Continue paying into a SIPP when over LTA

BPL

I'm a basic rate tax payer with a db pension in payment. Should i continue to contribute the max £2880 / £3600 to my SIPP if im just over LTA? I'm keen on the cash being outside my estate.

EdSwippet

The maths appears to suggest not.

On withdrawal above the LTA you pay a 25% penalty, and then your marginal tax rate on the remaining 75%. Assuming basic rate tax, on £3600 that means £900 in LTA penalty, and £540 in tax, leaving you £2160. That is a net loss of £720 on the £2880 contribution.

Even your best case, below the annual tax free allowance on withdrawal, still leaves you worse off. £3600 less just the £900 LTA penalty leaves £2700, for a net loss of £180.

Albermarle

As above, you would be making a loss whilst you are probably still alive, against your heirs saving some IHT when you are dead.

fizio

The only time I found where it was worthwhile continuing to pay into a DC pension after exceeding LTA was when it was free money i.e paid by the employer and not me. It still free money after LTA taxes 55% tax but agree that it doesn't make since to put any of your own money in..

Albermarle

fizio said:

The only time I found where it was worthwhile continuing to pay into a DC pension after exceeding LTA was when it was free money i.e paid by the employer and not me. It still free money after LTA taxes 55% tax but agree that it doesn't make since to put any of your own money in..

It is only 55% when taken as a lump sum, or of you are a higher rate taxpayer when you take it. For most people the tax is 40%. So as long as you are getting 40% tax relief on the way in then you do not win or lose. Usually to get the employer contribution you have to make some contribution yourself. 

Secret2ndAccount

But you also pay the charge on any gains your investments have made. So you've tied up the money for x years with no hope of any profit. Even if you'd put the money in a GIA you'd probably have paid less in dividend tax and CGT, and would have had access to the funds if you needed them. 
The benefit of going via the pension and paying the LTA charge could come in a saving of IHT by moving the money outside your estate. Also if you lacked the financial discipline to leave the money in, and not just spend it (though spending it might have been fine if you have this much pension). Or if you didn't fancy the paperwork involved in paying the tax on your annual gains.

The OP states they are looking to mitigate IHT. This could work, but remember, at age 75 you pay the LTA charge, even if you leave the money in place. So you could end up losing your heirs as much as you save them.

OP, have you considered gifting some money to your heirs, so that they can pay more into their SIPPs?

Edit to add:  I'm assuming the OP is already putting the max 20k/yr into an ISA. Otherwise that would be a good way to go, rather than the SIPP.

zagfles

Secret2ndAccount said:

But you also pay the charge on any gains your investments have made. So you've tied up the money for x years with no hope of any profit. Even if you'd put the money in a GIA you'd probably have paid less in dividend tax and CGT, and would have had access to the funds if you needed them. 
The benefit of going via the pension and paying the LTA charge could come in a saving of IHT by moving the money outside your estate. Also if you lacked the financial discipline to leave the money in, and not just spend it (though spending it might have been fine if you have this much pension). Or if you didn't fancy the paperwork involved in paying the tax on your annual gains.

The OP states they are looking to mitigate IHT. This could work, but remember, at age 75 you pay the LTA charge, even if you leave the money in place. So you could end up losing your heirs as much as you save them.

OP, have you considered gifting some money to your heirs, so that they can pay more into their SIPPs?

Edit to add:  I'm assuming the OP is already putting the max 20k/yr into an ISA. Otherwise that would be a good way to go, rather than the SIPP.

That's always something that confuses people. It's technically correct but effectively not.

If you get 40% relief going in and pay 40% tax on the way out (LTA compounded with basic rate tax) then it's neutral. Paying tax on the gains is cancelled by those gains being higher because you get the gains on the tax relief.

For the OP they clearly won't get 40% relief going in so not a good idea for him/her. But for someone who can get 40%+ tax relief on contributions and will be a basic rate taxpayer in retirement it's likely to be a winner even ignoring IHT effects. Particularly now that basic rate tax is going down to 19%.

BPL

Albermarle said:

fizio said:

The only time I found where it was worthwhile continuing to pay into a DC pension after exceeding LTA was when it was free money i.e paid by the employer and not me. It still free money after LTA taxes 55% tax but agree that it doesn't make since to put any of your own money in..

It is only 55% when taken as a lump sum, or of you are a higher rate taxpayer when you take it. For most people the tax is 40%. So as long as you are getting 40% tax relief on the way in then you do not win or lose. Usually to get the employer contribution you have to make some contribution yourself. 

If I'm doing phased FAD when is a taxable withdrawal income and when is it a lump sum....? 

zagfles

BPL said:

Albermarle said:

fizio said:

The only time I found where it was worthwhile continuing to pay into a DC pension after exceeding LTA was when it was free money i.e paid by the employer and not me. It still free money after LTA taxes 55% tax but agree that it doesn't make since to put any of your own money in..

It is only 55% when taken as a lump sum, or of you are a higher rate taxpayer when you take it. For most people the tax is 40%. So as long as you are getting 40% tax relief on the way in then you do not win or lose. Usually to get the employer contribution you have to make some contribution yourself. 

If I'm doing phased FAD when is a taxable withdrawal income and when is it a lump sum....? 

Income. The amount over the LTA can either be taken as a lump sum with a 55% tax, or crystallised when you pay 25% tax then income tax as normal on drawdowns.

Secret2ndAccount

zagfles said:

Secret2ndAccount said:

But you also pay the charge on any gains your investments have made. So you've tied up the money for x years with no hope of any profit. Even if you'd put the money in a GIA you'd probably have paid less in dividend tax and CGT, and would have had access to the funds if you needed them. 
The benefit of going via the pension and paying the LTA charge could come in a saving of IHT by moving the money outside your estate. Also if you lacked the financial discipline to leave the money in, and not just spend it (though spending it might have been fine if you have this much pension). Or if you didn't fancy the paperwork involved in paying the tax on your annual gains.

The OP states they are looking to mitigate IHT. This could work, but remember, at age 75 you pay the LTA charge, even if you leave the money in place. So you could end up losing your heirs as much as you save them.

OP, have you considered gifting some money to your heirs, so that they can pay more into their SIPPs?

Edit to add:  I'm assuming the OP is already putting the max 20k/yr into an ISA. Otherwise that would be a good way to go, rather than the SIPP.

That's always something that confuses people. It's technically correct but effectively not.

If you get 40% relief going in and pay 40% tax on the way out (LTA compounded with basic rate tax) then it's neutral. Paying tax on the gains is cancelled by those gains being higher because you get the gains on the tax relief.

For the OP they clearly won't get 40% relief going in so not a good idea for him/her. But for someone who can get 40%+ tax relief on contributions and will be a basic rate taxpayer in retirement it's likely to be a winner even ignoring IHT effects. Particularly now that basic rate tax is going down to 19%.

The bit that you highlighted is, as you state, true.
The bit that a 40% relief / 40% taxpayer achieves nothing except tying up their money is correct, as we both stated.
Your point that a 40% in, basic rate out person could gain 0.75% once the BR goes to 19% is correct, but would apply equally to the principal as to any gains.
So, if a 40% taxpayer pays 2880 into a SIPP, he gets out 3600x0.75x0.81=2187. He also received tax relief of 720, so he has made £27 on the roundtrip. If the pot grew 10% he gets another £219 for a total of £246 If he put the money in a savings account, he would make 2 or 3%pa, and probably pay no tax. If he put it in a GIA and gained 10% (£288) he could very likely keep all of it or at least pay only 10% tax on the gain. So, even for the 40in/19out guy it's a no go unless he has absolutely maxed out every kind of tax free investment return available to him. In which case he can make 0.75% via the SIPP. Once he hits SPA, he is almost certainly a higher rate taxpayer, so now he can't take the money out without a hefty tax bill. The only reason to go here is IHT mitigation.

zagfles

Secret2ndAccount said:

zagfles said:

Secret2ndAccount said:

But you also pay the charge on any gains your investments have made. So you've tied up the money for x years with no hope of any profit. Even if you'd put the money in a GIA you'd probably have paid less in dividend tax and CGT, and would have had access to the funds if you needed them. 
The benefit of going via the pension and paying the LTA charge could come in a saving of IHT by moving the money outside your estate. Also if you lacked the financial discipline to leave the money in, and not just spend it (though spending it might have been fine if you have this much pension). Or if you didn't fancy the paperwork involved in paying the tax on your annual gains.

The OP states they are looking to mitigate IHT. This could work, but remember, at age 75 you pay the LTA charge, even if you leave the money in place. So you could end up losing your heirs as much as you save them.

OP, have you considered gifting some money to your heirs, so that they can pay more into their SIPPs?

Edit to add:  I'm assuming the OP is already putting the max 20k/yr into an ISA. Otherwise that would be a good way to go, rather than the SIPP.

That's always something that confuses people. It's technically correct but effectively not.

If you get 40% relief going in and pay 40% tax on the way out (LTA compounded with basic rate tax) then it's neutral. Paying tax on the gains is cancelled by those gains being higher because you get the gains on the tax relief.

For the OP they clearly won't get 40% relief going in so not a good idea for him/her. But for someone who can get 40%+ tax relief on contributions and will be a basic rate taxpayer in retirement it's likely to be a winner even ignoring IHT effects. Particularly now that basic rate tax is going down to 19%.

The bit that you highlighted is, as you state, true.
The bit that a 40% relief / 40% taxpayer achieves nothing except tying up their money is correct, as we both stated.
Your point that a 40% in, basic rate out person could gain 0.75% once the BR goes to 19% is correct, but would apply equally to the principal as to any gains.
So, if a 40% taxpayer pays 2880 into a SIPP, he gets out 3600x0.75x0.81=2187. He also received tax relief of 720, so he has made £27 on the roundtrip. If the pot grew 10% he gets another £219 for a total of £246 If he put the money in a savings account, he would make 2 or 3%pa, and probably pay no tax. If he put it in a GIA and gained 10% (£288) he could very likely keep all of it or at least pay only 10% tax on the gain. So, even for the 40in/19out guy it's a no go unless he has absolutely maxed out every kind of tax free investment return available to him. In which case he can make 0.75% via the SIPP.

You're making the mistake of assuming the £720 is not invested. If that was put into a GIA which gained 10% it would make £72. Plus the £246 makes £318. Therefore made £30 more than putting it all into a GIA, even with no tax on GIA gains.

The maths is very simple, you don't need to work out the actual numbers. If you get 40% tax relief going in to a pension and pay 40% on the way out, then it's the same end result as investing in a GIA if there no tax on GIA gains.

If there is any tax on the GIA gains, eg CGT or dividend tax, the pension wins. If the tax relief is better than 40% and/or the tax paid on the pension income (accounting for LTA) is less than 40%, the pension wins.

Growth inside the pension is effectively tax free, because growth on a higher value cancels the tax paid on growth if the relief and tax paid on the way out are the same.

Pension basically defers income tax and gets "tax free" growth. Investment x tax hit x growth factor  = investment x growth factor x tax hit. Multiplication is commutative.

Once he hits SPA, he is almost certainly a higher rate taxpayer, so now he can't take the money out without a hefty tax bill. The only reason to go here is IHT mitigation.

It's easily possible to exceed the LTA and remain a basic rate taxpayer in retirement even with the state pension. If just DC, you could crystallise up to the LTA so you have about £805k after the PCLS, and draw the supposedly "safe" drawdown rate of 4% pa, about £32k. Add a state pension of say £10k and that's still well within the basic rate band with considerable margin (unless you're Scottish). 

OP has DB so it's a bit different, however none of this appies to OP as he/she's a basic rate payer, so the above doesn't apply to them anyway.