Tax advantage to taking DB pension early

[abbeymeadster]

Hello All,

I'd be really interested to know if what I'm proposing seems sensible to you?

I'm planning to give up my main job next year when I'll be 57, although I'll continue with a very casual job from which I'll probably earn around £4k pa. I have a number of DB pensions which kick in at 60, 65 and 67. I'll be eligible for the full state pension at 67 and also have significant ISAs, SIPPs etc.

Given that the personal allowance is £12,570 I'm wondering if I should take one of my DB pensions early (at 57) to make use of that allowance?

My DB pension that's supposed to start at 60 is predicted to pay £9,287 then (assuming RPI is 2.5% between now and then). I've had a quote from them for taking it 2 years 7 months early of £7,895. Obviously adding £7,895 to the £4k-ish I'll earn means that I wouldn't pay any tax at all during those years.

I've plotted it into Excel, assuming everything increases by 2.5% pa and it seems that, on a gross position, I would be better off taking it early for about 22 years (when I turn 79). I'm not really sure how to account for the tax advantage of paying no tax for some years and then less tax than I would for the rest of the period, but that must improve the advantage by an extra few years I'd have thought.

FYI irrespective of whether I take this pension early or not, it will increase by RPI (max 5%) between now and when I turn 60. After that the GMP (about 15% of the total) will increase by CPI (max 3%) and the excess by RPI (max 5%). However, for ease I have just assumed that everything increases by 2.5% pa.

A further option is to give up some of the annual payment for a tax-free lump sum and the commutation rate at age 57 is approx 22 times. I don't actually "need" a lump sum, but the tax-free status and 22x looks attractive to me.

Am I missing something? What would you recommend?

Many thanks.

[JohnB]

A bird in the hand is good, especially if you can move the bird into ISAs which have seen much less political fiddling over the years. Are you likely to hit LTA in the pension at any point?

[abbeymeadster]

I don't think I'll hit LTA. DB pensions are valued at 20x the annual payment right? Presumably that's 20x the initial annual payment, in which case it won't be an issue unless my SIPPs surge in value.

[JohnB]

20*payment at time of test + lump sum yet to be taken. Taking a lump sum reduces your LTA by a %age at that point, then you apply that %age again for the LTA in force for later tests.

at 60 LTA =£1m, take lump sum of £100k, 90% of LTA left

at 75 LTA=£2m, take 90% of that and compare with pension at that time and any lump sum to take + SIPP value.

[abbeymeadster]

Oh gosh, this LTA thing is more complicated than I thought!

Are those the correct ages and amounts i.e. you're tested at age 60 (even if I start taking at 57) against £1m and again at 75 against £2m? If the LTA increases to £2m at 75, I don't think I'm in any danger of breaching that.

[TUK020]

Primary issue is whether you are likely to hit the LTA.
Secondary issue is the level of inflation protection in your DB schemes.

If you are not likely to hit LTA in the next 10 years, and you have a reasonable measure of inflation protection in you r DB schemes, then it may be more advantageous to use your SIPP funds to bridge the gap until your DB schemes hit their maturity date, rather than take an early access penalty on your DBs.
Harvest SIPP money to use your income tax allowance until the DB schemes arrive

[abbeymeadster]

My DB schemes do all have an element of inflation protection. The ones starting at 65 and 67 are all LGPS and increase by CPI. The final-salary one starting at 60 will have the GMP part increase by CPI (but with a max of 3%) and the "excess" increase by RPI (but with a max of 5%.)

When you say "harvest SIPP money to use your income tax allowance until the DB schemes arrive" do you mean just withdraw £12,500 each year? Is that Drawdown? And could I do that as well as continue to make pension contributions if I wanted to?

[JohnB]

LTA was meant to rise with CPI, but has been frozen at 1071k for 4 years. Anyone's guess what it might be in future, or what the multipliers might be. Hence bird in hand

[ursaminortaur]

My DB schemes do all have an element of inflation protection. The ones starting at 65 and 67 are all LGPS and increase by CPI. The final-salary one starting at 60 will have the GMP part increase by CPI (but with a max of 3%) and the "excess" increase by RPI (but with a max of 5%.)

When you say "harvest SIPP money to use your income tax allowance until the DB schemes arrive" do you mean just withdraw £12,500 each year? Is that Drawdown? And could I do that as well as continue to make pension contributions if I wanted to?

If you take more than just a tax free lump sum from the SIPP in drawdown then that will cause your annual allowance for future contributions to any DC scheme to fall to £4,000 per year - this limit is known as the MPAA. This triggering of the MPAA limit applies if you use UFPLS drawdown (in which case each drawdown amount will consist of 25% tax free and the other 75% taxed at your marginal rate) or if using flexi-access to drawdown potentially taxed income.(With flexi-access drawdown the whole pot is crystallised at once and you take the tax free lump sum but can then choose whether to take any potentially taxed drawdowns whenever you wish in the future but aren't forced to take them).

Note this MPAA limit only applies to future contributions to DC schemes, contributions to your DB scheme will still be subject to the normal Annual allowance limit which is currently £40,000. The MPAA also doesn't apply if you start taking your DB scheme (whether at the normal retirement age or earlier) so you could still make contributions to a SIPP of upto £40,000 subject to your relevant earnings if you took your DB pension but hadn't taken anything( or more than the tax free lump sum) from a DC pension/SIPP.

[abbeymeadster]

Good to know about the £4k MPAA limit. As it happens, I'll only be earning about that when I give up my main job next year, so that's all I'd be allowed to contribute anyway

I always thought I'd leave my SIPPs alone for the forseeable. Conscious of the IHT exemption. Hence why I was drawn to the idea of taking income from a DB pension early instead. Isn't that the best way of getting "a bird in the hand"? If I die early (although I obviously hope I won't!) the DBs die with me; whereas the SIPPs can be passed on.

Do people think the penalty to access the DB early is off-putting? It seemed quite reasonable to me.

PS I appreciate people's input. It's good to be able to mull it over.

[ursaminortaur]

Oh gosh, this LTA thing is more complicated than I thought!

Are those the correct ages and amounts i.e. you're tested at age 60 (even if I start taking at 57) against £1m and again at 75 against £2m? If the LTA increases to £2m at 75, I don't think I'm in any danger of breaching that.

No, the tests will occur when you take the pension. So if you took the DB pension at 57 the test would occur then and the percentage of the LTA limit used would be

100 * (20* initial pension payment + any lump sum taken ) / LTA limit at that time

There would be no more LTA tests carried out on that DB pension.

For a DC pension going into drawdown when the tests are carried out depends upon the type of drawdown.

If you use flexi-access then the whole pot will be crystallised at once and you will be able to take the tax free lump sum at that point and the percentage of the LTA limit used would be

100* whole pot / LTA limit at that time.

At age 75 there would then be another test but that only covers growth remaining in the pot

ie the LTA percentage used up then would be

100 * ((crystallised pot at age 75) - ( whole pot when crystallised - tax free lump sum)) / LTA limit at age 75

Since Drawdowns from the crystallised pot are NOT tested against the LTA this age 75 test can be rendered toothless by just drawing down the growth before reaching age 75.

If instead you use UFPLS drawdown the each drawdown will be made up of 25% which is tax free and 75% which will be taxable at your marginal rate and each UFPLS drawdown will be tested against the LTA limit at the time you make the drawdown.

Each drawdown will use up a percentage of the LTA limit

100 * drawdown amount/ LTA limit at time of drawdown.

There will also be a final test at age 75 on anything left uncrystallised in your pot which will use up the following percentage

100* uncrystallsed pot at age 75 / LTA limit at age 75.

This will capture growth in the uncrystallised pot over the years you were using UFPLS and hence may cause you to use up more of your LTA limit. Hence if you are getting close to the LTA limit then it would be better to use flexi-access drawdown rather than UFPLS.