Avoiding 40% tax in SIPP drawdown

fizio

kinger101 said:

fizio said:

Is there merit in entering the 40% tax bracket via drawdown in order to put the money into the same S&S but in an ISA instead - especially if you have no other funds to keep the ISA going? The money is not needed for day to day but am thinking its easier to manage spending/gifting/etc the mony from an ISA and avoiding all the potenti
issues with a pension such as tax/regulation changes etc? 

I think realistically, I'd only consider it if I was pretty sure I'd be a higher-rate taxpayer for the remainder of my retirement.

DB+State pension means this is inevitable in a few years time for me. Only option was an increase in tax bands but that looks unlikely for next 5 years at least - obviously hard to predict the future so no decision will be the right one for sure - especially if inheritance isn't a major factor. 

In simple terms I am thinking that if 100k in a drawdown pots doubles to 200k then 40% means 120k after 40% tax but can't be taken out in 1 go due to next tax band so spread over a few years. If 100k removed giving 60k net and put into ISA and double to the same net 120k as sipp - with no impact of future tax changes etc.. 

I have done this once (taken out net 20k) and pondering if its a good strategy annually as drawdown pot is not earmarked for anything in particularly.  

MetaPhysical

My counsel is to not get too hung up on the 40% threshold, especially if you have milked the 40% tax relief on the way in, especially especially if you had good employer contribution and especially especially especially if you did this whilst maxing out the annual allowance.  In such circumstances a 60k annual contribution. may have only "cost" you £25k and you got tax free growth and gains!  Win, win, win!

I like to zoom out and think of the bigger picture and think of it more as my "blended" income tax rate I am taking a hit on across all my sources of income.  If you're taking UFPLS, say, and considering your personal allowance then even if you step over the 50270 threshold and take an income of say 60k, you're only changing your "blended" tax rate by a relatively small amount. Why limit the enjoyment of your retirement just because of a psychological aversion to a bit of extra tax?  By all means avoid 40% tax if you can but don't let it stop you living the life you want.

feetupgininhand

[Deleted User] said:

You could have a think about where the growth in value of your assets is likely to be and ensure that that those assets are outside the pension scheme to take advantage of lower rates of tax (e.g. for capital gainss 24% after annual exemption in a GIA (or 0% in ISA) vs 40% when you withdraw the pension). 

So if you have, say, £10k of cash earning 4% pa outside and equity where you expect the nominal return to be, say 8% pa on average then buy £10k of equity outside and sell £10k of equity in your pension and invest it at 4%.  For £10k of assets it's probably not worth doing this but with larger amounts it becomes more interesting.

Another thing is not to think about IT without IHT.  The permutations get quite complicated (pre-2027, married, age at death, etc).  So simplifying things, say that it is post-2027, you are in IHT paying territory and you survive your wife.  Then you get the following on your pension pot:

1. Die before 75: IHT but no IT for beneficiaries
2. Die after 75: IHT and IT for beneficiaries

Looking at a post-75 death, you get 40% IHT and (say) 40% IHT for your beneficiaries.  That sound like is 64% marginal tax rate (but the way that the IHT nil rate bands are currently expected to be shared gives a higher marginal tax rate).  For someone at or around £2m, and 45% tax paying beneficiaries, the marginal rate can be 91.3% (or more in Scotland and with student loans).  To be honest, that does feel excessive but that's the rules being consulted on.  Let's assume that the marginal rate when IT and IHT is due 64% for now.  You then end up with:

1. Do nothing: Leave the value in the SIPP - 64% marginal rate (IHT and then IT for beneficiaries)

2. Take it out and save it: 40% income tax now, 40% IHT later - again a 64% marginal rate

3. Take it out and spend it: 40% income tax now, no IHT

4. Take it out and give it away to the kids and survive seven year: 40% income tax now, no IHT.  If you don't survive seven years then it goes back to 64% marginal rate (IHT and then IT for beneficiaries).

If you like kicking the can down the road and think you are going to die after you are 82:

a. Do nothing before April 2027 as the mechanics of the new IHT rules might change and so you can stick your head in the sand.

b. Before age 75: Do nothing as there will only be IHT on death, no income tax. 

c. After age 75: Take it out with 40% income tax and spend it / give it away as a PET

d. Die after age 82: Only relevant if you gave money away at age 75.  If you die before it will be a failed PET but if the numbers are big, the tapering before then might reduce the IHT (but increase the IT for the beneficiaries).

Some subtlety then is around how many years you take the money out post age 75 and stay a 40% taxpayer and not a 45% taxpayer.  If you plan to spend the money, you need to make sure you live long enough to do that.  If you give it away you need to die seven years after the delayed last gift.  If you think that you are only going to live to 77 though, you would want to make sure that you took the last amount of the SIPP and gave it away by the time that you are age 70.  If you are not sure when you will die, don't worry as this or another government will surely have changed the rules by then.

If the amounts were bigger you could spend a year in a nice warm country paying no tax, then another four years somewhere you want to live (*) and then you won't have any UK tax.  But you'd still have to spend / gift the money to avoid IHT unless you leave the UK for ten years (*).  * = it is much more complicated than that.    

Wow, and Ow, still recovering from the possible permutations. 40% income tax and spend/PET(especially PET combined with bolstering offspring SIPP arrangements) doesn't seem so bad stacked against the possibility of some of the combinations. Knowing RIP key.

feetupgininhand

Bostonerimus1 said:

feetupgininhand said:

Bostonerimus1 said:

I've thought about this question of "40% tax" in planning for a potential return to the UK from the US. I plan to defer both US social security and UK state pension to give me as many years as possible to move money from my tax deferred US DC pension accounts to the UK and US tax free ROTH DC pension accounts. Of course I must pay tax on the money that I 

The crossover point when you defer something like a DB or state pension is generally around the average life expectancy for when you decide to take the pension. As with all such payments the longer you live the better you do. If you can afford to defer, the generous increase in payment amounts rapidly improves the total life time income once you live longer than average over taking the pension sooner and it might give you some tax planning opportunities. So do you feel lucky, or maybe healthy?

There must be something wrong with my figures or thinking how this would work. UK state pension for example. 
£11502. Don't take that for 1 year and you'd get a 5.8% uplift when you start taking it a year later, then comparable increases. To get back £11502 I think would take > 20 years. Have I missed something?

Pat38493

feetupgininhand said:

[Deleted User] said:

You could have a think about where the growth in value of your assets is likely to be and ensure that that those assets are outside the pension scheme to take advantage of lower rates of tax (e.g. for capital gainss 24% after annual exemption in a GIA (or 0% in ISA) vs 40% when you withdraw the pension). 

So if you have, say, £10k of cash earning 4% pa outside and equity where you expect the nominal return to be, say 8% pa on average then buy £10k of equity outside and sell £10k of equity in your pension and invest it at 4%.  For £10k of assets it's probably not worth doing this but with larger amounts it becomes more interesting.

Another thing is not to think about IT without IHT.  The permutations get quite complicated (pre-2027, married, age at death, etc).  So simplifying things, say that it is post-2027, you are in IHT paying territory and you survive your wife.  Then you get the following on your pension pot:

1. Die before 75: IHT but no IT for beneficiaries
2. Die after 75: IHT and IT for beneficiaries

Looking at a post-75 death, you get 40% IHT and (say) 40% IHT for your beneficiaries.  That sound like is 64% marginal tax rate (but the way that the IHT nil rate bands are currently expected to be shared gives a higher marginal tax rate).  For someone at or around £2m, and 45% tax paying beneficiaries, the marginal rate can be 91.3% (or more in Scotland and with student loans).  To be honest, that does feel excessive but that's the rules being consulted on.  Let's assume that the marginal rate when IT and IHT is due 64% for now.  You then end up with:

1. Do nothing: Leave the value in the SIPP - 64% marginal rate (IHT and then IT for beneficiaries)

2. Take it out and save it: 40% income tax now, 40% IHT later - again a 64% marginal rate

3. Take it out and spend it: 40% income tax now, no IHT

4. Take it out and give it away to the kids and survive seven year: 40% income tax now, no IHT.  If you don't survive seven years then it goes back to 64% marginal rate (IHT and then IT for beneficiaries).

If you like kicking the can down the road and think you are going to die after you are 82:

a. Do nothing before April 2027 as the mechanics of the new IHT rules might change and so you can stick your head in the sand.

b. Before age 75: Do nothing as there will only be IHT on death, no income tax. 

c. After age 75: Take it out with 40% income tax and spend it / give it away as a PET

d. Die after age 82: Only relevant if you gave money away at age 75.  If you die before it will be a failed PET but if the numbers are big, the tapering before then might reduce the IHT (but increase the IT for the beneficiaries).

Some subtlety then is around how many years you take the money out post age 75 and stay a 40% taxpayer and not a 45% taxpayer.  If you plan to spend the money, you need to make sure you live long enough to do that.  If you give it away you need to die seven years after the delayed last gift.  If you think that you are only going to live to 77 though, you would want to make sure that you took the last amount of the SIPP and gave it away by the time that you are age 70.  If you are not sure when you will die, don't worry as this or another government will surely have changed the rules by then.

If the amounts were bigger you could spend a year in a nice warm country paying no tax, then another four years somewhere you want to live (*) and then you won't have any UK tax.  But you'd still have to spend / gift the money to avoid IHT unless you leave the UK for ten years (*).  * = it is much more complicated than that.    

Wow, and Ow, still recovering from the possible permutations. 40% income tax and spend/PET(especially PET combined with bolstering offspring SIPP arrangements) doesn't seem so bad stacked against the possibility of some of the combinations. Knowing RIP key.

The comments about putting your high growth assets outside of the pension if possible are may be valid (especially if you can get them in ISAs) - however if you only have limited funds available outside the pension, you are running the risk of being forced to take money out of the pension rather than cash in distressed assets outside, if there is a significant financial crash.  This could force you to incur the 40% tax that you were trying to avoid in the first place.

FIREDreamer

feetupgininhand said:

Bostonerimus1 said:

feetupgininhand said:

Bostonerimus1 said:

I've thought about this question of "40% tax" in planning for a potential return to the UK from the US. I plan to defer both US social security and UK state pension to give me as many years as possible to move money from my tax deferred US DC pension accounts to the UK and US tax free ROTH DC pension accounts. Of course I must pay tax on the money that I 

The crossover point when you defer something like a DB or state pension is generally around the average life expectancy for when you decide to take the pension. As with all such payments the longer you live the better you do. If you can afford to defer, the generous increase in payment amounts rapidly improves the total life time income once you live longer than average over taking the pension sooner and it might give you some tax planning opportunities. So do you feel lucky, or maybe healthy?

There must be something wrong with my figures or thinking how this would work. UK state pension for example. 
£11502. Don't take that for 1 year and you'd get a 5.8% uplift when you start taking it a year later, then comparable increases. To get back £11502 I think would take > 20 years. Have I missed something?

It is 1/0.058 =17.25 years, otherwise you are correct.

Bostonerimus1

feetupgininhand said:

Bostonerimus1 said:

feetupgininhand said:

Bostonerimus1 said:

I've thought about this question of "40% tax" in planning for a potential return to the UK from the US. I plan to defer both US social security and UK state pension to give me as many years as possible to move money from my tax deferred US DC pension accounts to the UK and US tax free ROTH DC pension accounts. Of course I must pay tax on the money that I 

The crossover point when you defer something like a DB or state pension is generally around the average life expectancy for when you decide to take the pension. As with all such payments the longer you live the better you do. If you can afford to defer, the generous increase in payment amounts rapidly improves the total life time income once you live longer than average over taking the pension sooner and it might give you some tax planning opportunities. So do you feel lucky, or maybe healthy?

There must be something wrong with my figures or thinking how this would work. UK state pension for example. 
£11502. Don't take that for 1 year and you'd get a 5.8% uplift when you start taking it a year later, then comparable increases. To get back £11502 I think would take > 20 years. Have I missed something?

Ignoring inflation the 5.8% uplift increases the annual pension by £667, 17.25*667 = 11505, so it takes 17.25 to make up for the year that you deferred and got nothing. However, inflation is also a factor, and using 3% and a 5.8% up lift, the break even point is around 15 years. If your pension age is 66 and you defer it to 67 you'll break even at age 82 which is just before the average life expectancy, actually 2 years for a man and 4 for a woman.

eltisley98

penners324 said:

Why so worried about paying 40% tax?

Surely it'll lead to increased quality of life? Ie spending it. 

I guess if you pay 40% tax on your pension income, there is no longer an advantage compared to paying 40% income tax while working and putting the money into an ISA rather than a pension scheme? Growth wise I don't think an ISA and a pension differs that much.

eltisley98

NoMore said:

saucer said:

PropertyGuru_Wannabe said:

Getting to your point means that you are going to be financially secure so congratulations on that. Once you breach the 40% tax threshold on retirement income and reached the maximum lump sum allowance, there is no reason why you should put more funds into your pension. 

I don’t agree with this. I’m also likely to be paying higher rate tax on a lot of my SIPP and yet continue to contribute to it. Why? Any contribution now is to avoid 40% tax, and this will be then accessible subject to 25% tax free, if the rules don’t change. It is also protected from inheritance tax on the same basis. That and the fact that I can’t see a better alternative whatever way I model it. ISAs maybe but they’re only helpful after I’ve already been taxed out of income. 

As others have suggested, I’d relax and count yourself as very fortunate (as I do). 

The point PropreryGuru was making is that above the Lump Sum Allowance you don't get the 25% tax free anymore so that's a reason to not contribute more once you hit the amount to provide the LSA (just over a million in pension). You are advocating still contributing while LSA still available, which nobody is arguing with. Also Pensions are going to be no longer exempt from IHT soon.

Effectively without the 25% tax free, you are neutral if you draw at the same rate you contribute at. Without IHT protection and no LSA available, pensions have little advantage (at >£1 million) anymore if you are withdrawing at the same rate you contribute at.

Agreed.

I'd also add that there are other contributing factors such as the freezing of the tax threshold and various other allowances, the flexibility of having access to the fund whenever you need it, rather than only after 57, and that pension will be subject to IHT while cash can be gifted to children 7 years before the death IHT free.

MallyGirl

eltisley98 said:

penners324 said:

Why so worried about paying 40% tax?

Surely it'll lead to increased quality of life? Ie spending it. 

I guess if you pay 40% tax on your pension income, there is no longer an advantage compared to paying 40% income tax while working and putting the money into an ISA rather than a pension scheme? Growth wise I don't think an ISA and a pension differs that much.

If you contribute to a pension by salary sacrifice then you also benefit from paying less NI and some employers also give some/all of the NI they save too.