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

YellowCarBlueCar

j2009 said:

YellowCarBlueCar said:

It's also not a question of limiting how much to drawdown to avoid the 40% band, just a question of whether it would be better to not pay in with 20% relief and drawdown some at 40%.  

I'm not sure I fully understand the question but if you pay money in with 20% relief and you then withdraw that money and pay 40% tax you are absolutely losing money; excluding I suspect the edge case where you're getting company matching. However, simplistically, growth does not factor into that decision as money can grow whether it's in a pension or not.

If this wasn't what you meant then please can you clarify?

Sorry for the lack of clarity - I was trying to answer many points in one post - this was really in reply to @GunJack comment "I still don't get it......if you're that well off you're paying some 40% tax, so what? Why limit your income to 50k if you could afford it to be 60k just because of a relatively small amount of tax?? It's still extra 6k nett a year..."

The only complication that I had in mind is whether the compound growth on the investment within the pension, protected from tax on growth, would outweigh the tax on the way out, and have concluded (thanks to the various points on here) that it's probably not.

@Albermale - to an extent I do like the spreadsheets, but it's more that I like to have a proper understanding of the options, even if the outcome isn't that different.  I'm a chartered engineer in my day job (for now ) so feel a bit uneasy making decisions based on a fuzzy understanding.

And yes - the switch from saving to spending is looming large.  Even though I know logically that we're in a good position it still feels like a Bold Leap.  Hopefully I'll relax into it!

Thanks for all your inputs - it had broadened my thoughts on the bigger picture.
I think it's clear to me now that it's not worth adding more than I need to keep me out of the 40% tax bracket this and next FY (especially as it also impacts personal savings allowances).
I need to take a wider approach to the unwrapped investments - stop letting the tax tail wave the dog.

ex-pat_scot

Simplistically, as follows:

1. enjoy the full company matching, regardless of whether you've hit the notional max tax free cash element
2. ditto sal sac for ees (and ideally ers) NI
3. tax rate arbitrage
    (a) if marginal tax rate when contributing is greater than at retirement, then keep going. Eg if you're in the 62% or 47% marginal rates whilst working, then you're still better off contributing, as long as you are only a 20% or 40% taxpayer in retirement

  (b) if you are a 40% (higher rate) taxpayer now, and expect to be 40% in retirement - which, if you have £1m plus in SIPP, you will be - then it's still slightly advantageous if under sal sac once over the £1.071m ceiling.

  (c) can you max out contributions to your partner's pension, in preference to over-stuffing yours?

4. political risk. You are a very tempting morsel for a cash-strapped chancellor. A pension is a conveniently gift-wrapped opportunity for future meddling. Even if the marginal rates above make numerical sense, you might want to consider your concentration / political risk, and diversifying ...

5. being in the lower foothills of higher rate tax band in retirement is not necessarily to be avoided at all costs.
It is helpful in focusing the thinking around things like efficient giving (GiftAid), and in stopping work as early as possible without accumulating lots of "just in case" surplus

6. decumulation strategy. You could use an overstuffed SIPP to buy a very nice "bells and whistles" joint life RPI linked annuity - you'd sacrifice a little opportunity income perhaps vs drawdown, but you'd have great peace of mind for you and partner.

 

YellowCarBlueCar

ex-pat_scot said:

Simplistically, as follows:

1. enjoy the full company matching, regardless of whether you've hit the notional max tax free cash element
-doing that
2. ditto sal sac for ees (and ideally ers) NI
-doing that - though only ees
3. tax rate arbitrage
    (a) if marginal tax rate when contributing is greater than at retirement, then keep going. Eg if you're in the 62% or 47% marginal rates whilst working, then you're still better off contributing, as long as you are only a 20% or 40% taxpayer in retirement
-not applicable - never reached those heady heights!
  (b) if you are a 40% (higher rate) taxpayer now, and expect to be 40% in retirement - which, if you have £1m plus in SIPP, you will be - then it's still slightly advantageous if under sal sac once over the £1.071m ceiling.
-doing this - but currently on course to be well into the basic rate band - so reining back there now after this thread.

  (c) can you max out contributions to your partner's pension, in preference to over-stuffing yours?
-doing this too - capped by earnings.

4. political risk. You are a very tempting morsel for a cash-strapped chancellor. A pension is a conveniently gift-wrapped opportunity for future meddling. Even if the marginal rates above make numerical sense, you might want to consider your concentration / political risk, and diversifying ...
-currently about 50% in pensions and 50% out.  But agree this (along with maybe tapering state pensions or other 'taxing those with the broadest shoulders' approaches) wouldn't be too much of a surprise.  But then a good chunk of the pot has come from legal tax avoidance, so couldn't feel too aggrieved.

5. being in the lower foothills of higher rate tax band in retirement is not necessarily to be avoided at all costs.
It is helpful in focusing the thinking around things like efficient giving (GiftAid), and in stopping work as early as possible without accumulating lots of "just in case" surplus
-Agreed, and I'm not too hung-up on this.  The imbalance between my own and my wife's pensions mean that higher rate is a probability rather than a possibility.  Gift Aid at the moment - and this is actually one benefit of being a taxpayer in retirement (at least to the beneficiary). 

6. decumulation strategy. You could use an overstuffed SIPP to buy a very nice "bells and whistles" joint life RPI linked annuity - you'd sacrifice a little opportunity income perhaps vs drawdown, but you'd have great peace of mind for you and partner.
-I'm less certain on this - at the moment.  Retiring at an earlier age means that the rates are poor compared to buying one later, so currently thinking of keeping this under review.  This may of course be offset by a general reduction in annuity rates!

Thanks for the concise guide - some comments in italics in-line above.
One question on point 6.  If I keep my payments to the company pension to the minimum to get the max matched contribution, but then pay the rest of my annual allowance to the SIPP, then can I then use the SIPP to buy an annuity without taking any tax-free cash?  In that way the SIPP value would not 'consume' from my LTA.

zagfles

EdSwippet said:

YellowCarBlueCar said:

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

As already stated above, where the tax rates are the same the results are identical, because at 10% gains (say), 80% of 110% of £x is the same as 110% of 80% of £x.

The better question is whether tax-deferred growth in the pension beats annually taxable growth outside. Because here the tax rates can be different; specifically, dividends and capital gains have lower tax rates than income from a pension.

Taking a simple (and unrealistic) case. Suppose investments gain 7% over one year, 4% capital gain and 3% from dividends. On £70 of gain outside a pension, at basic rate tax you would pay 8.75% of £30 and 18% of £40 for £9.83 in tax. On £70 of gain inside a pension, 20% is £14 in tax on withdrawal. Investing outside the pension wins.

However, the annual tax outside the pension is a drag on compounding, which is tax-deferred inside the pension. This means there's a break-even point where the pension can start to win. So now the decision rests on how long you can leave this money inside the pension to compound.

And this is where things get tricky. Now you have to start modelling the future with spreadsheets or similar. There are multiple tax rates to consider, some of which may change, and usually not to your advantage, multiple inflexion points or other life changes, and also multiple assumptions about future growth, so that the possible outcomes branch ferociously.

For what it's worth, when I did this for my own case (back when the 25% LTA penalty was still a thing), I found my break-even on leaving my PCLS inside the pension compared to taking it now and reinvesting outside was likely to be around age 95. While this is technically a "win", it isn't a useful one.

This is completely wrong logic. You need to account for the growth on the tax relief element, £1000 invested in a pension would be £1250 assuming 20% tax relief. The extra income tax on growth is partly tax on the tax relief amount, which you wouldn't have outside the pension. So despite paying more tax, the pension will always be better assuming tax relief on the way in is the same as tax rate on withdrawal. 

For instance assuming your 7% growth of which 4% capital gain and 3% dividends. £1000 paid into a pension would be £1250, and growth would be £87.50, and on withdrawal would be £70 after BR tax. Outside the pension, that £70 growth would be £60.17 after tax. So despite paying more tax using the pension, you're better off. Because the extra £17.50 tax is tax on the growth of money you wouldn't have had outside the pension. So effectively the growth in the pension is tax free. 

Albermarle

One question on point 6.  If I keep my payments to the company pension to the minimum to get the max matched contribution, but then pay the rest of my annual allowance to the SIPP, then can I then use the SIPP to buy an annuity without taking any tax-free cash?  In that way the SIPP value would not 'consume' from my LTA.

The large majority of annuities, work by taking the pension pot, giving you the 25% tax free, and then the annuity is bought with the 75%.
You can then buy another much rarer type of annuity, which you buy with the cash, but that would not meet your objective
I am pretty sure you can not just buy an annuity though with 100% of the original pension pot. If you can it would be some kind of niche product you would have to go via an IFA, if it was possible at all.

In theory you can move 100% of a DC pot into drawdown, forgoing the tax free cash.
However apart from it normally not being a very good idea, most providers systems could just not cope with such an unusual request. Normally you move funds into drawdown, by requesting the tax free cash. That is how the systems work. 

zagfles

YellowCarBlueCar said:

ex-pat_scot said:

Simplistically, as follows:

1. enjoy the full company matching, regardless of whether you've hit the notional max tax free cash element
-doing that
2. ditto sal sac for ees (and ideally ers) NI
-doing that - though only ees
3. tax rate arbitrage
    (a) if marginal tax rate when contributing is greater than at retirement, then keep going. Eg if you're in the 62% or 47% marginal rates whilst working, then you're still better off contributing, as long as you are only a 20% or 40% taxpayer in retirement
-not applicable - never reached those heady heights!
  (b) if you are a 40% (higher rate) taxpayer now, and expect to be 40% in retirement - which, if you have £1m plus in SIPP, you will be - then it's still slightly advantageous if under sal sac once over the £1.071m ceiling.
-doing this - but currently on course to be well into the basic rate band - so reining back there now after this thread.

  (c) can you max out contributions to your partner's pension, in preference to over-stuffing yours?
-doing this too - capped by earnings.

4. political risk. You are a very tempting morsel for a cash-strapped chancellor. A pension is a conveniently gift-wrapped opportunity for future meddling. Even if the marginal rates above make numerical sense, you might want to consider your concentration / political risk, and diversifying ...
-currently about 50% in pensions and 50% out.  But agree this (along with maybe tapering state pensions or other 'taxing those with the broadest shoulders' approaches) wouldn't be too much of a surprise.  But then a good chunk of the pot has come from legal tax avoidance, so couldn't feel too aggrieved.

5. being in the lower foothills of higher rate tax band in retirement is not necessarily to be avoided at all costs.
It is helpful in focusing the thinking around things like efficient giving (GiftAid), and in stopping work as early as possible without accumulating lots of "just in case" surplus
-Agreed, and I'm not too hung-up on this.  The imbalance between my own and my wife's pensions mean that higher rate is a probability rather than a possibility.  Gift Aid at the moment - and this is actually one benefit of being a taxpayer in retirement (at least to the beneficiary). 

6. decumulation strategy. You could use an overstuffed SIPP to buy a very nice "bells and whistles" joint life RPI linked annuity - you'd sacrifice a little opportunity income perhaps vs drawdown, but you'd have great peace of mind for you and partner.
-I'm less certain on this - at the moment.  Retiring at an earlier age means that the rates are poor compared to buying one later, so currently thinking of keeping this under review.  This may of course be offset by a general reduction in annuity rates!

Thanks for the concise guide - some comments in italics in-line above.
One question on point 6.  If I keep my payments to the company pension to the minimum to get the max matched contribution, but then pay the rest of my annual allowance to the SIPP, then can I then use the SIPP to buy an annuity without taking any tax-free cash?  In that way the SIPP value would not 'consume' from my LTA.

Yes. Assuming you mean the LSA. 

zagfles

Albermarle said:

One question on point 6.  If I keep my payments to the company pension to the minimum to get the max matched contribution, but then pay the rest of my annual allowance to the SIPP, then can I then use the SIPP to buy an annuity without taking any tax-free cash?  In that way the SIPP value would not 'consume' from my LTA.

The large majority of annuities, work by taking the pension pot, giving you the 25% tax free, and then the annuity is bought with the 75%.
You can then buy another much rarer type of annuity, which you buy with the cash, but that would not meet your objective
I am pretty sure you can not just buy an annuity though with 100% of the original pension pot. If you can it would be some kind of niche product you would have to go via an IFA, if it was possible at all.

In theory you can move 100% of a DC pot into drawdown, forgoing the tax free cash.
However apart from it normally not being a very good idea, most providers systems could just not cope with such an unusual request. Normally you move funds into drawdown, by requesting the tax free cash. That is how the systems work. 

What makes you think that? You can buy an annuity from a pot already in drawdown, plenty of people do that, crystallise and drawdown for a while, then buy an annuity when they're a bit older. So using an uncrystallised pot with no LSA left (or wanting to the use the LSA elsewhere) is perfectly possible. 

Alexland

Albermarle said:

In theory you can move 100% of a DC pot into drawdown, forgoing the tax free cash.
However apart from it normally not being a very good idea, most providers systems could just not cope with such an unusual request. Normally you move funds into drawdown, by requesting the tax free cash. That is how the systems work. 

It might be more common in future with the LSA frozen possibly forever. For example I might take the full LSA from my larger SIPP (which might be worth around the LTA by then) which means I won't be asking my other pensions to give me anything tax free.

ukdw

Once you hit the LSA then I think any additional pension contributions and growth in those contributions is likely to be charged 40%,60% or 45% tax on drawdown, 

If you get 40% tax relief on the way in then fairly neutral on fund withdrawal from pensions for withdrawal up to £50k above the basic rate per year. Growth also likely to be taxed at the same rates on drawdown.

If you get 20% tax relief on the way in - then less favourable - if withdrawals charged at least 40%.

Comparing above to leaving funds tax unwrapped - I think it currently looks like the following:

Original funds no more tax to pay.
Capital Gains - assuming they are for a higher rate tax payer -  24%
Dividends - 33.75%
Cash interest - 42%
So other than cash interest it looks like a slightly lower rate of tax on the gains than if funds put in the pension and taken out again.
With more flexibility on accessing the original funds without triggering 60% or 45% tax rates.

Also these rates on gains would have some annual allowances and could gradually be mitigated by rolling funds into ISAs each year.

Also if one of the couple is still in basic rate after pension withdrawals then lower rates on the gains in their name could apply.

MallyGirl

This is where Mr Mally is but he has the added factor that he gets the employer NI with his Sal sac. For now that swings the balance towards continuing max contributions. I am still hoping that he follows me into retirement in 2026