When to stop/reduce pension contributions and rely on growth?

[djbenedict]

I'm hoping for some thoughts on when to stop or reduce pension contributions so as not to breach the LTA. I do appreciate that there is a very large element of this which is unknowable (!), so I'm not seeking a definitive answer so much as some different ways of looking at the problem.

Background: I am 45, current DC pension pot is £0.54M. I probably don't intend to retire when I am 55 but I wouldn't rule it out either. Some ISA-sheltered shares, both individual and IT, amounting to about £80K. Some cash which more or less offsets the mortgage on our primary residence (so will ignore this for the sake of argument). One BTL property jointly owned with my wife that has some mortgage remaining, current equity of probably about £0.3M, but mentally earmarked as inheritance for our children and we may end up just gifting this to them when they are old enough - currently they are primary school age.

Anyway, what I am trying to think about is when to stop making pension contributions. My employer makes some level of contribution which I can top up via salary sacrifice. Over the last 10 years I've made a total of £0.15M contributions this way. The total growth in fund value over these 10 years has been £0.44M, so in other words fund value growth has contributed £0.44 - £0.15M = £0.29M in the same period (or 290% of the initial sum). Another way I can calculate this is to look at each year's increase in value, subtract the in-year contributions and calculate the growth. This obviously varies a lot (from -12% in 2009 to 22% in 2013) but averages out at: 9.2% for 2007-17, 8.6% for 2008-18, 10.0% for 2009-19. (Sadly my data only goes back to 2006).

I am mostly disinclined to change the investment strategy, e.g. by changing the risk profile, partly because I regard the end date as flexible, and that flexibility works to provide the hedge to the 'sequence of events' possibility of large drop in fund value in 10 years' time; and partly just because it seems to have worked out quite well over a medium period of time. (It's equity heavy obviously).

My current thinking is probably another couple of years of additional salary sacrifice contributions, and then just rely on the employer contributions and fund value growth beyond that. This would allow for greater use of my ISA, which I'm not currently maxing out each year. That seems like good risk diversification in the event of pension rules changing. My modelling suggests that I would hit the LTA at age 56 if the LTA grows at 2.5% per annum and the fund value growth is 8.6% per annum with these assumptions. A nagging voice tells me that 8.6% is a very high annual growth rate, and 4% would be more realistic. Under that assumption I would continue with additional contributions and still not hit the LTA even by age 67. But on the other hand, the 8.6% figure is not made up, but the lowest 10-year average annual performance I can extract from these numbers.

Of course the reality is that this isn't a once-and-for-all decision. In the past I've varied my level of voluntary additional contribution in a contrarian way, such that it was particularly high from '09 to '12. However at the moment my voluntary contribution levels are as high as they have ever been, and higher than my market conviction would dictate, and that is perhaps because my thinking is starting to be influenced by 10 years not being all that long of a time.

Anyway, I would be very grateful for any thoughts on what to do, but even more so for meta-cognitive thoughts about how to think about what to do... I assume there must be many people needing to make this kind of decision at about the T-10 point.

[JohnB]

Both the 2.5 and 8.6% numbers include inflation, stripping it our leaves your growth at 6%, which is higher than I picture (4% dividends, 1% capital growth, less 0.5% costs). The last 10 years have been a good market, I doubt the next 20 will be as good.

You need to think about political risk to the LTA, as Labour are likely to cut it, and they may not adopt the protected rights approach Osbourne adopted, and even if they did you get stung as they don't allow for growth. I've little confidence in the Tories fiscal prudence either. ISAs could come under fire too, so its best to have a bit of everything, so you don't stand out from the crowd. On that basis your ISA looks less of a target for a raid than the rest, and you might want to get junior ISAs for the kids, again to spread your exposure.

The marvel of salary sacrifice is the NI boost (do you get your employer's half?), which makes exceeding the LTA more bearable, but NI is under political threat too.

With 12 years (and could be much more) before you can get to a SIPP, you do want to be wary tying up too much money there.

[genou]

Can you confirm that your employer will continue to fund your pension if you are making no contribution at all? I think that would be quite unusual.

You seem to have the rest modelled out quite well. If you do pause pension funding, it is not an irreversible decision - you can always choose to unwind the pause by using ISA funds to contribute to the pension later on if you are clearly below the LTA, up to the limit of 40k/year. Given you will still be a scheme member during the pause, you will have carry-forward available as well, assuming you have high enough earnings to use it.

What is the unrealised gain on the BTL? If it continues to gain value that issue is only going to get worse.

[moorfield]

I'm hoping for some thoughts on when to stop or reduce pension contributions so as not to breach the LTA. I do appreciate that there is a very large element of this which is unknowable (!), so I'm not seeking a definitive answer so much as some different ways of looking at the problem.

Anyway, I would be very grateful for any thoughts on what to do, but even more so for meta-cognitive thoughts about how to think about what to do... I assume there must be many people needing to make this kind of decision at about the T-10 point.

Hi djbenedict

You could start by observing how much income your pension is generating now, and figuring out how much you want it to be generating when you retire (a portfolio of £1m, near enough the LTA, yielding a not-too-dangerous 4.5%, pays a £45k income). That gives you a guesstimate of the rate your income needs to grow annually. I would suggest <~8% pa is sustainable through the combined effects of dividend increases and reinvestment alone, if you are following the HYP method or similar, without further capital contributions. Higher than that and you ought to keep contributing.

[djbenedict]

Both the 2.5 and 8.6% numbers include inflation, stripping it our leaves your growth at 6%, which is higher than I picture (4% dividends, 1% capital growth, less 0.5% costs). The last 10 years have been a good market, I doubt the next 20 will be as good.

Indeed, hence my comment about market conviction. In some ways the sooner the next recession comes the happier I will be (and I will happily increase contributions into a falling market).

You need to think about political risk to the LTA, as Labour are likely to cut it, and they may not adopt the protected rights approach Osbourne adopted, and even if they did you get stung as they don't allow for growth. I've little confidence in the Tories fiscal prudence either. ISAs could come under fire too, so its best to have a bit of everything, so you don't stand out from the crowd. On that basis your ISA looks less of a target for a raid than the rest, and you might want to get junior ISAs for the kids, again to spread your exposure.

(My emphasis added) Thanks - the 'have a bit of everything' and 'don't stand out from the crowd' are just the kind of thing I'm looking for. The kids do have junior ISAs, in that vein.

The marvel of salary sacrifice is the NI boost (do you get your employer's half?), which makes exceeding the LTA more bearable, but NI is under political threat too.

With 12 years (and could be much more) before you can get to a SIPP, you do want to be wary tying up too much money there.

12 years? Current age 45 (nearly 46 in fact), so access SIPP at 55 = 10 years surely? But I guess your point 'could be much more' is that this is subject to political whim, which is thought provoking indeed. Yes, my employer contributes their NI. Thanks again for your reply.

[djbenedict]

Can you confirm that your employer will continue to fund your pension if you are making no contribution at all? I think that would be quite unusual.

Good point, but yes, they will. In fact (because of colleagues nearing LTA) they will even convert their contribution to salary, which is accommodating.

You seem to have the rest modelled out quite well. If you do pause pension funding, it is not an irreversible decision - you can always choose to unwind the pause by using ISA funds to contribute to the pension later on if you are clearly below the LTA, up to the limit of 40k/year. Given you will still be a scheme member during the pause, you will have carry-forward available as well, assuming you have high enough earnings to use it.

What is the unrealised gain on the BTL? If it continues to gain value that issue is only going to get worse.

Hmm, probably something like £200K although that is shared between my wife and I, and also we lived in the house and it is currently rented out. So there ought to be a fair number of reliefs to operate, although your point serves as a reminder that I should check out the CGT rules for property for when the time comes.

Good point about being able to circulate money back from the ISA, although I would likely not have large sums sitting as cash therein.

Thanks again for your reply.

[genou]

Hmm, probably something like £200K although that is shared between my wife and I, and also we lived in the house and it is currently rented out. So there ought to be a fair number of reliefs to operate, although your point serves as a reminder that I should check out the CGT rules for property for when the time comes.

Emphasis added. You might think so, but they are scheduled for demolition: https://www.accountingweb.co.uk/tax/per ... homeowners

Good point about being able to circulate money back from the ISA, although I would likely not have large sums sitting as cash therein.

In principle in specie contributions are possible, but depends whether your broker will do it ( mostly not I suspect ). But most will do a back-to-back sale-in-ISA / buy-in-SIPP .

[JohnB]

The current legislation says access age is 55, but the stated intention from some years back was to change it to State Pension Age - 10, which will be at least 68 when you get to 58, and could be lots more if right-wing think tanks who want to raise it very fast get their way.

That number 10 is a worry, as the government could change it to 5, and few people would complain. Again, best to not stand out from the crowd.

* Its 10 years less the current SPA, not your own SPA. So at 51 my access age is related to the SPA in 2023, not the 67 of my actual SPA

[Chrysalis]

The stated intention is for access to SIPP to rise to be state pension age minus 10 years. That said, SP age reaches 66 next year and the rules have not yet changed so I am not sure of the timing of that move. But you’re only 45, your state pension age is likely to be 68 and I would think your access to SIPP might well be 57.

[Chrysalis]

Sorry cross posted.
What is the proposed timetable for increasing the access age, JohnB? I’m 53, SP age will be 66 before I turn 55. Am I likely to have to wait a year?

[JohnB]

Visit https://www.gov.uk/state-pension-age and enter ages for someone 10 years younger than yourself. It tends to be stepped in months per extra year older, and it would be the date valid on your birthday, with year jumps

I think everyone expected the SPA-10 figure to be enshrined in law a couple of years back, but it fell through the cracks with finance bills being killed before the last election. No idea when government will consider it again given the current political mess.

[TUK020]

2 other points to consider:

a) Tax rate now vs. likely tax rate when drawing pension
b) same, but for spouse.

a) Pensions are great if you have a big difference in tax rate likely. If you are earning >100k, but <123k, your marginal tax + NI rate is 62%. If you are going to be a basic rate tax payer when you draw the pension, then don't worry about LTA, keep contributing. Tax rates 40% vs future 20% more marginal calculation, and ISA may be lower risk.

b) What is your spouse's tax rate? Her pension pot? From a family unit point of view the best strategy my be for you to take taxed income, give it to your wife so that she can boost her pension.

[DrBunsenHoneydew]

Sorry cross posted.
What is the proposed timetable for increasing the access age, JohnB? I’m 53, SP age will be 66 before I turn 55. Am I likely to have to wait a year?

The proposal is to move to age 67-10=57 in 2028, with no change to the simple age 55 rule before then.
But the legislation has not been passed yet. However, a Pensions Bill is to be put to Parliament next month. Watch this space.

[Chrysalis]

Thanks, looks like I’ll be ok with 55 then. Although with the current govnt, old rules seem there to be ignored/ripped up.

[djbenedict]

Hmm, probably something like £200K although that is shared between my wife and I, and also we lived in the house and it is currently rented out. So there ought to be a fair number of reliefs to operate, although your point serves as a reminder that I should check out the CGT rules for property for when the time comes.

Emphasis added. You might think so, but they are scheduled for demolition: https://www.accountingweb.co.uk/tax/per ... homeowners

Hmm, thanks. It's not clear from that article what happens to a letting period that spans the existing rules and some proposed new rules. My expectation is that the new rules cannot take effect retrospectively (or can they? Sometimes it seems like anything goes), which should leave PPR and a good few years of the current regime of lettings relief. But anyway, thanks for the flag.

(Although tangentially I do think these Osborne-era minimisations of the BTL incentives, including also the tapered loss of mortgage interest as an allowable cost, are an overall good for UK society.)

[djbenedict]

2 other points to consider:

a) Tax rate now vs. likely tax rate when drawing pension
b) same, but for spouse.

a) Pensions are great if you have a big difference in tax rate likely. If you are earning >100k, but <123k, your marginal tax + NI rate is 62%. If you are going to be a basic rate tax payer when you draw the pension, then don't worry about LTA, keep contributing. Tax rates 40% vs future 20% more marginal calculation, and ISA may be lower risk.

b) What is your spouse's tax rate? Her pension pot? From a family unit point of view the best strategy my be for you to take taxed income, give it to your wife so that she can boost her pension.

Thanks, that is a neat way to think about it, although for a) I doubt I'll be a basic rate tax payer although to some extent that is going to be up to me. For b), my wife has a DB public sector - will need to check whether this can be boosted but I suspect not.

[djbenedict]

The current legislation says access age is 55, but the stated intention from some years back was to change it to State Pension Age - 10, which will be at least 68 when you get to 58, and could be lots more if right-wing think tanks who want to raise it very fast get their way.

That number 10 is a worry, as the government could change it to 5, and few people would complain. Again, best to not stand out from the crowd.

* Its 10 years less the current SPA, not your own SPA. So at 51 my access age is related to the SPA in 2023, not the 67 of my actual SPA

Ah - thanks. That makes a big difference of course, because the extra 2 years are right at the end of the compounding process.

[djbenedict]

You could start by observing how much income your pension is generating now, and figuring out how much you want it to be generating when you retire (a portfolio of £1m, near enough the LTA, yielding a not-too-dangerous 4.5%, pays a £45k income). That gives you a guesstimate of the rate your income needs to grow annually. I would suggest <~8% pa is sustainable through the combined effects of dividend increases and reinvestment alone, if you are following the HYP method or similar, without further capital contributions. Higher than that and you ought to keep contributing.

Actually that is a neat way to think about it. If I consider the yearly fund growth exclusive of in-year contributions, that has some equivalence to a sustainable withdrawal rate. Over the last 5 years this averages £40K, but with a minimum of £22K. Over the last 10 years the average is £29K. So I might continue with the current rate of contribution until the 10 year average is £40K, and then switch to filling ISAs. Probably 2 more years, or 3 to be on the safe side.

[TUK020]

Thanks, that is a neat way to think about it, although for a) I doubt I'll be a basic rate tax payer although to some extent that is going to be up to me. For b), my wife has a DB public sector - will need to check whether this can be boosted but I suspect not.

Even if she has a DB pension scheme, she could operate a SIPP in parallel. This would be of particular value if the DB scheme is only accessible at age 65. She could then drawdown the SIPP to cover intermediate years between stopping work, and accessing pension

[djbenedict]

Thanks, that is a neat way to think about it, although for a) I doubt I'll be a basic rate tax payer although to some extent that is going to be up to me. For b), my wife has a DB public sector - will need to check whether this can be boosted but I suspect not.

Even if she has a DB pension scheme, she could operate a SIPP in parallel. This would be of particular value if the DB scheme is only accessible at age 65. She could then drawdown the SIPP to cover intermediate years between stopping work, and accessing pension

Excellent point, thank you.