What caught my eye this week.

Unlike some vocal Monevator readers, I’m nearly all-in on the cashless society.

I even have a long-running email thread with a few sceptical and long-suffering friends, where I goad them with statistics about cashless shops and restaurants, and stories about homeless people taking donations via their own QR codes.

They post counterpoints, of course. Usually something about how Great Aunt Beryl can’t use a smartphone. Or how making all payments digital will only enable the surveillance state.

That’s fair. There surely are still too many Aunt Beryls around for us to go fully cashless. And though there’s nothing much I can do about it, our privacy protections are too feeble for me to be completely comfortable with the paperless spending trails our taps and swipes leave behind us. Even if “you only need to worry if you’re doing something wrong” as the complacent always say.

Okay, but what if my wrong is my own (romantic) affair or – more sympathetically – an escape fund that I’m amassing to get away from an abusive and controlling partner, rather than a matter of public safety?

I believe there are ways around these concerns, both technological and legislative. Whether we’ll see them is another matter.

But in any event I’m not sure what we can do about Amazon going down.

Unable to connect

Yes, the vulnerability that hogged the limelight this week when the hyper-scaler’s AWS cloud service went offline was a dry run of another of my pals’ concerns.

Their Doomsday version includes EMP weapons in space that knock out the payments rails, alongside anything else with an electronic pulse. For my part I contend we’d have other problems in such a scenario that a wallet with a few tenners wouldn’t solve. Not least the tills not working!

But putting that debate to one side, according to Which:

A service outage at Amazon Web Services (AWS) […] caused widespread disruption, taking down millions of major apps and websites – including HMRC, Snapchat and Duolingo.

As the world’s largest cloud computing provider, AWS underpins many online platforms through its storage and database services.

The issue has also affected some of the UK’s biggest banks under the Lloyds Banking Group umbrella, leaving many customers unable to access mobile or online banking.

You can add Royal Bank of Scotland to the list too, according to This Is Money.

Customers of the affected banks were unable to access their apps – although I presume physical credit cards continued to work.

But then I no longer even take a credit card out of the house except on special occasions, let alone cash.

Well over 95% of my spending is done via my Apple Watch. That includes just getting around the Tube (which still feels like magic).

But I admit this week’s outage gave my cashless evangelism pause.

Restore from backup

The immediate fix is to have more than one bank account – with the second bank being one that works with a different cloud provider.

From This Is Money:

The main way to protect yourself if your bank goes down in an outage is to have a second bank account with access to online banking.

Though Lloyds and the banks across its brand were down, other banks for example First Direct, Monzo, Starling and Chase were not affected.

You don’t need to keep a huge balance in it but it should have enough to cover you if you need to go to the shop and for essentials.

This is good advice, similar to why I suggest spreading your assets between different platforms in case of failure, even if you expect to ultimately be made whole again through regulatory protections.

That’s because there’s a hassle factor if all your investments are inaccessible in the meantime. Hence redundancy protects you from more than just loss.

Same with spending money, if all your money is only accessible via one bank for a time.

Registry not found

The snag: who knows which bank uses what cloud service?

Perhaps there should be a public cloud register, in the same way that we can consult a Bank of England registry to show which banks belong to the same group for FSCS purposes?

You could then pick one bank that works with Amazon, and another than runs off Google or Microsoft. (At least until they switch…)

I can’t find anything like that in existence. Just lots of stories about cloud providers winning bank business, as well as this ominous piece from a cloud trade publication from 2022:

Prudential Regulation Authority concerned over banks’ reliance on cloud

The Prudential Regulation Authority (PRA), responsible for regulating UK banks, credit unions, and insurers, plans to increase its scrutiny of major cloud computing providers.

Concerns stem from the growing reliance the banking sector has on the Big Three to maintain its systems and the threat an outage or hack could pose.

As a result, the PRA is looking into ways to access more data from Amazon, Microsoft, and Google, particularly in relation to the operation resilience of their services, the Financial Times reports.

In recent years, Amazon Web Services has struck deals with Barclays and HSBC. Meanwhile, Microsoft Azure and Google Cloud have both managed to partner with Lloyds Banking Group.

Whilst UK banks’ use of cloud computing is covered by the PRA, there are growing worries over the scale of disruption that multiple services failing in unison could cause.

Time to address those worries, I’d say. At the least with a public registry.

Of course there’s nothing in the laws of physics that says all the cloud providers can’t go down at the same time. So having two bank accounts isn’t failsafe.

Ironically, given my stance, I’ve always kept some cash hidden at home. Though that is more in case the credit card payment rails fell over for a bit – and also because some tradespeople will always prefer cash.

Sleep mode

These episodes mostly show us how reliant we are on the cloud as a society, given such services are dominated by just three companies – and hence how protections and failsafes must be a national affair as much as a personal one.

I mean, some people couldn’t even get to sleep due to the Amazon outage.

According to the Guardian:

Customers of Eight Sleep – a smart bed company that connects to the internet to control the temperature and incline of a person’s bed – found they were unable to adjust the bed or the temperature of the bed during the outage because they were unable to connect to the bed in their phone app.

That takes the old adage about having backups so you can sleep at night to another level!

Have a great weekend.

[continue reading…]

In his debut article for Monevator, new contributor The Engineer ponders the imponderable: should he take his tax-free lump sum from his pension before the chancellor potentially takes the perk off him?

Hold onto your hats: it’s Budget season once more! Where will the tax axe will fall this time: rental income, pension tax relief, property, capital gains, or inheritance?

Pick your poison punters.

The contender that has generated the most column inches is the potential curbing or demise of the 25% tax-free pension lump sum – the beloved pot at the end of the long slog of a working life rainbow that is all yours to keep, unmolested by HMRC.

Generally, the advice from the experts is it’s foolish to second guess the chancellor and take drastic steps with your personal finances based on rumours. More specifically, it’s that you shouldn’t take your tax-free cash unless you already have a plan to spend it on something sensible like paying off the mortgage or giving it to your kids.

But ever more people are ignoring that advice. They are grabbing the tax-free cash while they can.

As This Is Money reports:

Mounting fears of further changes to pension rules in the upcoming Autumn Budget are pushing more savers to withdraw from their retirement pots, figures show.

The investment platform Bestinvest said it saw a 33% rise in withdrawal requests from customers with self-invested personal pensions or SIPPs in September […]

Bestinvest said the recent withdrawals were largely made up of those aged over 55 accessing their 25% tax-free cash lump sum, amid concerns that Chancellor Rachel Reeves may slash the tax-free withdrawal allowance.

I too am weighing up the pros and cons.

The media debate is mostly an emotional one. “The government’s going to rob me!” versus “Pensions are great! They’re tax-free!”

However I’m not sure either of those claims is true.

Monevator readers will demand a more sober analysis. Here is my attempt.

Wealth warning and disclaimer Everyone’s tax situation is famously individual, and your pension is a super-valuable and usually irreplaceable asset. This article is not personal financial advice – it’s just one man’s musings about his own situation. Seek professional advice as needed.

A sober analysis of the Lump Sum Allowance

The question under the microscope: in what circumstances would it make sense to take your tax-free lump sum out of your defined contribution (DC) pension and then invest it outside of the pension?

The crux? That future growth on my lump sum could be taxed outside of the pension – ISAs notwithstanding – but would compound tax-free while it’s still inside.

Then again, any growth inside a pension might still get taxed on withdrawal.

Hence we need to compare:

• income tax on pension withdrawals at some unknown point many years in the future

against…

• the compound effect of some combination of interest, dividend, and capital gains tax on my lump sum when it’s invested outside of my pension.

The sheer number of factors at play is mind-boggling. Any attempt at a general analysis is doomed to die in a morass of imponderables.

But maybe we can look at it one factor at a time? Then we can at least establish some guidelines that might help us reach a decision.

For a start, we’ll assume that all pension and tax rules remain unchanged for the duration. (Although we will come back to this.)

Effective tax rate INSIDE the pension

Let’s assume your pension has already reached the old Lifetime Allowance (£1,073,100) and therefore the maximum possible tax-free lump sum (£268,275), now known as the Lump Sum Allowance (LSA).

In this case all future growth inside the pension will be taxed on the way out. If you expect to be a basic-rate taxpayer at the point of withdrawal, say, then this will mean tax at 20%.

Remember this is the effective tax rate on the future growth in the pension. Not necessarily on the whole pension.

I’m assuming here that you don’t have any protected allowances.

Your going rate

It’s unlikely that your marginal tax rate will be lower than 20% later in retirement. The state pension is already using up pretty much all of the personal allowance, pushing most people into the basic-rate band on any additional income.

But it’s possible you expect to be a higher-rate or even additional-rate taxpayer in retirement.

Maybe you have a huge DC pension with protected allowances? Or a defined benefit pension (DB) as well as the DC pension. Or you’ll inherit a trust fund from great uncle Bertie.

In those cases the effective tax rate on growth inside your pension is going to be a lot higher.

Below the LSA

If you have yet to reach the LSA, then 25% of future growth will be tax-free (until you do hit the maximum).

For our analysis, we can think of this as two separate pots:

• The 25% tax-free part on which future growth will be tax-free when withdrawn (at least while you’re still under the LSA)
• The remaining 75% on which future growth will be taxed at your nominal tax rate on withdrawal

This approach reflects the fact that if you were to take out the tax-free lump sum, then the remaining 75% would be taken into drawdown and all subsequent withdrawals taxed at your nominal rate.

So, whilst the rate of tax on the growth of the pension as a whole would be 15% for a basic rate taxpayer (that is, 75% of 20%), the tax on the growth of the 25% lump sum can be considered as 0%.

And an effective tax rate of 0% is hard to beat!

Effective tax rate OUTSIDE the pension

The effective tax rate on growth of a lump sum held outside of a pension is even harder to tie down.

If you have spare ISA allowance, then the effective tax rate on the growth of whatever you manage to squirrel away into it would be zero.

Similarly, it would be zero if you have enough spare tax allowance to accommodate all the future growth, in whatever form.

As for tax rates:

• If you keep the lump sum in cash, money markets, or bond funds, then you’ll pay your marginal rate of tax: 20%, 40%, or 45%.
• Take your returns in dividends and it’s taxed at 8.75%, 33.75% or 39.35%.
• As capital gains it’s 18% or 24%.
• If you invest the lump sum in low-coupon gilts (directly held, not in a fund), then your effective tax rate would be very low, perhaps 1% or 2%.

Most probably your effective tax rate outside of a pension will be a combination of more than one of these, depending on your asset mix. In this case the rate will land somewhere in the middle.

Or perhaps it’ll be something very different if you’re prepared to take on truly esoteric tax planning.

What could be – ahem – simpler?

Comparing the tax rates

Obviously, if withdrawing the tax-free lump sum is going to work then I need to keep the effective tax rate on growth outside of the pension below the effective rate inside.

If you’re below the LSA, then you can’t beat the 0% effective tax inside a pension. The best you could do is match it with spare ISA and tax allowances.

If you’re above the LSA then some further thinking is needed.

The graph below shows the value of £1,000 lump sum invested outside a pension for 20 years (Y-axis), with a 7% growth rate, assuming varying effective tax rates on that growth (X-axis):

Here we’re comparing that lump sum growth (cyan line) against the same £1,000 tax-free lump sum held inside the pension and subject to a 20% tax on the growth when its withdrawn (pink line).

Again, note this is the tax rate on the growth only. The original sum is still tax-free whenever you decide to take it out. And we’re only thinking about the tax-free part of the current pension here.

So… eureka! With a lower tax rate the lump sum withdrawn will be worth more later!

“No shit, Sherlock“, I hear you cry.

Ah but it’s not quite that simple. You’ll see the lines in our graph don’t cross at 20%. Even if we have the same effective tax rate both inside and outside the pension, the lump sum outside the pension still loses.

Taxing matters

This is because there is a cost to paying tax as you go along, versus paying just once at the end. (It’s for the same reason that annual fees are so insidious.)

More graphs required, clearly.

Below the difference for the same £1,000 tax-free lump sum is illustrated for varying investment durations – that is, how long the money is invested for before being needed – and again assuming 7% growth and an effective tax rate of 20% both inside and outside the pension:

And now for a varying growth rate assuming a 20-year investment duration:

This shows that the damage done to your lump sum outside the pension grows with time and growth rate. It arguably suggests that high-growth long-duration investments are best left inside the pension.

But wait! That high growth and long duration might mean you end up paying a higher tax rate on withdrawal from the pension.

So perhaps it’s better to get it out early?

Also, I’ve assumed capital gains tax is paid each year. Whereas in fact it could be left to accumulate and be paid at the end of the period. Although that too might not be a good idea.

Enough! I have fallen into that morass of imponderables. Let’s just say that you’re going to need to see some clear daylight between the effective tax rates to make withdrawing fly.

Asset allocation

Some of this discussion on tax rates has implications for asset allocation.

If you have spare ISA or tax allowances, then the world is your oyster. Fill your boots with any asset class you fancy.

If, however, you’re trying to minimise your tax rate by allocating to higher dividend-paying assets or direct holdings in low coupon gilts, then you’re making decisions on asset allocation.

And it’s almost certainly not wise to change your asset allocation solely to get that clear daylight between effective tax rates.

If you were already planning to include higher dividend assets or gilts in your portfolio then great. Move that part outside of the pension.

Otherwise, best to knock the whole thing on the head. 

Inheritance

The tax-free inheritance of pensions will be gone by 2027.

This swings the pendulum a long way towards taking the lump sum sooner. Indeed it’s what has driven much of the increase in debate on this subject.

If you die before 75 then your heirs would currently inherit your pension tax-free. Any tax you’ve paid on a lump sum outside of the pension would have been wasted.

But I wouldn’t be surprised if this perk too is axed at some point. And in any case, you’ll be dead!

If you die after 75 then your heirs would pay tax on their inherited pension. In this case, if it made sense to take the lump sum when you were alive, then it will still make sense when you’re dead.

So not much to sway us either way here.

Known unknowns

Some things could change in future that would make me regret taking my lump sum early.

Such as:

• The tax-free allowance is increased.
• Tax-free inheritance of pensions gets a reprieve.
• The tax rates on unwrapped investments are increased.
• I am beset by riches from a burgeoning new career at Monevator and rocket up through the tax bands. [Um, take the lump sum if this is your concern – Ed]

Conversely, some things could change that would make me feel extra warm inside because I already have my lump sum tucked away in a GIA:

• The tax-free allowance is reduced or axed.
• The lifetime allowance is reintroduced.
• Pension income is subjected to National Insurance or the equivalent in extra tax.

Our soaring national debt makes it hard to imagine that pension rules will get more generous. So on balance, the second set of risks seem more likely to materialise than the first.

That’s not to say that any of these will happen this November. It’s unlikely that the government would suddenly introduce a cliff edge cut to the tax-free allowance, say.

But neither do I think the issue will go away. Somehow, sometime, by a government of one colour or another, I believe it’s probable that pension tax relief will become less generous.

A tax increase on unwrapped assets would be a blow but it’s just as likely that the tax on pension income will be increased. Still, it’s another risk to keep in mind when looking at your relative effective tax rates.

The conclusion

If you think the government is out to get you then you should probably take the lump sum early.

Use it to buy gold bars and guns. To keep in your cabin in the woods.

Otherwise, if you’re still below the Lump Sum Allowance, then you should probably leave the lump sum in the pension, although you shouldn’t lose out if you take the cash and have enough spare ISA and/or tax allowances to accommodate it.

Even if you’re already over the LSA, in my opinion it would probably only make sense to take the lump sum early if:  

• You have retired or have low earnings and therefore your future tax band is unlikely to be lower than your current one  
• You have unused ISA or tax allowances and/or you plan to have higher dividend assets or gilts in your portfolio (as these would all enable you to keep your tax rate down)  
• You don’t expect to die before 75  

This list is not definitive.

You don’t necessarily need all these to be true to make it worthwhile. Conversely, even if they are all true you might sensibly still not want to take the tax-free lump sum now.

You could wait a while and think about it later. The situation probably won’t change drastically in November.

(Probably.)

Decision time for yours truly

Of course it depends on your situation, but the arguments for withdrawal seem to stack up for me. That’s because I’m already at the maximum tax-free lump sum allowance and it makes sense for me to keep this part of my portfolio in gilts.

Even in the absence of any adverse tax changes, if I manage my tax carefully, I should still be up on the deal. And if – or more likely when – the pension tax axe falls then I’m supremely indifferent.

But before I push the Button of No Return, I’ll wait for any comments from you guys.

It’s quite possible the Monevator regulars will point out the flaws in my logic, and I will appear foolish.

Just as the experts in the media forewarned.

We’re certain to get new – even contrary – points raised by sharp Monevator readers in the comments. So even if you’re not a regular commenter, be sure to come back and check them out in a few days.