Author Topic: tax free 25% pension allowance / tax planning  (Read 1812 times)

MisterA

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tax free 25% pension allowance / tax planning
« on: April 07, 2021, 06:31:49 AM »
Situation
I’m married and over 55, my wife is currently under 55. We plan to retire early, but we will only have a single digit number of years to cover before state pensions commence. We have a mixture of defined contribution pensions, and modest final salary pensions between us. We have no debts of any kind. When the state and final salary pensions kick in, we’ll have enough of an income. The majority of my pension is in SIPP type DC investments, and I plan to finish a few years before my wife (I’m older). Because my wife’s pension provision is almost entirely final salary (and we don’t want to take them early), we’ll both live off my SIPP by draw-down for a few years.

My plan
How does this sound, to maximise income during our early years:
Let’s assume that my SIPP is £500k, and I draw the full tax-free 25%, so £125k.
We re-invest this into a (eg Vanguard Lifestrategy) SIPP for my wife over maybe 3 years, so it gains 20% from income tax credit and becomes worth £150k. A £25k gain at the cost of £87.5k income tax relief (my wife can take 25% of the £150k tax-free!).

But then, when we’re both FIRE’d and before state and final salary pensions start, my wife will have her new SIPP to draw-down (she’ll be over 55 by then). So instead of just my £12k annual income tax allowance, we’ll have £24k income tax allowance between us. If we drew-down £24k per year, this would equate to a tax saving of £2.4k/year (versus just me drawing down). I realise that this equates to a 5% withdrawal rate (on the initial £500k), but it would only be for a few years.

Does this sound like a plan, are there any unforeseen issues and does it sound legitimate?! Seems like a no-brainer.

From age 66. We’ll have full state pensions x2, modest final salary pensions and the balance of the SIPP’s, although these will all be staged due to our age differences.

vand

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Re: tax free 25% pension allowance / tax planning
« Reply #1 on: April 07, 2021, 07:34:41 AM »
The income from the various retirement pots is fungible.  You put it as moving 125k from your pot over to your wife, but an alternative way to look at it is you are living off the lump sum which allows your wife to then top up her pot more aggressively.

Sure, it sounds like a good plan if you can then still live off the 375k pot for a few years. Any juggling you can do between wrappers to minimize your overall tax liability is a good idea.

Be careful though that you aren't drawing down your own pension too aggressively at the start. 375k supports a £15k income at 4% - are you both OK living on 15k?. If you deplete your own pot too soon it may not be easy to allow it the chance to replenish, and the opposite trick will not be available to you (ie moving money from your wife's pension back to yours).

MisterA

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Re: tax free 25% pension allowance / tax planning
« Reply #2 on: April 07, 2021, 07:49:58 AM »
Be careful though that you aren't drawing down your own pension too aggressively at the start. 375k supports a £15k income at 4% - are you both OK living on 15k?. If you deplete your own pot too soon it may not be easy to allow it the chance to replenish, and the opposite trick will not be available to you (ie moving money from your wife's pension back to yours).
My wife will still be working during this period, and so we won't really be drawing anything from the pot, living off her income. When she does retire, we'll still have the whole £500k between us both (actually £525k with the tax gain!), and we can then share 2 peoples income tax allowances. Our finances are shared.

I had to google fungible!
« Last Edit: April 07, 2021, 07:56:11 AM by MisterA »

Playing with Fire UK

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Re: tax free 25% pension allowance / tax planning
« Reply #3 on: April 07, 2021, 08:25:20 AM »
...
Let’s assume that my SIPP is £500k, and I draw the full tax-free 25%, so £125k.
We re-invest this into a (eg Vanguard Lifestrategy) SIPP for my wife over maybe 3 years, so it gains 20% from income tax credit and becomes worth £150k. A £25k gain at the cost of £87.5k income tax relief (my wife can take 25% of the £150k tax-free!).

Pension contribution tax relief is a maximum of earned income and £40k, whichever is lower, so it'll take at least four tax years to feed all this into a SIPP. Are your wife's earnings likely to be above £40k? The £40k allowance will be reduced by the increase in her final salary scheme. All limits subject to change.

Remember that you can also take the 25% tax free every year rather than all in one go: so your wife could take ~£16k out of the the SIPP each year before the other pensions come on board if you need to spend more.

5% WR with state and DB pensions around the corner seems perfectly reasonable to me.

MisterA

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Re: tax free 25% pension allowance / tax planning
« Reply #4 on: April 07, 2021, 08:56:47 AM »
Pension contribution tax relief is a maximum of earned income and £40k, whichever is lower, so it'll take at least four tax years to feed all this into a SIPP. Are your wife's earnings likely to be above £40k? The £40k allowance will be reduced by the increase in her final salary scheme. All limits subject to change.

Remember that you can also take the 25% tax free every year rather than all in one go: so your wife could take ~£16k out of the the SIPP each year before the other pensions come on board if you need to spend more.
Thanks.

No, my wife doesn't earn above £40k (unfortunately!). Spare pension contribution can be carried forward, by up to 3 years which will help. But yes, that could be an issue, I need to check my sums.
https://www.gov.uk/guidance/check-if-you-have-unused-annual-allowances-on-your-pension-savings

vand

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Re: tax free 25% pension allowance / tax planning
« Reply #5 on: April 07, 2021, 09:25:55 AM »
It depends if you want a lump sum to do anything with.

If not, they you can just simply crystalize the maximum tax-free amount each tax year and live off that, and meanwhile put all your wife's income towards her pension, at least down to below the £12570 standard band lower threshold.

MisterA

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Re: tax free 25% pension allowance / tax planning
« Reply #6 on: April 08, 2021, 06:29:59 AM »
If you take the 25% tax free money from one account, they convert the remaining value into a different type of account, and (obviously) you can't take any more tax free money.

I have several different SIPP accounts. I'd like to be able to take 25% tax free from one of my accounts, whilst leaving the other accounts (different providers) untouched. But, I don't think that this is possible (or legal!). If it were possible, you could take the tax free money from one provider, then pay it into a SIPP with a different provider, and gain more income tax credit.

And once you've taken tax-free money, you're limited as to what you can pay into a SIPP. I think it's about £2800/year.

Getting the best benefit from the 25% tax break, and minimising income tax paid in retirement takes a little thought. You could easily get it wrong in a multi pension, 2-person set up, like mine.

Playing with Fire UK

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Re: tax free 25% pension allowance / tax planning
« Reply #7 on: April 08, 2021, 07:08:37 AM »
Do check the guidance and the rules at the time, but I don't think the pension carry forward gives you the tax uplift.

PhilB

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Re: tax free 25% pension allowance / tax planning
« Reply #8 on: April 09, 2021, 04:55:13 AM »
I like the overall plan.  The key limiting factor is that the maximum gross amount you can put into MrsA's pension is the total of her pretax earnings over the period in question.

Unfortunately you have just missed the last tax year, but I  would suggest therefore that you start crystallising in the 2021/22 tax year to give you the funds to put 100% of Mrs A's gross earnings (less any pension contributions she's already making) into a pension.  Eg If she earns £32k and pays £2k of that into her DB scheme then you contribute £24k into her SIPP to be grossed up to £30k.  Repeat each year until she stops work - or at least until you have enough in there to fully utilise her tax free allowance for the period between stopping work and DB / SP kicking in.

It's vital that you don't take anything beyond the tax free portion out of your own pensions whilst still working as then your own annual allowance would permanently drop to £4k pa.  Once you are past the last tax year where you will be contributing more than this, you could withdraw your PA each year to go into MrsA's pension and possibly even more than that if you haven't yet filled her pot.

Then you will just be left with the challenge of actually spending some of that capital in the period before the pensions kick in - which believe me can be harder than you might think!

MisterA

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Re: tax free 25% pension allowance / tax planning
« Reply #9 on: April 09, 2021, 01:28:29 PM »
Do check the guidance and the rules at the time, but I don't think the pension carry forward gives you the tax uplift.
I hadn't considered that, but fortunately it's not the case. This from iii:

This means, you can receive tax relief on pension contributions which exceed the usual £40,000 annual allowance.

https://www.ii.co.uk/pensions/contributions/carry-forward-rule

MisterA

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Re: tax free 25% pension allowance / tax planning
« Reply #10 on: April 09, 2021, 01:40:42 PM »
Then you will just be left with the challenge of actually spending some of that capital in the period before the pensions kick in - which believe me can be harder than you might think!
Thanks for your thoughts (everyone).

Regarding drawing from the capital, I agree. I'm currently so focussed on not spending (I'm obsessed), and nurturing my stash, that dipping into it won't be easy. Especially in the knowledge that I'll never ever be able to replenish it from earnings.

PhilB

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Re: tax free 25% pension allowance / tax planning
« Reply #11 on: April 10, 2021, 01:35:21 AM »
Do check the guidance and the rules at the time, but I don't think the pension carry forward gives you the tax uplift.
I hadn't considered that, but fortunately it's not the case. This from iii:

This means, you can receive tax relief on pension contributions which exceed the usual £40,000 annual allowance.

https://www.ii.co.uk/pensions/contributions/carry-forward-rule

True, but only if your the amount contributed doesn't exceed your earnings in the tax year you make the contribution.  The limit to get tax relief is the lower of AA plus carry forward, or your relevant earnings.

 

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