Lump Sum Contribution and Immediate Draw Down

banky777

Hi Experts! I recently turned 55 and whilst I'm not looking to take any tax free cash from my pension just yet, I have a scenario which I'd like some advice on. Over the last few years, rather than overpaying on my mortgage, I've been saving at a more favourable rate and have about £30K in an ISA. My mortgage deal ends soon and as my wife is no longer working, I want to use this money to reduce the mortgage. However, if I pay this into my pension, and I'm correct, I'll get an immediate 25% tax boost and as I'm a higher rate tax payer, another 25% through self-assessment, turning £30K into £45K. If I then draw down the original £30K, leaving the initial £7.5K and later the other £7.5 invested in my pension, the only downside I can see is that when I do start to draw down my pension, the point at which I use up my 25% tax free amount will be £30K 'earlier', costing £6K, assuming I'm a basic rate tax payer at that point and not taking account of the fact that my tax free allowance will have increased by then anyway.

This seems like a no-brainer - £15K invested, versus an additional future cost of £6K, but am I missing something?

I should also add that I wouldn't be using up my annual contribution allowance by paying the £30K into my pension.

Thanks in advance.

GrumpyDil

If you are still working as soon as you take 1p of taxable income you will trigger the MPAA which limits future pension contributions to a defined contribution scheme to £10000 per year. Not sure how that works in relation to defined benefit plans but something to be aware of and investigate.

Linton

It would seem your scheme may have ticked all the boxes necessary for HMRC to regard the transaction as "pension recycling".  This would be an unusual achievement.  However some info is missing to reach that conclusion and there are could be some gotchas which may cause you to reconsider.  More info would clarify the situation:

1) Have you withdrawn anything from your pension previously? If so tax free or taxed?
2)  When you withdraw the original £30K will you still be a higher rate tax payer?
3)  When you withdraw the original £30K how much will be covered by the Tax Free 25% generated either by the £37.5K contribution ( your payment + basic rate tax relief) or already earned from previous contributions? 

Also I dont quite understand your numbers.  If a higher rate tax payer pays into a pension the pension gains the basic rate relief but the individual gains the higher rate relief outside the pension.  The contribution is how much actually goes into the pension, in this case £37.5K.

banky777

GrumpyDil said:

If you are still working as soon as you take 1p of taxable income you will trigger the MPAA which limits future pension contributions to a defined contribution scheme to £10000 per year. Not sure how that works in relation to defined benefit plans but something to be aware of and investigate.

I hadn't thought of that, thank you. I'm currently contributing about £20K a year so this would be a spanner in the works.

Thanks again.

banky777

Linton said:

It would seem your scheme may have ticked all the boxes necessary for HMRC to regard the transaction as "pension recycling".  This would be an unusual achievement.  However some info is missing to reach that conclusion and there are could be some gotchas which may cause you to reconsider.  More info would clarify the situation:

1) Have you withdrawn anything from your pension previously? If so tax free or taxed?
2)  When you withdraw the original £30K will you still be a higher rate tax payer?
3)  When you withdraw the original £30K how much will be covered by the Tax Free 25% generated either by the £37.5K contribution ( your payment + basic rate tax relief) or already earned from previous contributions? 

Also I dont quite understand your numbers.  If a higher rate tax payer pays into a pension the pension gains the basic rate relief but the individual gains the higher rate relief outside the pension.  The contribution is how much actually goes into the pension, in this case £37.5K.

Thanks for the reply.

1) No, not yet.
2) Yes I will be.
3) I currently have close to £270K in my pot, so £300K if I chuck this in.

I would likely put the higher rate relief element into my pension after self-assessment, hence the £15K.

Based on yours and GrumpDil's replies, I don't think I'll be doing it now!

Thanks again.

Yorkie1

Would you earn enough this year to input £30K extra into your pension?

QrizB

Yorkie1 said:

Would you earn enough this year to input £30K extra into your pension?

More than this, will you be earning (and paying income tax on) at least £37.5k above the higher rate tax threshold, ie. ~£88k?
If not, you won't be able to make full use of the extra £37.5k of basic rate tax band.

banky777

QrizB said:

Yorkie1 said:

Would you earn enough this year to input £30K extra into your pension?

More than this, will you be earning (and paying income tax on) at least £37.5k above the higher rate tax threshold, ie. ~£88k?
If not, you won't be able to make full use of the extra £37.5k of basic rate tax band.

QrizB said:

Yorkie1 said:

Would you earn enough this year to input £30K extra into your pension?

More than this, will you be earning (and paying income tax on) at least £37.5k above the higher rate tax threshold, ie. ~£88k?
If not, you won't be able to make full use of the extra £37.5k of basic rate tax band.

Thanks for the reply. After salary sacrifice for pension contributions and 2 weeks holiday, my adjusted gross salary is around that amount. Please can you explain how this affects me? Presumably, it just means that I wouldn't be able to benefit from the whole basic rate £15K + higher rate £15K if I'm not over £88K but would still benefit from 'some of it'?

Thanks again.

QrizB

For someone in England and Wales who isn't making RAS pension contributions, their earnings from £12570 to £50270 will be taxed at 20%. Earnings above that up to £125240 are taxed at 40% (although complications come in at £100k).

If you make a £30k net contribution to a RAS pension scheme, the £37.5k gross pension contribution increases your 20% band by that amount. So you'll be paying 20% tax on earnings up to £87770.

If you're earning less than £87770, you won't have any income that can take advantage of this increase in your tax band.

So for example if your taxable earnings were £51000, you'd only gain from paying 20% rather than 40% on the £770 above £50270.

banky777

QrizB said:

For someone in England and Wales who isn't making RAS pension contributions, their earnings from £12570 to £50270 will be taxed at 20%. Earnings above that up to £125240 are taxed at 40% (although complications come in at £100k).

If you make a £30k net contribution to a RAS pension scheme, the £37.5k gross pension contribution increases your 20% band by that amount. So you'll be paying 20% tax on earnings up to £87770.

If you're earning less than £87770, you won't have any income that can take advantage of this increase in your tax band.

So for example if your taxable earnings were £51000, you'd only gain from paying 20% rather than 40% on the £770 above £50270.

Ah OK, I understand. Thanks.

If I earn even a pound over £87770, I would gain from the higher rate, but otherwise, not.

If my salary wasn't sacrificed for pension contributions, I'd be over that amount but presumably that doesn't make a difference?

QrizB

banky777 said:
If my salary wasn't sacrificed for pension contributions, I'd be over that amount but presumably that doesn't make a difference?

No, that doesn't help you here!