Whether to topup SIPP immediately prior to retirement

Lowtrawler

In a couple of weeks time, I am planning to retire. Is there any advantage to me making a lump sum personal contribution into my SIPP prior to retirement? I have maxed out the £60k contributions for the last few years and have made one-off personal contributions in the past.

This year, at the point of retirement, I will have salary sacrificed £30k which is paid into my SIPP as an employer contribution. I will have earned a gross £25k and made no personal contributions.

After retirement, I expect to take the full PCLS and start to drawdown from the SIPP with the aim of drawing taxable income to the annual Higher Rate threshold. I expect at some point I will need to draw down amounts from the SIPP that attract higher rate tax as my SIPP contains more value than can be contained within the basic rate band throughout my retirement.

To reiterate, my question is whether there is any advantage to me making a lump sum personal contribution into my SIPP prior to retirement? If there is, what would be the optimal value of that lump sum and are there any gotcha’s to look out for?

Baldytyke88

I intend to put more into my SIPP before the next tax year, as I retire in December. But contributions are limited. I am sure someone will post those limits.

Isthisforreal99

So 20% tax relief going in with the potential for 40% tax paid on withdrawal. Not convinced it's the best strategy.

Exodi

I think the problem with always looking to contribute as much as possible into your SIPP is people can often overdo it and eventually end up in a worse position than if they were just paid the amount and put it in ISA's (which could also help bridge early retirement).

From what you've said, you're currently a basic rate tax payer.

You are making contributions via sal sac - effectively saving yourself 20% Income Tax and 12% NI if it were paid through your salary. However you've gone on to say "I expect at some point I will need to draw down amounts from the SIPP that attract higher rate tax as my SIPP contains more value than can be contained within the basic rate band throughout my retirement.", meaning cash you put into your pension to save 32% tax on, may end up liable for 40% tax.

If we consider the tax free allowance:

£100 paid in salary, would net you £68 after tax and NI.

£100 paid in to pension and withdrawn would net you £25 tax free, and then £75 taxable. At a marginal tax rate of 20% this means you'd receive £80 in total, at 40% this means you've receive £65, less than if you were just paid it at the time.

I'd be very careful because this can then cause people to let the tail wag the dog, deliberately spending less than they could to continue their lifetime ambition of tax efficiency. It ends up being a tremendous waste to work hard your whole life to squirrel money away and then ultimately not fully enjoy the fruits of their labour because everyone's obsessed with avoiding tax at all costs. Though I'm sure their future beneficiaries may appreciate it.

If you are likely to pay higher rates of tax in retirement, I'd consider putting money in ISA's instead.

Lowtrawler

https://forums.moneysavingexpert.com/discussion/comment/82124285#Comment_82124285

Thanks, I am actually a higher rate taxpayer as based in Scotland, on a pro-rata basis, I am into the higher rate band. Obviously, when I retire, I am planning to try and keep myself below the higher rate band for this year and so will effectively become a basic rate taxpayer. As a result, I think you are correct, there is no value in me making any new contributions this year - Mainly because I will only get basic rate relief and will likely have to pay higher rate tax on removing the funds. Appreciate the quick response and logic.

FatherAbraham

If it wont make your SIPP so large that withdrawals get heavily taxed, then the mathematically optimum contribution for you sounds like your entire residual gross salary of £25k (taking your entire contribution to £55k).

That's because you would only need to contribute a net sum of £20k, using relief-at-source, with the £5k taxation being claimed from the state by your pension provider.

The important point here is that you will have gained tax relief on the entire 0% tax band, where you never paid tax in the first place.

FatherAbraham

However:

After retirement, I expect to take the full PCLS and start to drawdown from the SIPP with the aim of drawing taxable income to the annual Higher Rate threshold. I expect at some point I will need to draw down amounts from the SIPP that attract higher rate tax as my SIPP contains more value than can be contained within the basic rate band throughout my retirement.

If you can foresee hitting 40% taxation on future withdrawals, then it's not worth overcontributing now. Indeed, with a total income from employment of £55k this year, your contribution of £30k to the pension was already too much.

Note that one way to avoid future higher taxation is to buy a costly annuity, which sounds insane, but isn't always. Adding features such as joint life and RPI-indexation to an annuity, if those features are genuinely useful to you, can make the income from the annuity fall under the higher-rate band.

Lowtrawler

https://forums.moneysavingexpert.com/discussion/comment/82124377#Comment_82124377

Looking at this logically, I would contribute £20k to get £25k in my SIPP. On retirement, I would get 25% PCLS = £6,250 but would then likely have to pay 40% tax on the remaining £18,750 when I come to draw it = £18,750 - £7,500 = £11,250, a total of £17,500 for my £20k contribution. However, as the contribution gives me an additional £25k headroom for the current tax year, the argument would be that the £18,750 could be taken this year at 20% tax = £18,750 - £3,750 = £15,000, a total of £21,250 for my £20k contribution. Not only that, I could draw an extra £6,250 this year at basic rate tax rather then higher rate before moving into the higher rate band = £1,250 extra saving. In total, I would be £2,500 better off?

Is this a logical argument or have I missed something?

Triumph13

As FatherAbraham says.

If you still have some headroom before the £268k lifetime TFLS limit, then you won't have lost much on your sal sac contributions YTD. If your employer shares their savings, then you might even have turned a small profit :)

zagfles

https://forums.moneysavingexpert.com/discussion/comment/82124398#Comment_82124398

Yes, although it's an unnecessarily complicated calculation to work out what should be obvious. Most of the previous replies haven't thought it through properly. As you say anything you contribute this year gives you extra basic rate headroom to withdraw within the basic rate band this year, so contributing an additional £X gross to your pension and withdrawing an additional £X from your pension this tax year after retirement is completely tax neutral.

So assuming you stick to the limits (tax relief, AA) which £25k appears to, and you have LSA headroom, then it should be obvious that you'll save tax on the PCLS element of any additional contributions, ie 25% of the gross contribution, and if the marginal rate you'd otherwise pay is 40% then you save 25k*0.25*0.4 = £2500

Triumph13

Doh! I missed the idea of pulling it back out in the same year. My only excuse is that I retired before pension access age ;)