DB Scheme and Minimising Future 40% Tax - What makes most sense?

kempiejon

kermchem said:

Contibute to pensions with 40% or more tax relief, and then withdraw with tax at 20% make sense, but I received 20% tax relief for many years and paying 40% on the way out is not attractive.

I can't quite square this in my head. Won't you be paying 20% tax on the money you take out first, then 40% or more as you take more same as at work.
I've arranged my affairs such that my income tax bill is optional for years and I intend to do so in retirement too so I've not grasped this alternative view.
Those who paid thousands in tax when employed and claimed relief into their pension at prevailing rates then don't want to pay tax at the prevailing rates when taking it out. Pensions are tax deferment but we can finagle them to our advantage.

SarahB16

kermchem said:

GunJack said:

"don't let the tax tail wag the dog" is such a great phrase. And it's so true, I never get why people with loads of pension income get so hung up on it. Every increase over the 40pct band gives you a 60pct takehome gain, what's not to like?

Of course, you could go and live in a 2nd or 3rd world country to make it stretch further but personally I'd rather pay a bit more tax and stay in the civilised world 🙂

Why do I seek to avoid paying 40% tax in retirement?

I spent the early years of my working life paying basic rate tax, and receiving tax relief on contributions to my employer's (then) final salary pension and my FSAVC. Promotions, increments, kids, fiscal drag, Higher Rate Child benefit charge, employer's move from FS to DB, move my FSAVC to SIPP, and then my pension contibutions received tax relief at 40%, in some years effectively 58% (HRCBC).

Contibute to pensions with 40% or more tax relief, and then withdraw with tax at 20% make sense, but I received 20% tax relief for many years and paying 40% on the way out is not attractive.

How do I persuade my kids that they should contribute to a pension when they are young, paying 20% tax, and they see me paying 40% in retirement?

Tell them @kermchem they can easily avoid paying 40% tax as long as they plan ahead and check their pension forecasts, e.g. if they are lucky enough to receive DB pensions when in retirement they need to on a regular basis forecast what these will be then add on income from the state pension.  Is there any headroom below the 40% threshold that drawdowns from a SIPP could utilise in those years?  If not then take the majority of the drawdowns from the SIPP before the DB pension(s) commence.   

The key really is to continually forecast and adjust contributions accordingly, e.g. contributions go to a SIPP when receiving 40% tax relief but not at 20% tax relief if you think you will be paying 40% tax in retirement on those drawdowns.  Instead increase ISA contributions.  If you have an AVC connected to a DB scheme how much can you take tax free (and have you maximised this amount but bear in mind you may only be able to take this at the same time as that DB pension).    

One really should avoid only receiving 20% tax relief on contributions and then paying 40% tax on these draw downs but key to this is planning ahead.  

If you have a significant SIPP/DC pot then retire a few years earlier (before drawing down DB pensions) and draw down the SIPP/DC pot paying only 20% tax.  Draw more than you need (to avoid paying 40% tax in later years) and put those drawdowns from the SIPP/DC pot into an ISA.  

Cobbler_tone

You can only be so wealthy before paying 40% tax via income and it isn’t about to increase. If I was that hell bent on not paying it I’d take max PCLS’s from the DB’s and drawdown to the limit. I don’t think this will give you the income you want and you’ll have money sitting in pensions and bank accounts to your grave. You will struggle to avoid it.
The alternative is to max your DB and drawdown down small amounts…or pay 40% tax.
Nice problem.

Albermarle

I'd like to keep my tax bill as low as possible, but appreciate probably can't avoid 40% in retirement at some point, however don't really need the £218K cash right now and would not be sure what to do with it to get the best return.

It did occur to me that I could take max tax free cash from DC and balance tax free cash from the DB schemes up to the £268K LSA limit to minimise the potential for 40% tax for longer? i.e. not take the full amount of tax free cash from DB, rather, a lower amount.

I think just one ( maybe two) other poster has mentioned inheritance tax.
If you take the full DB pensions, then on second death they will have no value for your estate.
If you take the tax free cash and it grows steadily, it will add to the estate and probably end up being taxed at 40%. Unless you spend it or give it away to family or charity. 

You also mentioned worrying about what you would do with all the cash, as you can only add so much to ISA's with it.
Basically you could save it and pay tax on the interest. Or you could invest it outside of ISAs- as well as potential tax it also brings a level of admin with it.

kermchem

SarahB16 said:

kermchem said:

GunJack said:

"don't let the tax tail wag the dog" is such a great phrase. And it's so true, I never get why people with loads of pension income get so hung up on it. Every increase over the 40pct band gives you a 60pct takehome gain, what's not to like?

Of course, you could go and live in a 2nd or 3rd world country to make it stretch further but personally I'd rather pay a bit more tax and stay in the civilised world 🙂

Why do I seek to avoid paying 40% tax in retirement?

I spent the early years of my working life paying basic rate tax, and receiving tax relief on contributions to my employer's (then) final salary pension and my FSAVC. Promotions, increments, kids, fiscal drag, Higher Rate Child benefit charge, employer's move from FS to DB, move my FSAVC to SIPP, and then my pension contibutions received tax relief at 40%, in some years effectively 58% (HRCBC).

Contibute to pensions with 40% or more tax relief, and then withdraw with tax at 20% make sense, but I received 20% tax relief for many years and paying 40% on the way out is not attractive.

How do I persuade my kids that they should contribute to a pension when they are young, paying 20% tax, and they see me paying 40% in retirement?

Tell them @kermchem they can easily avoid paying 40% tax as long as they plan ahead and check their pension forecasts, e.g. if they are lucky enough to receive DB pensions when in retirement they need to on a regular basis forecast what these will be then add on income from the state pension.  Is there any headroom below the 40% threshold that drawdowns from a SIPP could utilise in those years?  If not then take the majority of the drawdowns from the SIPP before the DB pension(s) commence.   

The key really is to continually forecast and adjust contributions accordingly, e.g. contributions go to a SIPP when receiving 40% tax relief but not at 20% tax relief if you think you will be paying 40% tax in retirement on those drawdowns.  Instead increase ISA contributions.  If you have an AVC connected to a DB scheme how much can you take tax free (and have you maximised this amount but bear in mind you may only be able to take this at the same time as that DB pension).    

One really should avoid only receiving 20% tax relief on contributions and then paying 40% tax on these draw downs but key to this is planning ahead.  

If you have a significant SIPP/DC pot then retire a few years earlier (before drawing down DB pensions) and draw down the SIPP/DC pot paying only 20% tax.  Draw more than you need (to avoid paying 40% tax in later years) and put those drawdowns from the SIPP/DC pot into an ISA.  

Planning ahead - I don't think anyone between 1990 and 2005 would have told me, a basic rate taxpayer, with any certainty that successive Conservative and Labour governments of the 2020s would freeze tax thresholds such that (a) I would be a higher rate tax payer in retirement, or (b) the new State Pension would exceed the basic rate threshold. Anyone who planned on that basis can send me the next set of lottery numbers please. The three financial salesmen I met between 1990 and 2005 told us to save in the FSAVCs they sold us. 

Best planning ahead might have been for those financial salesmen to make annual return visits. No, they and their companies moved on. 

My plan is to retire this year (voluntary severance already agreed), burn through my SIPP to keep income just below the 40% threshold, with all taxable savings in OH's name as they transfer to ISAs, all OH's gift-aid donations in my name, maximum contributions to still working OH's pension. OH will not be a 40/42% tax payer until/unless she gets 50% of my DB. Then when I get to SP age in 7 years and higher rate is inevitable I will see if another plan works - 95% of the SIPP will be gone. My planning spreadsheet is based on the 40% threshold increasing from 2028 by the same rate as the triple lock and the cap on the DB, i.e., some inflation index.

To go back to the OP's numbers, more generous than mine. I would see if the numbers make sense to take tax free lump sums (subject to communition rate being sensible), save them in OH's name, fill ISAs each year, make gifts, and draw from the DC pension now at just below the 40% threshold. Withdraw from the DC now at 20% or in future at 40%, or second estate pays IHT on DC at 40%. Above all, talk to an IFA about the whole picture, pension and IHT.

Bostonerimus1

Another consideration is to defer SP and to use any head room that creates upto the 40% threshold to take money from your DC pensions and gift that you your heirs. You might also look at doing that under the excess income rules. 

Taking the reduced pensions and tax free cash will obviously reduce your income tax burden and could either be put in an a GIA/ISA over the years to grow or once again gifted to heirs as part of an IHT strategy. But whether that is a good deal will depend on how the pension is index linked and survivor benefits. This sort of planning is very difficult because of the large number of interdependent parameters and the unknowns of tax rates, investment returns and inflation. But a good thing to hold onto is trying to even out the amount of tax you pay each year ie avoid income spikes, also to always remember that trying to avoid the 40% tax threshold is a problem most people would like to have and that gifting money early can minimize the headaches for your heirs.

michaels

BennyBrownBoy said:

ali_bear said:

Or indeed buy a nice sailing yacht. 

As ukdw points out the usually poor commutation rates on PCLS start to look better when you factor in the 40% tax you would otherwise be paying on the extra income. 

Some say that actual regular living costs in retirement are not large, at least not once you've paid off any mortgage. And having ready money gives you flexibility in what you decide to do. 

Thanks to everyone for comments so far - given me food for thought.

To answer a couple of questions asked:

DB 1 rises at RPI max 3.0% on 43% of the pension and at RPI max 5.0% on remaining 57% of pension once in payment.

DB2 rises at RPI max 2.5% on all of pension once in payment.

DB1 provides 55% survivor benefits to my wife, DB2 provides 50% survivor benefits.

Wife no longer working.

AVC linked to DB2 can be taken tax free when starting DB2 at full amount - if I take reduced DB2 the tax free cash is £32.7K plus the £17K AVC.

No mortgage or debts.

Reasonable health.

I was curious about ukdw comments on commutation rates when factoring in 40% tax - you mentioned that you would consider the PCLS at anything about 25x - can I ask why this is the case?

I would remain under 40% threshold for 5 years i.e. before state pension kicks in - I'm trying to understand what sort of return I would need to see on the PCLS cash in order to make it worth while - any thoughts anyone? Obviously I can't place in ISAs in one go and presumably would pay tax on some of the interest generated before moving to ISAs?

Maybe says something about my risk profile, but I would be nervous about generating enough with the PCLS cash to make it more favourable than the full pensions - my gut says I would need expert help for that and not DIY - do the rates at which my DB pensions increase in payment make anyone think any differently?

Out of interest I did a financial risk profile assessment on line and came out at "Balanced/Moderate".

Thanks again for anything anyone can add, for things I should consider/ask and IFA.

Given the caps on inflation increments I would take the max TFLS

I would also make sure I was drawing up to the 40% tax threshold every year starting now

I would take as much TFLS as soon as you can where you can shelter it somewhere, so enough to max out your isas and any PET gifting and maybe even leaving it unwrapped in low yield uk govt bonds held to maturity where most of the 'interest' is received as a tax free capital gain 

leosayer

1) £38.2K full pension or £27.8K and £185.3K tax free cash

Are these number confirmed?

A reduction from £38k to £28k seems much bigger than others I've seen in my (somewhat limited) experience.

katejo

leosayer said:

1) £38.2K full pension or £27.8K and £185.3K tax free cash

Are these number confirmed?

A reduction from £38k to £28k seems much bigger than others I've seen in my (somewhat limited) experience.

It sounds a big difference to me too. I have a similar type of quote (on a more modest DB  pension). 

FIREDreamer

katejo said:

leosayer said:

1) £38.2K full pension or £27.8K and £185.3K tax free cash

Are these number confirmed?

A reduction from £38k to £28k seems much bigger than others I've seen in my (somewhat limited) experience.

It sounds a big difference to me too. I have a similar type of quote (on a more modest DB  pension). 

It’s a lot better than the 12:1 factor used in the public sector.