Approaching LSA - pension still the most tax efficient way to invest?

YellowCarBlueCar

In the last few years I've been maximising my pension contributions with a plan to retire in July 26 age 56.

A recent(ish) inheritance and house sale means that I also have quite a lot of funds (several 100k) outside any tax wrapper after maxing out my ISA allowances.

We've also been maximising my wife's pension and ISAs, though pension contributions have been limited by earnings.  We'll continue to fill our ISA allowances.

My DC investments have just tipped the £1M mark with about another £50K to be added between now and retirement, so it's not going to take a lot of growth before I hit the LSA.

A small DB pension (ca £5k) kicks in at the start of 2030, and full state pension from 2037.

I'm planning to live off the investments and savings outside the tax wrappers for the first years of retirement, only drawing down enough to use my personal allowance, so the pension investments probably have another 5-7 years growth before any significant drawdown.

So I'm wondering if the pension is still the best place to put the £50K between now and next summer, especially as some of that will be at basic rate relief.

The benefits I see are that the investments in pension can grow tax-free.  But with frozen income tax thresholds, does it make sense to make contributions with basic rate relief when I'll later be making withdrawals at the higher rate?

Of course a market correction could solve the "problem" for me!

ali_bear

It is not guaranteed that you'll be paying higher rate tax on your pension income. You may by just a little bit. But retiring at 56 you would probably need a DC fund well over the old LSA limit for that. 

And to avoid HRT in retirement you would probably want to be taking close to the higher rate threshold in taxable income every year, not only up to the start of basic rate band. 

A nice problem to have. Perhaps take some professional advice. 

Alexland

From what you describe, and with income tax thresholds frozen until at least 2031, it seems you might be at risk of paying higher rate tax at some point in your retirement depending on your investment growth etc so I don't see much point in only getting basic relief now to pay basic rate or possibly even higher rate tax later especially if you only draw down the personal allowance for the first few years - that seems wasteful of the opportunity to draw at basic rate.

Obviously you could do more a detailed model with various assumptions but you seem roughly at the end of the journey of pension contributions being beneficial.

My thread about the reducing window to draw personal pension income at basic rate might be of interest.
https://forums.moneysavingexpert.com/discussion/6643130/reducing-window-to-draw-pension-income-at-basic-rate

PJZ

I agree with Alexland.   You need to do a cashflow model and its tax implication.  You seem very likely to lose 40%+ of any gain at sometime.

artyboy

At the very least I would still be paying in enough to take full advantage of whatever employer contribution matching is available to you.

Mrs Arty is way over the old LTA now - for her it's 47% on the way in and 40% on the way out, and has just reduced her contributions to just get the maximum matching. 

Without getting too political, there has been so much meddling with pension laws over the past decade that they are now IMO a fattened cow to be milked/slaughtered at will, so the upside would have to be very substantial before I ever paid into one again. Easy for me to say though...


Also, if you do have a lot of unwrapped assets right now, have you looked at gilts? Or premium bonds?

YellowCarBlueCar

Thanks, and agreed it's a nice 'problem' to have.  Until a few years back I was convinced I'd be working into my 70's - it's only a late realisation as to how tax-efficient pension savings are that got me to where I am.

What was swinging me towards adding it to the pension was:
-I only have a limited opportunity to add to the pension - once I retire I'll be capped at the £2880. (Though if it's a bad idea to do it, it's a mute point).
-If I don't put it in a pension, and I've already got funds to maximise my ISA, then growth outside the pension is going to be taxed as interest, dividends, or capital gains.

So I'm struggling with whether the tax-free growth in the pension outweighs the income tax on withdrawal.

BigTin

YellowCarBlueCar said:

Thanks, and agreed it's a nice 'problem' to have.  Until a few years back I was convinced I'd be working into my 70's - it's only a late realisation as to how tax-efficient pension savings are that got me to where I am.

What was swinging me towards adding it to the pension was:
-I only have a limited opportunity to add to the pension - once I retire I'll be capped at the £2880. (Though if it's a bad idea to do it, it's a mute point).
-If I don't put it in a pension, and I've already got funds to maximise my ISA, then growth outside the pension is going to be taxed as interest, dividends, or capital gains.

So I'm struggling with whether the tax-free growth in the pension outweighs the income tax on withdrawal.

If you'll be able to withdraw what you put in with 20% relief within 9 months at either 20% income tax (so no tax loss) or 0% because you're taking is as part of your lump sum then it seems a no-brainer to contribute it now.  

You also get NI relief on the contrib if it's coming through salary sacrifice and, as others have mentioned, you may get employer contributions matching (you should at least be making sure you get maximum advantage from that if it's available).

It's a bit complicated by your wife's position, but, if you're already contributing 100% of her earnings then you could discount that.   If not, then it could be better to divert the money to her scheme.  If she's retiring later then you might consider doing 100% of her earnings every year until she does.  You want to be trying to use as much of both your 0 and 20% tax bands when you are both living on pension income and of course, getting the max lump sums.

One further thing: you say you're planning to burn down your tax free investments before touching the pension.  this was the received wisdom until last year.  But I'm not sure this is the best plan in light of the fact that pensions will be subject to IHT (if that was your reason for taking from the tax free accounts) and you will get some kind of state pension in the future forcing you into paying income tax anyway.

If you burn your tax free accounts only to ensure you have to take more of your money as a taxable income later.. that seems foolish?   Better to maximise your use of your tax free lump sum, personal allowance (as you have planned) and perhaps pay some basic rate tax now to ensure your pension is whittled down somewhat and your ISAs fully stocked so that you can limit your higher rate tax later? 

This model also means you would weight your income more in your "go-go" years rather than hoarding it to pay less tax now and have it available when you might be less able to enjoy it (the go-slow or no-go years).

*None of the above should be regarded as advice* and I suppose I'm reiterating, what others have said:  think about your cashflow model and consider speaking to a professional for this.

Alexland

YellowCarBlueCar said:

So I'm struggling with whether the tax-free growth in the pension outweighs the income tax on withdrawal.

As above if you did a cashflow model with some reasonable assumptions then that would give an indication however it's hard to be too precise as your investment growth is unlikely to be linear and during your retirement the rules will probably further change.

Artyboy makes a good point that it's almost certainly going to be worth keep contributing enough to get employer contributions but after that then there's a real risk you will pay higher rate tax on withdrawal so if you are only getting basic rate relief that might cause a loss.

I'm nearing the old LTA (with around a decade before my earliest access age) so am reducing contributions to just that required to get employer matching. It's quite a mindset change to get comfortable with after so many years of pension stuffing. I'd rather pay the 40% tax now than later even with the modest 2% NI saving (until that's stopped in 2029) it's not worth locking more money away given how the government see pensions an an easy target.

Artyboy also makes some good suggestions to look at premium bonds or holding gilts in an unwrapped account (they can be bought at a discount and the capital gains as they return to redemption value are tax free) or maybe you might even consider VCTs (although the upfront relief is being reduced to 20% soon).

YellowCarBlueCar

Thanks - all food for thought, and yes maybe paid advice is the way to go.

I've always modelled cashflow in "today's money" which I was comfortable with while tax allowances broadly tracked inflation, so I guess I need to up my game and factor in growth and inflation assumptions.

Premium bonds, while tax-free still seem to offer pretty poor returns.  With savings accounts offering 4.5%, then even factoring in the tax on interest they still match the 3.6% average return on Premium Bonds.
I have looked at Gilts, but only in a half-hearted way.

For a fuller picture of current assets:
-My pensions:
   -£1M DC
   -£5k pa DB
-Wife's pensions
    -£150k DC
    -£5k pa DB
ISAs
-£360K between us
Cash
-£430K (which I know is too much to sit uninvested).
It's only since our house sale that we've been so cash-rich, so only been maxing my wife's pension and both ISAs for one year.

Future contributions to my pension would be via salary sacrifice (employer keeps employer's NIC savings).  5% of salary matched by 10% company contribution (so no brainer), but the bulk of the payments would be AVCs and bonus sacrifice. 

We also have another property up for sale, so that will swallow our CGT allowance in the FY that it sells, and will add about another £200-250K to the unwrapped funds.

So we can already fund ISAs for a good few years with the 'unwrapped' assets, and so would rather use flexi drawdown or ufpls to keep the tax-free component of the pensions invested within the pension wrapper for as long as possible, only drawing for the years between retirement and SPA to use the personal allowances, then funding with unwrapped funds until they are down to a 3-5 year buffer.
My wife is likely to work for about another year, so maxing this year and next-year's seem like a no-brainer too.

IHT isn't a concern.

Thanks again for the input.  I've already got a few points to follow-up:
-up my modelling game to include inflation and growth assumptions
-take a better look at Gilts as a tax-efficient vehicle
-I'll look into VCTs a bit more as well - though my gut feel is that they may not be a good fit with my risk appetite.
-If I don't come to a conclusion from the above, it's time to look for a good IFA.

Alexland

YellowCarBlueCar said:

I've always modelled cashflow in "today's money" which I was comfortable with while tax allowances broadly tracked inflation, so I guess I need to up my game and factor in growth and inflation assumptions.

I also like to model in today's money and estimate growth-above-inflation as it's easier but with the frozen income tax band that means if inflaiton is around 2% pa for the next 5 years then you will only be able to draw around £45k in today's money before paying higher rate tax. And worse with the triple lock and frozen personal allowance your state pension will likely be growing into the bottom of your basic rate band too. Doesn't leave much of a window to draw a large personal pension as income at basic rate.

GenX0212

You said "pension investments probably have another 5-7 years growth before any significant drawdown".
A 7% annual return would see you reach the LSA limit in less than 5 years time. What average return have you had over the past few years?