Avoiding the 40% tax on pension pot withdrawal

Greenoz

I don't have a huge salary, but my gross salary makes me a higher rate payer. It would also clearly be inefficient for me to pay into pension to below the higher rate tax band (which I'm currently doing) and then pay 40% income tax in retirement.

Does that mean some of your pension contributions are not getting HR tax relief?

If so you would be better off putting that into an ISA as it will give you greater flexibility going forward, especially if you want to retire early. You can always move that money into your pension in later life when your earnings will be greater.

mrklaw

https://forums.moneysavingexpert.com/discussion/comment/82042744#Comment_82042744

not in any case at all.

yes you can do anything with it. And yes if you hit the maximum PCLS it won’t grow any more in a pension. But you pull £268k out into the bright sunshine where HMRC can see it, you will be hit hard with tax on the interest it earns and won’t be able to shelter it quickly. Yes I suppose tax on interest is still allowing it to grow which is more than it’d do in the pension.. but without an explicit plan to spend it down I’d probably try to avoid the situation happening by blending contributions between ISA/pension approaching retirement

QrizB

For context, I am 32

If we have 3% inflation for the next 36 years, which will take you to your current state pension age of 68, prices will have risen by 290%. The state pension will be about 35k pa and average full-time earnings will be over £100k pa.

The chance of the HR tax threshold still being ~£50k in 2062 is essentially nil.

maxaxe

https://forums.moneysavingexpert.com/discussion/comment/82043009#Comment_82043009

Yes, some of my income is going into a SIPP without higher rate tax relief. But it's still better numerically to put it into pension if I am not near the SPLF because I get 25% tax free when I withdraw. I lose the flexibility of the ISA though. I also hope to be able to salary sacrifice soon so I get extra advantage from not paying NI or student loans.

maxaxe

https://forums.moneysavingexpert.com/discussion/comment/82043065#Comment_82043065

I don't quite understand this. Can you give an example where I'm better off by leaving money in pension if I hit max PCLS at 57 compared to withdrawing £268k?

maxaxe

https://forums.moneysavingexpert.com/discussion/comment/82043077#Comment_82043077

I agree that inflation is another factor in calculations. For simplicity, can we just use 2026 figures. It would be a guess that inflation, my salary and income tax bands all follow inflation over the next 30 or so years…

DRS1

https://forums.moneysavingexpert.com/discussion/comment/82043092#Comment_82043092

Well I am not going to say this is very likely thing you would do in real life but here is an example.

You take the £268k out of the pension. For whatever reason you can't put it in an ISA or in premium bonds or in low coupon gilts so you put it in a savings account and all the interest earned on the £268k is taxable at your marginal rate (assume it is basic rate - that will be 22%).

By contrast if you left it in the pension and had the same amount of growth within the pension as in the savings account when you draw that extra out as pension it will be taxed at your marginal rate. Let's say that is also basic rate - that will be 20%.

So on that basis you would be 2% better off leaving it in the pension because of the change in taxation of savings interest which is coming next year.

ali_bear

Of course you could always spend the £268k. Bigger house in a nicer area, sizeable yacht, a share in a private light aircraft ..

Or invest it and pay whatever tax bills come your way. Rental property, venture capital trust, ursine ponzi scheme ..

But unless you have a good reason to do so, taking out all of the TFLS because you're at the LSA limit is a drastic action to take. The limit may well go up in future.

maxaxe

https://forums.moneysavingexpert.com/discussion/comment/82043134#Comment_82043134

Would I not just get the additional limit to withdraw from my pension if the limit increases? How has previous increases to the LSA limit been done for people who had already used all their limit?

I don't see withdrawal of the full amount as extreme so long as I do with the money what I would have done with it in the pension. E.g. if I was going to invest the money in a 70/30 ETF in a pension wrapper, moving it to the same ETF in an ISA and GIA is not extreme.

mrklaw

https://forums.moneysavingexpert.com/discussion/comment/82043123#Comment_82043123

actually thinking it through - its still incremental growth outside of the pension - OPs example is maxing PCLS so it won’t grow any further. You’ll get taxed on interest very quickly, but it’ll still grow. So probably still a benefit even though you’re paying tax.