Frozen tax allowances - draw full standard rate allowance now to avoid HR in future?

hugheskevi

michaels said:

I will be allocating to DW as her provision is minimal.  Had dismissed commutation as it was 12x but perhaps 12x tax free becomes more attractive compared to 40% tax paid?!  Has anyone done the maths?

Is it as simple as 12x TFLS commutation is the same as:
12 years tax free
15 years @ 20% tax
20 years @ 40% tax

I wonder how lifetime allowance might work with these numbers?

Yes, it is that simple, so a lot depends on the age when you take pension. If you are going to be paying higher rate tax then commutation is still a bad deal at 55, not very good at 60, something to consider at age 65 and probably a good deal at older ages.

With LTA in the mix, assume for ease that your only pension is a DB pension and there is no automatic lump sum. You have a pension income of £54,655 which would exceed the LTA by £1,000 or £20,000 after applying the factor 20 multiplier. Further assume that in all cases the pension scheme applies a factor of 20 to pension reduced to pay a LTA charge (in practice it will vary by scheme and by age).

That is a breach of 20 x £1,000 = £20,000 if taken as income. A charge of £5,000 is due on this, which the scheme pays by reducing the pension by £5,000 / 20 = £250. So you receive £750 of income, which is then taxed at 40% so the net amount received is £450.

Instead, convert £2,725 of the income to lump sum at 12:1. This gives an income of £51,930 and a lump sum of £32,700 which is exactly equal to the LTA so there is no breach.

Taking the pension as income and paying LTA charge would give a net pension of £54,655 - £750 = 53,905.

That is £53,905 - £51,930 = £1,975 higher than if commuted with a lump sum of £32,700.

So after the LTA charge is taken into account the commutation rate is £32,700 / £1,975 =  16.56

So the equation now becomes:
16.6 years tax free
20.7 years @ 20% tax
27.6 years @ 40% tax

So still maybe not great at age 55 if a higher rate taxpayer, but worth it if starting at 60 or older.

hugheskevi

lithosyork said:

hugheskevi said:

But my expectation is that both my wife and I leave employment with DB pensions from age 55 of about £31K p/a and £28K p/a respectively (and DC pensions of around £265,000), and that should be fine without a need to play tax games. With State Pensions, that gives £42K and £40K respectively, so there is a bit of headroom to higher rate tax. We'll probably delay taking my wife's DB pension slightly, so as to equalise pensions and survivor benefits.

if you start your pension at 55  of say 31K, by the time you reach SPA of 68 (13 years!) that will be much higher (40K at 2%) and state pension will be much higher (15K at 2%)-  so very likely an HR payer.

Of course i dont know what will happen to growth rates if any, the state pension, allowance, LTA or anything else but at todays rules ....

It all depends on what happens to the higher rate threshold, which even under today's rules is only frozen until 2028. Although that is a Conservative policy so may be of little importance although Labour are going to need to find money from somewhere, and keeping Conservative tax-raising policies is likely to be easier than increasing other taxes. After 2028 who knows?

Our DB pension will increase by uncapped CPI and odds are the State Pension increases roughly in line with earnings growth, one way or another - whether that is Triple Lock or something else.

As things stand I have almost £10K of annual income headroom to counter fiscal drag. If that is insufficient I can't really do much about it other than consider whether taking DB pension earlier than age 55 is worthwhile even despite harsh reductions. If the headroom proves more than sufficient I can increase DB pension by delaying taking it beyond 55 and drawing more pension instead. It is frustrating that I can't really do much to improve the worst-case scenario, as the worst-case risks are the ones I am keenest to mitigate even if it were to mean sacrificing expected gains.

It is a sad state of affairs that even just 8 years from taking a pension there are so many policy guessing games to play, and keeping options open as far as possible may prove to be very valuable.

michaels

hugheskevi said:

michaels said:

I will be allocating to DW as her provision is minimal.  Had dismissed commutation as it was 12x but perhaps 12x tax free becomes more attractive compared to 40% tax paid?!  Has anyone done the maths?

Is it as simple as 12x TFLS commutation is the same as:
12 years tax free
15 years @ 20% tax
20 years @ 40% tax

I wonder how lifetime allowance might work with these numbers?

Yes, it is that simple, so a lot depends on the age when you take pension. If you are going to be paying higher rate tax then commutation is still a bad deal at 55, not very good at 60, something to consider at age 65 and probably a good deal at older ages.

With LTA in the mix, assume for ease that your only pension is a DB pension and there is no automatic lump sum. You have a pension income of £54,655 which would exceed the LTA by £1,000 or £20,000 after applying the factor 20 multiplier. Further assume that in all cases the pension scheme applies a factor of 20 to pension reduced to pay a LTA charge (in practice it will vary by scheme and by age).

That is a breach of 20 x £1,000 = £20,000 if taken as income. A charge of £5,000 is due on this, which the scheme pays by reducing the pension by £5,000 / 20 = £250. So you receive £750 of income, which is then taxed at 40% so the net amount received is £450.

Instead, convert £2,725 of the income to lump sum at 12:1. This gives an income of £51,930 and a lump sum of £32,700 which is exactly equal to the LTA so there is no breach.

Taking the pension as income and paying LTA charge would give a net pension of £54,655 - £750 = 53,905.

That is £53,905 - £51,930 = £1,975 higher than if commuted with a lump sum of £32,700.

So after the LTA charge is taken into account the commutation rate is £32,700 / £1,975 =  16.56

So the equation now becomes:
16.6 years tax free
20.7 years @ 20% tax
27.6 years @ 40% tax

So still maybe not great at age 55 if a higher rate taxpayer, but worth it if starting at 60 or older.

Thanks, really clear.

Interesting comment re the 20x factor applied by the scheme for the LA reduction in payment - do you have any more info on this as again it sounds like something that should vary depending how long the pension is likely to be in payment for?

hugheskevi

michaels said:

hugheskevi said:

michaels said:

I will be allocating to DW as her provision is minimal.  Had dismissed commutation as it was 12x but perhaps 12x tax free becomes more attractive compared to 40% tax paid?!  Has anyone done the maths?

Is it as simple as 12x TFLS commutation is the same as:
12 years tax free
15 years @ 20% tax
20 years @ 40% tax

I wonder how lifetime allowance might work with these numbers?

Yes, it is that simple, so a lot depends on the age when you take pension. If you are going to be paying higher rate tax then commutation is still a bad deal at 55, not very good at 60, something to consider at age 65 and probably a good deal at older ages.

With LTA in the mix, assume for ease that your only pension is a DB pension and there is no automatic lump sum. You have a pension income of £54,655 which would exceed the LTA by £1,000 or £20,000 after applying the factor 20 multiplier. Further assume that in all cases the pension scheme applies a factor of 20 to pension reduced to pay a LTA charge (in practice it will vary by scheme and by age).

That is a breach of 20 x £1,000 = £20,000 if taken as income. A charge of £5,000 is due on this, which the scheme pays by reducing the pension by £5,000 / 20 = £250. So you receive £750 of income, which is then taxed at 40% so the net amount received is £450.

Instead, convert £2,725 of the income to lump sum at 12:1. This gives an income of £51,930 and a lump sum of £32,700 which is exactly equal to the LTA so there is no breach.

Taking the pension as income and paying LTA charge would give a net pension of £54,655 - £750 = 53,905.

That is £53,905 - £51,930 = £1,975 higher than if commuted with a lump sum of £32,700.

So after the LTA charge is taken into account the commutation rate is £32,700 / £1,975 =  16.56

So the equation now becomes:
16.6 years tax free
20.7 years @ 20% tax
27.6 years @ 40% tax

So still maybe not great at age 55 if a higher rate taxpayer, but worth it if starting at 60 or older.

Thanks, really clear.

Interesting comment re the 20x factor applied by the scheme for the LA reduction in payment - do you have any more info on this as again it sounds like something that should vary depending how long the pension is likely to be in payment for?

It will vary by age.

Although HMRC use a factor of 20 to calculate the value of pension by age to calculate the capital value of pension regardless of age, the resulting Lifetime Allowance charge due is converted into a pension debit using actuarial factors by the pension scheme. Hence the pension reduction will be smaller the younger the member is when they commence the pension for a given charge amount compared to someone commencing their pension at an older age. The exact figures used will vary from scheme to scheme, although public service pension schemes use largely the same assumptions, so the figures should vary much.