In drawdown and paying in - does it make sense?

Diddidi

Hello everyone - am hoping that someone will be able to advise whether what I am currently doing makes any economic sense or not!

I am in early semi-retirement and am currently in monthly drawdown from my personal pension (25% tax free, 75% taxed) each month (£24k per year) and I top up my income with some freelance work  - about £8.5K per year. HMRC are taxing me on my pension rather than the freelance work. 

In addition, I am paying £240 net per month back into my pension (limited due to my own budget and MPAA rules). Does it make sense to continue to do this under the current economic climate? Is there any benefit in paying in (presumably investing in lower priced shares plus the top up by HMRC) while selling to fund the drawdown? Am assuming there is a sequence of returns issue here? 

I've tried researching and getting my head around all the pros and cons but am just getting myself confused! Thanks in advance for any insight from the wonderful team on this forum!

Marcon

Diddidi said:

Hello everyone - am hoping that someone will be able to advise whether what I am currently doing makes any economic sense or not!

I am in early semi-retirement and am currently in monthly drawdown from my personal pension (25% tax free, 75% taxed) each month (£24k per year) and I top up my income with some freelance work  - about £8.5K per year. HMRC are taxing me on my pension rather than the freelance work. 

HMRC are taxing you on your combined pension and earned income. It may simply be that the way your tax codes are arranged means that all the tax is actually being paid via the pension provider.

Diddidi said:

In addition, I am paying £240 net per month back into my pension (limited due to my own budget and MPAA rules). Does it make sense to continue to do this under the current economic climate? Is there any benefit in paying in (presumably investing in lower priced shares plus the top up by HMRC) while selling to fund the drawdown? Am assuming there is a sequence of returns issue here? 

I've tried researching and getting my head around all the pros and cons but am just getting myself confused! Thanks in advance for any insight from the wonderful team on this forum!

You are getting tax relief on new contributions, and 25% of your withdrawals are tax free. The current economic climate isn't the issue since nobody can predict if the investments being sold to fund your withdrawals are going to be at higher or lower prices than the investments you buy with your new contributions.

Albermarle

The only time it might be a bad idea was if your pension pot was near, or above the Lifetime Allowance of just over a Million Pounds.

Linton

I assume you are selling investments in order to fund your drawdown.  Surely your contributions of £240/month net= £3600/year gross are just replacing some of the shares you sold.  So where does any benefit from buying "lower priced shares" come from?

You are clearly making a tax gain by re-investing some of the money that you received tax free.  However it is rather complicated to work out and more information is needed - eg is the £24K/year gross or net. However it wont be more than about the tax on £720/year=£144/year.  Is it worth the effort? And you are missing out on investment gains from when the shares are sold to fund the drawdown to when the money is returned from your contributions plus possibly adding to the dealing costs.

In principle the reinvesting of the TFLS could be seen as "recycling", however HMRC are not conerned about such small amounts.

Marcon

Linton said:

I assume you are selling investments in order to fund your drawdown.  Surely your contributions of £240/month net= £3600/year gross are just replacing some of the shares you sold.  So where does any benefit from buying "lower priced shares" come from?

You are clearly making a tax gain by re-investing some of the money that you received tax free.  However it is rather complicated to work out and more information is needed - eg is the £24K/year gross or net. However it wont be more than about the tax on £720/year=£144/year.  Is it worth the effort? And you are missing out on investment gains from when the shares are sold to fund the drawdown to when the money is returned from your contributions plus possibly adding to the dealing costs.

In principle the reinvesting of the TFLS could be seen as "recycling", however HMRC are not conerned about such small amounts.

HMRC specifically exclude reinvesting any amounts up to £7,500 in a tax year.

Diddidi

Linton said:

I assume you are selling investments in order to fund your drawdown.  Surely your contributions of £240/month net= £3600/year gross are just replacing some of the shares you sold.  So where does any benefit from buying "lower priced shares" come from?

You are clearly making a tax gain by re-investing some of the money that you received tax free.  However it is rather complicated to work out and more information is needed - eg is the £24K/year gross or net. However it wont be more than about the tax on £720/year=£144/year.  Is it worth the effort? And you are missing out on investment gains from when the shares are sold to fund the drawdown to when the money is returned from your contributions plus possibly adding to the dealing costs.

In principle the reinvesting of the TFLS could be seen as "recycling", however HMRC are not conerned about such small amounts.

The £24k is gross. Good point about the dealing costs and investment gains time gap - hadn’t thought about that - thank you!

zagfles

Diddidi said:

Linton said:

I assume you are selling investments in order to fund your drawdown.  Surely your contributions of £240/month net= £3600/year gross are just replacing some of the shares you sold.  So where does any benefit from buying "lower priced shares" come from?

You are clearly making a tax gain by re-investing some of the money that you received tax free.  However it is rather complicated to work out and more information is needed - eg is the £24K/year gross or net. However it wont be more than about the tax on £720/year=£144/year.  Is it worth the effort? And you are missing out on investment gains from when the shares are sold to fund the drawdown to when the money is returned from your contributions plus possibly adding to the dealing costs.

In principle the reinvesting of the TFLS could be seen as "recycling", however HMRC are not conerned about such small amounts.

The £24k is gross. Good point about the dealing costs and investment gains time gap - hadn’t thought about that - thank you!

Those are unlikely to negate the tax benefit in paying back in, the really important point is about exceeding the LTA, if you ever exceed the LTA in the future then it would likely have been a bad move, if there's no chance you'll exceed it then probably a good move.

If you're taking £24k monthly UFPLS then you should be OK re recycling as the PCLS element is only £6k, if it goes over £7500 then could be an issue but unlikely. See https://www.gov.uk/hmrc-internal-manuals/pensions-tax-manual/ptm133810 

Linton

OK lets do a bit of maths...

2 scenarios:

A - you take £24K gross from your PP and then contribute £28880 net. £3600 gross

1 - gross income =£24K+£8.5K=£32.5K
2 - tax free amount of drawdown=£6K
3 - tax on income= 0.2 X (£32.5K-£12570-£6K)=£2786
4 - so you get £32.5K-£2786=£29714
5 - You contribute £2880 to your pension leaving you with £26834
7) Your pension has suffered a net loss of £24K-£3600=£20400

B - you take £20400 gross from your pension

1 - gross income=£20400+£8.5K=£28900
2 - tax free on drawdown=£5100
3 - tax on income=0.2X(£28900-£12570-£5100)=£2246
4 - so you get £26654
5- your pension has suffered a net loss of £20400

So overall "recycling" the £3600 gross gives you an extra £180/year 

zagfles

Or far easier, £3600*0.25*0.2 = £180. You get 25% of the "recycled" £3600 as an extra PCLS, and the benefit is 20% tax saving on it.

Diddidi

Thank you everyone for your help - really appreciated!

Bimbly

Just leave the money you're paying in in cash. When you take it out again, you will then have to sell fewer investments to fund drawdown.