Minimal tax when withdrawing from pension

Justso65

Hi

I am running some calculations on what to do to minimise my tax when drawing from my pension pot. As an example I will use some numbers to make calculations simple.  I have also used a tax calculator on the Which? site.

I have £640k in my DC pot.  
I want at least £40k in my hand per year.

Option 1.

Take 25% tax free cash from the whole pot.  This gives me £160k.
So this would give me £40k for 4 years not taking into account interest/investment returns on the £160k over the 4 years.  

During these 4 years I could withdraw another £12570 tax free from my pot as this is the personal tax free allowance. Correct or not?  If correct then after 4 years I have a further £50280 to see me through another year.  So far I haven’t paid tax in 5 years and it has cost £160000 + £50280 = £210280

Option 2.  Withdraw enough from my pot each year to satisfy the above.  i.e.  £40k in hand in years 1-4 and £50280 in hand in year 5.

Taking into account I can get 25% tax free from each withdrawal the Which? calculator says I would need to take £44150 to get £40k in hand and £56350 to get the £50280 in hand.  So by this method it costs my pot 4 x £44150 plus £56350 or £232950 from my pot.

So the first method gives me what I want over 5 years at around £22700 less tax.  

I know this is a rather simplistic view of a tax efficient method of withdrawing from my pension but I have a final salary pension I will kick in after 5 years and my strategy is to take what I can from my DC pot in the 5 years up to then happy in the knowledge that I will have to pay tax once my final salary and subsequent state pensions kick in.   I’m aware that at this time I no longer have any 25% tax free cash I can take from my DC pot but I can take some tax free from my DB pot and reduce my yearly taxable income on that. 

Any comments are welcome.

JS.  

El_Torro

Your logic seems sound to me. Generally speaking it's not a good idea to take the 25% tax free up front if you don't need the money for something specific, like paying off a mortgage. However since you are retiring before state pension and your DB pensions kick in I think your plan is good. 

Remember that if you take £160k up front you need to put this money somewhere. Not a lot of it can go into Cash ISAs. You will be paying a lot of tax on interest generated if you put it in a savings account. 

By my rough calculations you will be paying about £6,000 income tax over the 5 years on interest generated (total, not annual). This assumes that savings accounts pay out 5% annual interest over the next 5 years, which is probably wildly optimistic.

Secret2ndAccount

Do you plan to take all of the money out of the DC pot in due course? If so, you will pay more tax in total by burning through the tax free part right away (option 1). Your DB + SP will make you a taxpayer, so withdrawing the remaining 450k will cost you 90k in tax. The 23k you saved will gradually be paid back.
Option 2 will still have substantial tax free parts to the subsequent withdrawals. You get back the 23k in tax free withdrawals, but if the invested money grows, then your tax free portion also grows. You are likely to get back more than just the 23k over the duration of the pension.
Option 1 would be be better if you planned to leave the money in the DC pot in the hopes of passing it on through inheritance. That can currently happen tax free, even if you've taken your 25%, but check back after the budget...

tacpot12

I chose Option 2 as it maximized the tax free portion in future. Taking all the tax free cash you are entitled too at the outset locks in your gains as Secret2ndAccount says, but your logic/maths/understanding of the two options is sound. 

If you want to check the tax calculations you could also use ListenToTaxman - UK Tax Calculator Salary Wages PAYE Income Taxes 2023 - 2024 which I have found to be correct. (You will need to tick the I pay no NI checkbox).

As per El_Torros comment, you might be better off taking £20,000 of your tax free amount each year so you can pop it straight into an ISA.

Triumph13

Are the DB plus SP plus the rest of the DC going to make you a higher rater taxpayer later on?  If so then you probably want to be using the whole of your 20% band now.

An UFPLS of £67k uses up your PA and 20% band.  You pay £7.5k tax and are left with your £40k spending money and £19.5k to put into an ISA.

Sunnylifeover50plan

Is there a pension tax calculator where you can tick UFPLS? or would one simply take 25% off of the amount to be taken before running it through the tax calculator embedded above? 

Dazed_and_C0nfused

Sunnylifeover50plan said:

Is there a pension tax calculator where you can tick UFPLS? or would one simply take 25% off of the amount to be taken before running it through the tax calculator embedded above? 

Tax calculators generally deal with taxable income, it's counter intuitive to start including non taxable income in something designed for a totally different purpose!

Rattusnorvegicus

The short answer is pot growth beats crystallizing instantly.

The not short answer is use a compound interest calculator, plug in a reasonable return number, and how many years you expect to live... plug in a monthly withdrawal figure that gets you to a pot of £0 after 30 retirement years and then take that amount.... Ignore the tax obsession.

There isnt a chance looking at your pot, then looking at the growth, and the duration, and the tax bands that i'd care about higher rate tax.

If you want my strategy.... start at 55 withdraw £12k/quarter, and pay the limit into ISA .. live to your 95 , and congrats you'll have extracted it tax efficiently...

At this point it becomes clear tax efficiency isnt everything...The truth is you have to make a choice between living to 150 (to extract and then spend the extracted cash), and paying higher rate tax.

It boggles my mind how people have no idea how much growth will be generated over a pensioners retirement in theory, and how much gets extracted by the day they die.£640k pot is a pot that has reached escape velocity and that person will be a higher rate tax payer...of course you might be the one that lives to 120+ and proves me wrong...

But then again as manuel said .. i know nothing.

Albermarle

Rattusnorvegicus said:

The short answer is pot growth beats crystallizing instantly.

The not short answer is use a compound interest calculator, plug in a reasonable return number, and how many years you expect to live... plug in a monthly withdrawal figure that gets you to a pot of £0 after 30 retirement years and then take that amount.... Ignore the tax obsession.

There isnt a chance looking at your pot, then looking at the growth, and the duration, and the tax bands that i'd care about higher rate tax.

If you want my strategy.... start at 55 withdraw £12k/quarter, and pay the limit into ISA .. live to your 95 , and congrats you'll have extracted it tax efficiently...

At this point it becomes clear tax efficiency isnt everything...The truth is you have to make a choice between living to 150 (to extract and then spend the extracted cash), and paying higher rate tax.

It boggles my mind how people have no idea how much growth will be generated over a pensioners retirement in theory, and how much gets extracted by the day they die.£640k pot is a pot that has reached escape velocity and that person will be a higher rate tax payer...of course you might be the one that lives to 120+ and proves me wrong...

But then again as manuel said .. i know nothing.

I would not disagree with your general comments about not focusing too much on tax .
However taking too much from a pot each year can lead to the premature emptying of it, especially if there is a big downturn in the markets in the first few years.
A sensible withdrawal strategy should be the priority, with tax a secondary issue.

Justso65

Thank you for all the comments.  As usual great advice and much to ponder for me.  Some things I just hadn’t considered.  Like the tax on interest if I pull too much as a tax free lump sum.

Time4T_Accounts

I took the TFLS in four chunks over a period of several years (I retired at 60 and the TFLS will eventually have lasted 9 years), shouting ‘bank’ when I was happy to lock in gains. I was (and still am) happy to hold significant cash & money market funds so that I can sleep easy through any market falls (I created the first cash buffer not long after retirement and only a couple of months before the COVID drop in the markets - pure luck, no attempt at market timing involved, but there was a definite sense of relief in having that buffer*). I realise there is a body of opinion that says that staying invested gives better overall returns than holding a cash buffer, but I’ve done my calculations, and, like I said, I prefer to sleep at night.  Implicit in this, I think, is that my attitude to risk is changing as I age.
* And it was thanks to the contributors to these pages that I had learned about Sequence of Returns Risk.