Tax on Returns on Funds Held in Drawdown - Newbie Q

Scot_39

Most of the general guides on drawdown talk simply about the initial 25% tax free and the 75% on capital then being locked in as future taxable income.

But not about the longer term.

But what happens with tax on future returns on the 75% of capital ?

So say 100k, get 25k tax free, and 75k fully taxable.

But that 75k stays invested - for n years and if it then grows to say 100k.

Does the additional earned 25k get any tax free allowance or is the 100k now all fully taxable ?

If taxable, isn't that then worse than not using drawdown ?

And say 4 25k ufpls - which would gain tax free 25% on returns on 75k, 50k and 25k over next 3 years be better than putting money into drawdown up front.  Edit At least from the point of view of tax on future Returns.

Any links to multiple ufpls vs long term drawdown tax scenarios ?

MK62

That's the way it works for most people......
As to whether its best to fully crystallise your pension when you first access it.....that depends, in the first instance, on your life plans (ie you may have specific plans for that tax free cash, and so might need it all upfront).
If you don't have such plans, it's then a numbers game.......comparing full crystallisation against UFPLS and phased drawdown depends on your financial and tax positions and also means making some assumptions on growth and future tax (and tax free) rates.... those assumptions may well turn out to be wrong, and with so many variations in individual circumstances, it's impossible to make any general "rule".

Dazed_and_C0nfused

If you take £25k TFLS upfront and leave £75k crystallised and that £75k grows to £100k then the whole £100k is taxable when taken out of the pension.

You can't have 25% TFLS and then additional TFLS from the crystallised element.

zagfles

Scot_39 said:

Most of the general guides on drawdown talk simply about the initial 25% tax free and the 75% on capital then being locked in as future taxable income.

But not about the longer term.

But what happens with tax on future returns on the 75% of capital ?

So say 100k, get 25k tax free, and 75k fully taxable.

But that 75k stays invested - for n years and if it then grows to say 100k.

Does the additional earned 25k get any tax free allowance or is the 100k now all fully taxable ?

If taxable, isn't that then worse than not using drawdown ?

And say 4 25k ufpls - which would gain tax free 25% on returns on 75k, 50k and 25k over next 3 years be better than putting money into drawdown up front.  Edit At least from the point of view of tax on future Returns.

Any links to multiple ufpls vs long term drawdown tax scenarios ?

Why? If you pay tax now there is less to grow. Multiplication is commutative.

Pat38493

No the additional 25K is taxable as it is now part of your "crystallised" pot.

However - if you do a UFPLS, you only crystallise the total of the UFPLS, so any growth on the part of the pot that is not crystallised will gain extra tax free cash (or less if it shrinks obviously).

I think with some providers when you do this they move the crystallised part into a separate account, whereas others may track it as a % or somehow behind the scenes.

From what I've seen on other threads, all things equal, it's usually better in the long term to take your money out by UFPLS unless you need the tax free cash for some specific purpose or some part of your retirement planning where the benefit outweighs the loss of future tax free cash growth.  This obviously involves some calculations and modelling, some of which will be based on assumptions.

dunstonh

Most of the general guides on drawdown talk simply about the initial 25% tax free and the 75% on capital then being locked in as future taxable income.

If that is all you are getting on those "guides" then they are pretty rubbish guides and you should look elsewhere.

For example, we used phased UFPLS more than flexi-access drawdown with the 25% taken up front.     Flexi-access drawdown with 25% taken up front is the easiest to explain but it is also the option that is probably not the best option for most people.  Despite it being the option most of the non-advised public end up doing.

Scot_39

zagfles said:

Scot_39 said:

Most of the general guides on drawdown talk simply about the initial 25% tax free and the 75% on capital then being locked in as future taxable income.

But not about the longer term.

But what happens with tax on future returns on the 75% of capital ?

So say 100k, get 25k tax free, and 75k fully taxable.

But that 75k stays invested - for n years and if it then grows to say 100k.

Does the additional earned 25k get any tax free allowance or is the 100k now all fully taxable ?

If taxable, isn't that then worse than not using drawdown ?

And say 4 25k ufpls - which would gain tax free 25% on returns on 75k, 50k and 25k over next 3 years be better than putting money into drawdown up front.  Edit At least from the point of view of tax on future Returns.

Any links to multiple ufpls vs long term drawdown tax scenarios ?

Why? If you pay tax now there is less to grow. Multiplication is commutative.

OK my perhaps crass reasoning for "isn't that then worse" ?

100k to get 4x25k earnings.  Taken including share of return annually for simplicity, 0 after 4 withdrawals.

Full crystallisation.

25k tax free lump sum
75k remains invested - say 5% return - 78.75 eoy.
take 1/3  - 26.25 k taxable.
52.5k remains invested - say 5% return - 55.125 eoy
Take 1/2 - 27.56k taxable
27.56k remains - 5% return - 28.94
Take 28.94 taxable

25k tax free, 82.75 taxable over the four years. 107.75 total

Ufpls

25k ufplus 6.25k tax free, 18.75 taxable
75k remains invested,....
26.25k ufplus, 6.56k tax free, 19.86 tax
...
27.56 ufplus, 6.89k tax free
....
28.94 ufplus, 7.25k tax free

26.94 tax free, 80.81 taxable, over 4 years.  107.75 total.
You keep 1/4 of the growth tax free too.

But that might all be my lack of understanding, so nonsense ???????

All ignoring what you do with the money once withdrawn.

Above gross.
Net obviously dependent on personal tax position and potentially govt tax policy over the 4 years.


It's not a big hit, and if need the extra cash, ....you make your choices, and pay the difference.

20% on 5% return, may be a lot less than say mortgage debt or diy/car loans etc.


Of course if investments fall, you win, but no one hopes for that in their pension.

Albermarle

dunstonh said:

Most of the general guides on drawdown talk simply about the initial 25% tax free and the 75% on capital then being locked in as future taxable income.

If that is all you are getting on those "guides" then they are pretty rubbish guides and you should look elsewhere.

For example, we used phased UFPLS more than flexi-access drawdown with the 25% taken up front.     Flexi-access drawdown with 25% taken up front is the easiest to explain but it is also the option that is probably not the best option for most people.  Despite it being the option most of the non-advised public end up doing.

Maybe flexi access drawdown but take the 25% tax free in stages and  with some taxable income as well, can work ? Unless that is what you mean by phased UFPLS ?
Similar to taking UFPLS payments, but you can play around a little more with the tax free/taxable ratio of each payment, within limits?

dunstonh

Maybe flexi access drawdown but take the 25% tax free in stages and  with some taxable income as well, can work ? Unless that is what you mean by phased UFPLS ?

Where an amount is paid out as 25%+75%, then that is classed as UFPLS.

So, someone drawing £1000 per month using phased UFPLS would be paid £250 tax free and £750 taxable.

Similar to taking UFPLS payments, but you can play around a little more with the tax free/taxable ratio of each payment, within limits?

Exactly.     Plus, in some scenarios, you do a bit of phased UFPLS and drawdown together. 

i.e. £1,388.91 per month under UFPLS plus £277.75 per month under drawdown set to 25% TFC and nil income.  That would give the person £20k a year tax free income until state pension is paid and assuming no other income.   Then adjust when state pension is payable and when personal allowances change.   How long the 25% TFC will last will depend on the size of the pot and the size of the draw.

Scot_39

Why 1388.91 ?

Doesn't that work out at £12500 taxable, not the full 12570 PA ?

Or was it just to get 12500 / 7500 rounded split ?

dunstonh

Scot_39 said:

Why 1388.91 ?

Doesn't that work out at £12500 taxable, not the full 12570 PA ?

Or was it just to get 12500 / 7500 rounded split ?

I was rounding for speed.