What to do with tax free lump sum

OliverLacon

I'm thinking of putting my DC pension into draw down, and I'm wondering what to do the tax free lump sum. The amount is around 130K and I'm looking for ideas about what to do with it (and hopefully grow the amount without paying too much tax).

Until recently I would have left the money in the pension fund - but I'm convinced that at some point during the next 4 years, the government will reduce or eliminate the tax free element. They will probably hit the 20K ISA allowance  too.

kempiejon

OliverLacon said:

I'm thinking of putting my DC pension into draw down, and I'm wondering what to do the tax free lump sum. The amount is around 130K and I'm looking for ideas about what to do with it (and hopefully grow the amount without paying too much tax).

Until recently I would have left the money in the pension fund - but I'm convinced that at some point during the next 4 years, the government will reduce or eliminate the tax free element. They will probably hit the 20K ISA allowance  too.

I used to want the full 25% out as soon as I could. I changed my mind as I expect my pension to grow so the larger the amount I can apply the 25% to the better, one can wangle that with UFPLS taking an amount up to the tax threshold each year. The more I leave in the SIPP and it grows the less tax I pay.

I don't have your conviction that a change to legislation would be retrospective and so I'd have time to change my plan to prevailing tax treeatment, that's always been my strategy.

Aretnap

OliverLacon said:

 I'm thinking of putting my DC pension into draw down, and I'm wondering what to do the tax free lump sum. The amount is around 130K and I'm looking for ideas about what to do with it (and hopefully grow the amount without paying too much tax).

Leaving it in the pension until you actually need it would be the obvious answer - or at least only taking it out at a rate whatever you can transfer it into ISAs.

OliverLacon said:

Until recently I would have left the money in the pension fund - but I'm convinced that at some point during the next 4 years, the government will reduce or eliminate the tax free element. They will probably hit the 20K ISA allowance  too.

You must have good inside information about the governments economic plans if you are confident enough to take your money out of the perfect tax shelter on the back of it, so you don't really need advice. Just buy shares in the companies which are going to do best out of those plans.

(I suppose the alternative is that you have just been reading too much Daily Mail, in which case the best advice would be to plan around the tax system as it is, rather than around wild guesses about what it might be in future.)

DRS1

Your TFLS has plenty of scope to grow before it gets anywhere near the Lump Sum Allowance.  So as @kempiejon suggests using UFPLS would be a good idea for you.
The most likely thing that will happen to the LSA is that it stays at its current level and they let inflation eat away at the value of it - more likely than that they cut it to £100k in one fell swoop anyway.

ali_bear

Reducing the max TFLS would take years to bring in, if they ever did, which is very doubtful. Reducing the ISA annual contribution is much more feasible. 

Albermarle

OP - The advice is always to make your financial planning based on the rules as we know them today.
Planning based on media speculation, rarely makes for good decision making.
Especially when the speculation is from sources that are politically motivated to spread bad news about the Govt. and have no problems with just making stuff up, if it suits their agenda.

Notepad_Phil

Assuming your pension allows you to take multiple lump sums, then if you've got a partner than you could think about taking enough out now for 2 x £20k Stocks & Shares ISAs in this tax-year and then another 2 x £20k once we reach April 6th, which would then just leave £50k left to take.

Personally I don't think they'll reduce further on how much tax free money can be taken out, at least not without putting in some protection for people over that amount (as has previously happened), so I'd just leave the £50k until you get close to the end of the next tax-year.

af1963

kempiejon said:

I used to want the full 25% out as soon as I could. I changed my mind as I expect my pension to grow so the larger the amount I can apply the 25% to the better, one can wangle that with UFPLS taking an amount up to the tax threshold each year. The more I leave in the SIPP and it grows the less tax I pay.

I've heard this argument being made a few times, on here and elsewhere.  But on playing around with this in spreadsheets, I've found *no difference at all* between taking the lump sum out of the SIPP and leaving it in, as long as it can be reinvested in similar investments. At least to the extent that the money can be moved into ISAs or other tax sheltered locations.

As an example: Suppose I have a £40k fund and the option to take 10k tax free now or wait and use UFPLS each year, and I need an extra 2k each year to live on. And ( initially at least) assume that my investments (inside or outside the pension) only just match inflation, so we can work in today's money. And my state pension accounts for my tax allowance.

Taking the up front sum, I take out 10k up front, keep it invested, and spend 2k + inflation for 5 years. After 5 years, I've spent the lump sum, and what's left in my pension fund is the crystallised 30k. This is all now taxable, so if I withdraw it over several years to stay within the 20% band I'll receive £24k.

Not taking the lump sum, I need to take out £2353 per year as a UFPLS payment to generate 2k after tax (effectively 15% tax rate, allowing for the lump sum). After 5 years of doing that, I have about £28k left in an uncrystallised SIPP. Over the subsequent years, I can withdraw that at an effective tax rate of 15%, leaving ... exactly £24k.

Building in some above-inflation growth, the argument often made is that leaving it in the pension will generate a bigger lump sum. And that is true. If we run the calculations with a (very generous) 10% real growth, we end up taking UFPLS lump sums adding up to about £15k instead of £10k up front

But - where we took the up front £10k lump sum, that didn't stop it from growing. We store it in an ISA and invest it in the same things, and still gets that 10% growth outside the pension on the unspent balance.

Also our remaining total balance each year is a little bit more than in the UFPLS scenario, because under UFPLS we've paid out some income tax each year. So we earn a bit less in total investment returns in the UFPLS case.

Plugging in the numbers, the up front TFLS leaves me after 5 years with £48k in a crystallised SIPP which will become £39k after tax ; plus about £2.7k from the original lump sum including annual growth. Total £41k

Doing the same under UFPLS, there's no excess cash outside the SIPP, and £49k left uncrystallised in the SIPP, which after tax reduces to ... £41k.   ( figures here in both cases are rounded, but the totals match to the penny)

Doesn't matter what percentage real growth you plug in, the amounts remain identical to the penny. (Until you get to assuming enormous amounts of growth which take the available lump sum over the max limit, in which case the up front lump sum performs better because the whole amount grows outside the SIPP with no limit.)

EDIT: to be clear, I also agree with the suggestion that before state pension begins, it's a good plan to use pension withdrawals to make use of the tax allowance, and you might use UFPLS to do that. You could do that and *also* take out up to £20k of the tax free cash each year to stash in an ISA.

kempiejon

af1963 said:
I've heard this argument being made a few times, on here and elsewhere.  But on playing around with this in spreadsheets, I've found *no difference at all* between taking the lump sum out of the SIPP and leaving it in, as long as it can be reinvested in similar investments. At least to the extent that the money can be moved into ISAs or other tax sheltered locations.
.../

EDIT: to be clear, I also agree with the suggestion that before state pension begins, it's a good plan to use pension withdrawals to make use of the tax allowance, and you might use UFPLS to do that. You could do that and *also* take out up to £20k of the tax free cash each year to stash in an ISA.

I flip-flopped on the decision for years and recently settled on this view. I modeled with some spreadsheet for proofs as part of that process so I hope I'm right, might just check... It's not about returns but about tax free income. SIPP income is taxable but before state pension I have a personal allowance and I think I can get more total income out tax free using UFPLS. The numbers obviously don't care if the investments are within a SIPP or an ISA but my 25% won't fit in an ISA if it all comes out in one year so will be taxable until I can get shelter.
The plan doesn't necessarily need 25% at the beginning and I keep the chance to take whatever 25% of the total I have at anytime should legislation or my plans change. 

QrizB

af1963 said:

kempiejon said:

I used to want the full 25% out as soon as I could. I changed my mind as I expect my pension to grow so the larger the amount I can apply the 25% to the better, one can wangle that with UFPLS taking an amount up to the tax threshold each year. The more I leave in the SIPP and it grows the less tax I pay.

I've heard this argument being made a few times, on here and elsewhere.  But on playing around with this in spreadsheets, I've found *no difference at all* between taking the lump sum out of the SIPP and leaving it in, as long as it can be reinvested in similar investments.

Agreed, but with the caveat that the withdrawn TFLS needs to be "reinvested in similar investments" rather than spent or held as cash.

Some people (not necessarily anyone in this particular thread) want to take it and spend it. Some of that spending might be financially advantageous (eg. clearing your gambling debts to Tony Three Fingers), some of it might bring improved quality of life (eg. fitting a ground floor wet room when you can't climb the stairs any more) and some of sounds more like "splurging a windfall".

DRS1

af1963 said:

kempiejon said:

I used to want the full 25% out as soon as I could. I changed my mind as I expect my pension to grow so the larger the amount I can apply the 25% to the better, one can wangle that with UFPLS taking an amount up to the tax threshold each year. The more I leave in the SIPP and it grows the less tax I pay.

I've heard this argument being made a few times, on here and elsewhere.  But on playing around with this in spreadsheets, I've found *no difference at all* between taking the lump sum out of the SIPP and leaving it in, as long as it can be reinvested in similar investments. At least to the extent that the money can be moved into ISAs or other tax sheltered locations.

I think that is a key element to your sums.  They work fine if the lump sum is £20k and can go into an ISA (to be invested in exactly the same thing it was in in the SIPP) but in the OP's case it is £130k and the majority of that will spend some years outside an ISA.  Now it could go into Premium Bonds or low coupon short dated gilts bought for less than 100p per gilt.  But those things are probably not what he holds in the SIPP so the performance will not be the same.  So the take it all out at once and the take it in stages scenarios will diverge.

Having said that I did take my lump sum in one go but that was because I am old fashioned and bought an annuity with the rest of the personal pension.  UFPLS is too clever for me.