Comments on strategy re pensions and LTA

[rollo19]

I’m 46, with a dc pot of around £450k and a modest historical db that is worth c. £35k from a previous employment.

I pay in 8% of my salary and my employer contributes 12% into the dc pot.

At this rate, I reckon I’ll burst through the LTA in around eight years assuming a relative modest investment return and assumed salary increases in line with inflation. Depending on circumstances and my ability to save over the intervening period, I’m hoping to retire some time between 55 and 60 with some more work to do understanding what my spend in retirement might look like. However, I suspect it will be more than could be safely derived from a £1m pot for 30+ years.

I earn £100k or so at the moment plus bonus that typically varies between £10k and £25k each year.

Mortgage of £250k - house £750k
ISA savings of £50k

I’m also at the marginal tax rate of 60% so considering putting effectively all of my bonus into my pension this year (I.e. £20k bonus plus the c. £20k er and ee pension contribution thus using the full £40k allowance.)

Clearly that will only exacerbate the LTA issue, particularly if I continue this strategy in following years.

My current thinking is that I’m likely to be a basic, or possibly a higher rate tax payer when I get to retirement, so I should just plan to burst through the LTA on the basis that:

1. the employer benefit at 1.5x my contribution easily outweighs the tax cost (there is currently no option to receive the employer pension contribution as cash)
2. The tax saving now is likely to be higher than when I do draw it down as my marginal tax rate is now 60%.
3. If even the Conservative government is talking about limiting tax relief on pensions, the removal of higher rate relief in the next few years will change the sums involved, so making hay while the sun is shining makes sense.
4. My employer may be more flexible in the future that would allow

I’d welcome your comments on this strategy as I may have misunderstood the position and costs involved. TIA.

[xxd09]

I note your point re LTA limits
Increasingly this is becoming a problem for high earners
Presumably if a pension pot of a certain amount can be accumulated the the punitive 55%tax rate becomes less important
What size of pot that is needs to be needs the investor to do some math
Whether also you would have to halt your ISA investments in order to maximise the pension pot -tax free income is a good perk too!
Pencil and paper time!
xxd09

[rollo19]

Yes - exactly those questions that are exercising my mind. At the moment I think I’d prefer £20k in my pension versus £8k in an ISA which is the main decision I face imminently.

[TUK020]

I’m 46, with a dc pot of around £450k and a modest historical db that is worth c. £35k from a previous employment.

I pay in 8% of my salary and my employer contributes 12% into the dc pot.

At this rate, I reckon I’ll burst through the LTA in around eight years assuming a relative modest investment return and assumed salary increases in line with inflation. Depending on circumstances and my ability to save over the intervening period, I’m hoping to retire some time between 55 and 60 with some more work to do understanding what my spend in retirement might look like. However, I suspect it will be more than could be safely derived from a £1m pot for 30+ years.

I earn £100k or so at the moment plus bonus that typically varies between £10k and £25k each year.

Mortgage of £250k - house £750k
ISA savings of £50k

I’m also at the marginal tax rate of 60% so considering putting effectively all of my bonus into my pension this year (I.e. £20k bonus plus the c. £20k er and ee pension contribution thus using the full £40k allowance.)

Clearly that will only exacerbate the LTA issue, particularly if I continue this strategy in following years.

My current thinking is that I’m likely to be a basic, or possibly a higher rate tax payer when I get to retirement, so I should just plan to burst through the LTA on the basis that:

1. the employer benefit at 1.5x my contribution easily outweighs the tax cost (there is currently no option to receive the employer pension contribution as cash)
2. The tax saving now is likely to be higher than when I do draw it down as my marginal tax rate is now 60%.
3. If even the Conservative government is talking about limiting tax relief on pensions, the removal of higher rate relief in the next few years will change the sums involved, so making hay while the sun is shining makes sense.
4. My employer may be more flexible in the future that would allow

I’d welcome your comments on this strategy as I may have misunderstood the position and costs involved. TIA.

At 100k+, a marginal tax + NI rate of 62% does mean that pension contributions are a bit of a no brainer.
An overall strategy you could consider is:
- max out pension contributions over the next few years, until you get to the LTA
- then crystalise the Pension, this means you will be limited in what yo can contribute further if you take any taxable benefits.
- stop contributing to pension, stuff max into ISAs, reduce hours worked to keep you tax bill sensible.
- at some future point retire, and start drawing pension, ideally draw max amount to stay just in the basic rate income tax band, balance with what you need to spend by drawing on/continuing to fund ISAs.

[tjh290633]

One thought about reducing taxable income below a threshold, is that you can also make use of charitable donations with gift aid to the same effect.

If you have a favourite charity, why not think of that?

TJH

[ursaminortaur]

I’m 46, with a dc pot of around £450k and a modest historical db that is worth c. £35k from a previous employment.

I pay in 8% of my salary and my employer contributes 12% into the dc pot.

At this rate, I reckon I’ll burst through the LTA in around eight years assuming a relative modest investment return and assumed salary increases in line with inflation. Depending on circumstances and my ability to save over the intervening period, I’m hoping to retire some time between 55 and 60 with some more work to do understanding what my spend in retirement might look like. However, I suspect it will be more than could be safely derived from a £1m pot for 30+ years.

I earn £100k or so at the moment plus bonus that typically varies between £10k and £25k each year.

Mortgage of £250k - house £750k
ISA savings of £50k

I’m also at the marginal tax rate of 60% so considering putting effectively all of my bonus into my pension this year (I.e. £20k bonus plus the c. £20k er and ee pension contribution thus using the full £40k allowance.)

Clearly that will only exacerbate the LTA issue, particularly if I continue this strategy in following years.

My current thinking is that I’m likely to be a basic, or possibly a higher rate tax payer when I get to retirement, so I should just plan to burst through the LTA on the basis that:

1. the employer benefit at 1.5x my contribution easily outweighs the tax cost (there is currently no option to receive the employer pension contribution as cash)
2. The tax saving now is likely to be higher than when I do draw it down as my marginal tax rate is now 60%.
3. If even the Conservative government is talking about limiting tax relief on pensions, the removal of higher rate relief in the next few years will change the sums involved, so making hay while the sun is shining makes sense.
4. My employer may be more flexible in the future that would allow

I’d welcome your comments on this strategy as I may have misunderstood the position and costs involved. TIA.

At 100k+, a marginal tax + NI rate of 62% does mean that pension contributions are a bit of a no brainer.
An overall strategy you could consider is:
- max out pension contributions over the next few years, until you get to the LTA
- then crystalise the Pension, this means you will be limited in what yo can contribute further if you take any taxable benefits.
- stop contributing to pension, stuff max into ISAs, reduce hours worked to keep you tax bill sensible.
- at some future point retire, and start drawing pension, ideally draw max amount to stay just in the basic rate income tax band, balance with what you need to spend by drawing on/continuing to fund ISAs.

Since he is 46 he won't be able to crystallise the pension until he is 57 in 2033 (the minimum age is rising from 55 to 57 in 2028).

[Kantwebefriends]

My current thinking is that I’m likely to be a basic, or possibly a higher rate tax payer when I get to retirement, so I should just plan to burst through the LTA on the basis that:

1. the employer benefit at 1.5x my contribution easily outweighs the tax cost (there is currently no option to receive the employer pension contribution as cash)
2. The tax saving now is likely to be higher than when I do draw it down as my marginal tax rate is now 60%.
3. If even the Conservative government is talking about limiting tax relief on pensions, the removal of higher rate relief in the next few years will change the sums involved, so making hay while the sun is shining makes sense.
4. My employer may be more flexible in the future that would allow.

Your proposal seems spot on to me. Remember too that a well timed stock market crash could have a silver lining of saving you from LTA embarrassment. Or an ill-health retirement. Or a change in career direction. Or ... Make hay while the sun shines.

[hiriskpaul]

Each pound put into a pension that ends up being over the LTA is essentially taxed at 40% if withdrawn at basic rate tax - £1 becomes 75p after the LTA charge and that gets reduced to 60p after 20% income tax. If withdrawn at higher rate the total tax is 55%. So if you are getting 60% tax relief then it is still worthwhile contributing to the pension.

If you only get 40% tax relief there is no income tax advantage of the pension over an ISA, assuming basic rate tax in retirement and tax rates don't change.

The main additional tax benefit of the pension is that the it falls outside your estate for inheritance tax purposes. Whether that is of value to you depends on your personal circumstances.

[1nvest]

I assume that LTA is based on the value of the pension, contributions + investment growth, and not just on contributed amounts alone? Is that a correct assumption?

[hiriskpaul]

I assume that LTA is based on the value of the pension, contributions + investment growth, and not just on contributed amounts alone? Is that a correct assumption?

It is based on contributions and growth, which is what makes the decision making so tricky.

[rollo19]

I assume that LTA is based on the value of the pension, contributions + investment growth, and not just on contributed amounts alone? Is that a correct assumption?

It is based on contributions and growth, which is what makes the decision making so tricky.

Yes. I’ve assumed a relatively modest 5% p.a. investment growth and a 3% salary increase p.a. (which obviously drives contributions). The reality is that either could be more or less. But whether I end up reaching the LTA in six years or ten, maximising contributions now seems like the sensible choice.

Thanks very much all for the comments - it’s made me much happier that I’m not missing something obvious.

[vand]

Be careful. I am in a similar position to you and used to think that it was a good plan to run up to 99.9% of the LTA on the day I turned 57 and started drawing from my pension, but I've come to realise that you don't want to be anywhere near the LTA by the time you start drawing from your pension.

The uncrystalized part of your pension pot will continue to remain invested and growing, such that it is impossible to avoid the LTA at some point, even as you move a part of it down into the crystalized pot every year.

Depending on the growth rate and how much of your pot you are drawing each year, you could easily still run into LTA problems even if you have only reached 75% of it by the time you start drawing from it.

So personally I am going to aim to get to about 75-80% of the LTA by the time I access my pot.

[TedSwippet]

Be careful. I am in a similar position to you and used to think that it was a good plan to run up to 99.9% of the LTA on the day I turned 57 and started drawing from my pension, but I've come to realise that you don't want to be anywhere near the LTA by the time you start drawing from your pension.

The uncrystalized part of your pension pot will continue to remain invested and growing, such that it is impossible to avoid the LTA at some point, even as you move a part of it down into the crystalized pot every year.

The trick here would be to crystallise the entire pension at this point; that is, over 55/57 and exactly at the LTA. You take the full 25% tax free lump sum, and then immediately defer taxable withdrawals on the remaining 75% drawdown component until you need it. Crystallising a (chunk of) a pension and making actual taxable pension withdrawals are two separate activities, and do not have to occur at the same time.

Admittedly, this strategy lands you with a fairly indigestible lump sum, currently around £250k. Over time you can funnel this into an ISA, but in the interim you have to do something with it. Even if you just reinvest in the same things as it was when in your pension, but just outside, though, you should find that you pay lower tax on its dividends and gains than you would have if left in the pension (because the LTA penalty rates of 40-55% handily exceed the unsheltered higher rate dividend and capital gains tax rates).

And then, at age 75 there is a second forced LTA test. This captures any uncrystallised sums (if you follow the strategy above, you won't have any of these) and rather spitefully, also any overall gain in the crystallised components. To avoid this one, you need to be sure to have withdrawn at least the full nominal gains between crystallising and age 75.

Follow the above and you entirely avoid paying any LTA penalty. The downside is finding a home for a large tax free lump sum, and also that this part of things then becomes in scope for inheritance tax, whereas money in your pension (currently) avoid inheritance tax. That makes it a nuanced decision if you plan to use your pensions as inheritance tax bypass rather than to spend.

[vand]

Excellent clarification, TedSwippet.

Yes this is a nuclear alternative option using flexi-access drawdown if you feel up to the task of reinvesting the TFLS and managing the crystalized pot in non-pension wrappers.

You will likely take tax hits in other forms along the way on both of these, but that may well be less than the tax hit of the LTA charges.

Frankly, it's easy to see how it can quickly become a minefield... if you think that you know what's optimal then you probably haven't studied it hard enough!

[ursaminortaur]

Be careful. I am in a similar position to you and used to think that it was a good plan to run up to 99.9% of the LTA on the day I turned 57 and started drawing from my pension, but I've come to realise that you don't want to be anywhere near the LTA by the time you start drawing from your pension.

The uncrystalized part of your pension pot will continue to remain invested and growing, such that it is impossible to avoid the LTA at some point, even as you move a part of it down into the crystalized pot every year.

The trick here would be to crystallise the entire pension at this point; that is, over 55/57 and exactly at the LTA. You take the full 25% tax free lump sum, and then immediately defer taxable withdrawals on the remaining 75% drawdown component until you need it. Crystallising a (chunk of) a pension and making actual taxable pension withdrawals are two separate activities, and do not have to occur at the same time.

Admittedly, this strategy lands you with a fairly indigestible lump sum, currently around £250k. Over time you can funnel this into an ISA, but in the interim you have to do something with it. Even if you just reinvest in the same things as it was when in your pension, but just outside, though, you should find that you pay lower tax on its dividends and gains than you would have if left in the pension (because the LTA penalty rates of 40-55% handily exceed the unsheltered higher rate dividend and capital gains tax rates).

And then, at age 75 there is a second forced LTA test. This captures any uncrystallised sums (if you follow the strategy above, you won't have any of these) and rather spitefully, also any overall gain in the crystallised components. To avoid this one, you need to be sure to have withdrawn at least the full nominal gains between crystallising and age 75.

Follow the above and you entirely avoid paying any LTA penalty. The downside is finding a home for a large tax free lump sum, and also that this part of things then becomes in scope for inheritance tax, whereas money in your pension (currently) avoid inheritance tax. That makes it a nuanced decision if you plan to use your pensions as inheritance tax bypass rather than to spend.

As far as the IHT is concerned you can potentially bypass this by gifting the money to your intended beneficiaries whilst you are alive. The 25% tax free lump sum will be capital and will be a PET (Potentially Exempt Transfer) if you gift it which will escape IHT so long as you survive seven years after making the gift. Income drawdown from the pension will be taxed at your marginal rate but since it is income can be gifted as a "gift out of surplus income". In order to do this you need to show that you are regularly giving such gifts - the advantage of gifting in this way is that you don't need to survive for seven years the gift immediately escapes IHT.

https://www.gabyhardwicke.co.uk/briefing-notes/inheritance-tax-exemption-for-gifts-out-of-surplus-income/

In order for a gift to be exempt as a gift out of surplus income, the following conditions must be satisfied:

The gift must be part of your normal (i.e typical or habitual) expenditure; and
The gift must be made out of your after tax income taking one year with another; and
After allowing for all other transfers of value forming part of your expenditure, you are left with sufficient income, in order to maintain your usual standard of living;

In order to satisfy H M Revenue & Customs that the gifts were part of your normal expenditure, it will be necessary to show a commitment to make regular gifts as part of a settled pattern of giving.

The exemption only applies where the gifts are made from surplus income after tax. Examples of income will include pension income, interest from savings, dividend income, rental income or income payments received from a trust. If you prepare income tax returns, your tax return will help you identify the sources of your income but you should remember to also take into account any income from ISAs, which will not show up on your income tax return, but which will still be considered income, for the purposes of the gifts out of surplus income IHT exemption.

Your executor will need to be able to show the regular nature of this gifting so it helps to keep good records.

[TedSwippet]

Yes this is a nuclear alternative option using flexi-access drawdown if you feel up to the task of reinvesting the TFLS and managing the crystalized pot in non-pension wrappers.

I embarked on this a couple of years ago, and it really isn't that much of a chore. I'm a staunchly 'passive' investor, so everything I hold, both inside my SIPP and outside (the 25% tax free lump sum) is in broad-based cheap global tracker funds. Because I don't actively trade or performance-chase, the capital gains roll up without tax, and dividends are relatively lightly taxed. Probably the biggest nuisance is getting the numbers together for annual self-assessment tax return, but even that isn't a heavyweight chore, perhaps half an hour or so.

You will likely take tax hits in other forms along the way on both of these, but that may well be less than the tax hit of the LTA charges.

Not only will these tax hits be lower than the LTA charges, but they can generally also be managed for minimisation. Dividends are fairly inescapable, but as mentioned already, the tax on these can be low, due to the separate dividend allowance and the low rate if in basic rate tax (not so great in higher rate tax). And capital gains can be deferred for years or even decades, and defused annually either partially or completely by switching between equivalent funds -- easy when you use trackers -- to realise up to the £12k or so annual capital gains tax allowance.

The age 75 LTA test is relatively distant, but managing away any LTA charge at that point really means just withdrawing all the drawdown gains by then. Even if (pretty much worst case!) you wait until age 74 and 11 months and then take the lot, tax at 45% additional rate is still below the 55% LTA rate. So in a sense, anyone paying the LTA charge on drawdown funds at age 75 is really doing so voluntarily.

There is also something psychologically comforting in knowing that now that you have used up your entire lifetime allowance, any future government shenanigans that (yet again) freeze or reduce the LTA are no longer your problem.

[JohnB]

Exactly my plan Ted, as I'm at 96% of LTA with 13 months to go. The £200k I will have to withdraw is a nuisance, and will finally tip me into paying tax (this year I came to within £1 of paying it, I wonder if HMRC thought I was working backward on my tax return!), but 7.5% of 3.5% of £200k won't hurt too much.

[CaitrionasDad]

Be careful. I am in a similar position to you and used to think that it was a good plan to run up to 99.9% of the LTA on the day I turned 57 and started drawing from my pension, but I've come to realise that you don't want to be anywhere near the LTA by the time you start drawing from your pension.

The uncrystalized part of your pension pot will continue to remain invested and growing, such that it is impossible to avoid the LTA at some point, even as you move a part of it down into the crystalized pot every year.

The trick here would be to crystallise the entire pension at this point; that is, over 55/57 and exactly at the LTA. You take the full 25% tax free lump sum, and then immediately defer taxable withdrawals on the remaining 75% drawdown component until you need it. Crystallising a (chunk of) a pension and making actual taxable pension withdrawals are two separate activities, and do not have to occur at the same time.

Admittedly, this strategy lands you with a fairly indigestible lump sum, currently around £250k. Over time you can funnel this into an ISA, but in the interim you have to do something with it. Even if you just reinvest in the same things as it was when in your pension, but just outside, though, you should find that you pay lower tax on its dividends and gains than you would have if left in the pension (because the LTA penalty rates of 40-55% handily exceed the unsheltered higher rate dividend and capital gains tax rates).

And then, at age 75 there is a second forced LTA test. This captures any uncrystallised sums (if you follow the strategy above, you won't have any of these) and rather spitefully, also any overall gain in the crystallised components. To avoid this one, you need to be sure to have withdrawn at least the full nominal gains between crystallising and age 75.

Follow the above and you entirely avoid paying any LTA penalty. The downside is finding a home for a large tax free lump sum, and also that this part of things then becomes in scope for inheritance tax, whereas money in your pension (currently) avoid inheritance tax. That makes it a nuanced decision if you plan to use your pensions as inheritance tax bypass rather than to spend.

Hi Ted,

I don't think this is correct (apologies in advance if I am mistaken)

My understanding of crystallisation and LTA is that when you access the 25% tax free component you crystalise an amount of your pension (and LTA). 25% of this is Tax free and the other 75% moves into Drawdown.

I recently moved a portion of my pension into Drawdown. I took £100k as Tax Free lump sum and £300k was moved into a SIP drawdown account.
The LTA Certificate states that I have used 38% of my LTA - so both the Lump Sum and Drawdown amounts are tested for LTA.

I have not "accessed" my pension income as I have not taken any taxable payment from the Drawdown account, so I can still make payments into a pension as normal. The £300k is taxable as I take it and is tested again at age 75 to account for any growth above £300k as part of the final LTA test at age 75.

However I plan on taking taxable withdrawals from this £300k as income and keep the below £300k so it is not part of the final LTA check.

So for the original poster he should reduce pension payments to a level that maximises his employers contribution whilst diverting money to ISAs to live off for two years if he retires at 55.

At 57 he could crystalise his full LTA and use the Drawdown component for his annual costs while feeding the Tax Free component into a ISA to avail of tax free growth/income

When the final LTA check is done at 75 the only taxable component is the element that was already above the LTA at 57 - his long term growth has moved to the ISA element.

I believe this is the model suggested by Kate Smith of Aegon in the Daily Telegraph this week
https://www.telegraph.co.uk/pensions-re ... ng-happen/

This is behind their pay wall - apologies if you cannot access

[TedSwippet]

Hi Ted, ... I don't think this is correct (apologies in advance if I am mistaken) ...

Can you say which part of what I wrote was not correct? As far as I can tell, we're in agreement.

For the OP to 'win' the LTA game, they need to capture the full employer match and/or avoid the 60% tax trap while at the same time ensuring that they do not hit the LTA until age 55/57 and so able to crystallise the pension.

[CaitrionasDad]

Hi Ted,

I misread this part of the reply

You take the full 25% tax free lump sum, and then immediately defer taxable withdrawals on the remaining 75% drawdown component until you need it. Crystallising a (chunk of) a pension and making actual taxable pension withdrawals are two separate activities, and do not have to occur at the same time.

I thought you were suggesting you can take the 25% lump sum without crystallising the accompanying 75% of the rest of the pension.

I agree we are in agreement