except, if you are a >£100k salary earner, those criteria will result in a substantial drop in standard of living when you retire.  Unless you will top-up whatever you draw as pension by other assets that you will just spend down.

In fact, for a >£100k salary earner, maintaining a life-style comparable ("2/3rd income" was the rule of thumb my Father used, based on how final salary pensions worked) you need a retirement spend pot of around £70k.  If all of that is to be met from the pension, then LTA will be an insufficient level of fund.

True but I don't really need that amount of money in retirement for several reasons.  First, we intend to downsize the house to help fund some items during retirement.  Second, my partner has a full DB NHS fully funded pension scheme.  Third, when I am looking at our outgoings, we are spending a lot of money on things which won't be needed in future.  I am currently running a more detailed analysis by categorising all transactions in detail over the next few years to see what I need.

Further, I am pretty sure I would need funds in excess of the LTA in order to maintain my current theoretical net income on "normal" levels of pension contributions (I am currently putting in the max each year).

A financial adviser told me that the 2/3rd income rule might be a bit overkill if you are a high earner like me if you assume you will pay off major items like mortgage and so on.

Pat38493

EdSwippet said:

Pat38493 said:
... and I am sure that I won't go over the LTA.  ...  I am also not really expecting to bust the LTA although I guess higher than expected returns could change that.

So not completely sure, then. :-) Don't forget the possibility that even if your funds don't grow to above the LTA, the LTA could shrink to below what you hold.

Pension savers have been blindsided, multiple times, by government "commitments" to raise the LTA with inflation, swiftly followed by freezes (reductions in real terms) or outright and overt cuts (reductions in both real and nominal terms).

How close are you to (a) the LTA, and (b) the age at which you can start crystallizing some or all of your pension(s)?

Well yes - I might have to take my DB benefits early (before 65) in order to avoid hitting LTA as I have a mix of DB and DC pots.

Based on current valuations and in that earlier scenario I guess my total pot would be about 80% of the LTA, assuming the LTA does not change, so I guess I don't have that much headroom.  

When the LTA was changed (lowered in nominal terms), weren't existing people who had already retired given the possibility to get some kind of protection if I remember correctly?

Given the current rate of inflation, I think it would be a brave government of any party who would start cutting the LTA even further in nominal terms.  

I am 53 - I can take benefits from Jan 2024.

Grumpy_chap

Pat38493 said:

True but I don't really need that amount of money in retirement for several reasons.  First, we intend to downsize the house to help fund some items during retirement.  Second, my partner has a full DB NHS fully funded pension scheme.  Third, when I am looking at our outgoings, we are spending a lot of money on things which won't be needed in future.  I am currently running a more detailed analysis by categorising all transactions in detail over the next few years to see what I need.

Further, I am pretty sure I would need funds in excess of the LTA in order to maintain my current theoretical net income on "normal" levels of pension contributions (I am currently putting in the max each year).

A financial adviser told me that the 2/3rd income rule might be a bit overkill if you are a high earner like me if you assume you will pay off major items like mortgage and so on.

So, by down-sizing the house, the pension income will be supplemented by a large cash pot from which you will draw down.

Your partner will have a very good gold-plated pension, but that will still be lower than their FTE currently.


I am always intrigued by people who state they will need less money disposable once they retire.  Yes, no mortgage to pay, but increased costs for:

• More leisure time, meals out, holidays.  And pick the best, no slumming it in Economy if you don't have to.
• Take up an expensive hobby - I fancy gaining a pilots licence for Micro-Light.  Or membership of a golf club, not cheap.
• Paying for help around the house and garden as mobility starts to decrease
• Eventually, nursing home fees.

When I retire, I am going to need a good £1M upwards annually

EdSwippet

Pat38493 said:
When the LTA was changed (lowered in nominal terms), weren't existing people who had already retired given the possibility to get some kind of protection if I remember correctly?

Given the current rate of inflation, I think it would be a brave government of any party who would start cutting the LTA even further in nominal terms.  

I am 53 - I can take benefits from Jan 2024.

Two types of protection: Individual, and Fixed. In practice, both come with what can be pretty hefty downsides.

Protect your pension lifetime allowance - HMRC

With individual protection, everything you planned to contribute in future that would have been, before LTA reductions, below the LTA, shifts to being above the LTA. This (understandably) demotivates future pension saving.

With fixed protection, you only have that as long as you do not make any of the future pension contributions that you planned, and which would, before LTA reductions, have been below the LTA. If you make any further pension contributions, you entirely lose your protection, possibly bringing a lot of money from outside LTA penalty to inside LTA penalty. This also ... um ... demotivates future pension saving.

Being close to the age at which you can crystallise a pension does however give you a potential route to mitigating the worst of the LTA damage, if/when your investments start bubbling up towards it. Once over 55, you can crystallise some or all of your DC pensions and so jump the LTA hurdle (or limbo under the LTA bar; choose your preferred metaphor) before exceeding the LTA. At that point, your next worry is the second forced LTA test at age 75. You do have two decades to prepare for that, though.

Searching the pensions board should pull up details and war stories on the above.

Finally, government braveness, or otherwise, doesn't seem to be the issue. Rather, it appears simply ignorant and clueless when it comes to the real-world effects of these sorts of policies. Exhibit A would be both past and current furore in the NHS over pension allowances. The round numbers, £1.5mm, £1.25mm, £1mm, are a vivid clue that none of these allowances were ever carefully calibrated; all are simply wet-finger guesses. "£1m sounds about right" is probably the fullest extent of the analysis done for the 2016 reduction.

Pat38493

EdSwippet said:

Pat38493 said:
When the LTA was changed (lowered in nominal terms), weren't existing people who had already retired given the possibility to get some kind of protection if I remember correctly?

Given the current rate of inflation, I think it would be a brave government of any party who would start cutting the LTA even further in nominal terms.  

I am 53 - I can take benefits from Jan 2024.

Being close to the age at which you can crystallise a pension does however give you a potential route to mitigating the worst of the LTA damage, if/when your investments start bubbling up towards it. Once over 55, you can crystallise some or all of your DC pensions and so jump the LTA hurdle (or limbo under the LTA bar; choose your preferred metaphor) before exceeding the LTA. At that point, your next worry is the second forced LTA test at age 75. You do have two decades to prepare for that, though.

For sure but this could also go the other way if the LTA actually goes up in future years and I have crystallised a large % of it already.