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.
Just please don’t let it be reintroducing the Pension Lifetime Allowance on 26 Nov.
Going from no LA, via ever reducing LAs, to no LA, and then possibly back to a reintroduced LA, makes sensible planning for the future next to impossible.
And all (so its reported in the press) for perhaps only a few hundred million p.a., peanuts for a government spending nearly £1.2 Tn and collecting already over £1 Tn annually.
Thanks for the interesting article! As a soon-to-be early retiree, I decided to take out the full lump sum. I’m up against the LSA, so I figured any future gain inside the pension will be taxed at least at 20%, since I’ll be already taking at least 12.5k Pa from the pension.
After reading your articles on gilt ladders, I figured the best destination for the funds are Index Linked Gilts, which, as I understand it, have not capital gains tax on the increase on the principal. And the yields are really low, so any income tax is likely to fall under the personal allowance. Also, the lump sum can be gifted to your spouse, something that can make a lot of sense if you are the one with the biggest pension. Currently there is no other way of transferring part of your pension to you spouse (except via death or divorce, neither of which sounds appealing…!)
A solution I am considering is to draw the maximum TFC and invest it in a Discounted Gift Trust with the Prudential, investing in their Prufund Growth fund. This is partially IHT exempt immediately and the balance exempt on survival for seven years. These pay a tax-free income of 5% (for 20 years) The gross return on the prufund Growth fund has been 7.26% p.a. over the last five years and it is a smoothed funds which reduces the sequence of return risk. That fits with my philosophy of having a foundation income in retirement to cover all the essentials alongside the State Pension. Aside from the income, the capital is also secure against long-term care fees if they arise. I am at the maximum TFC so feel it is unlikely to get any more and a good chance it could be less. I’d lose access to the capital but no worse than if buying an annuity.
I am a bit over the LA now, but nevertheless my plan remains to be to take the tax free lump sum bit by bit over 20 years or so, with the aim of avoiding paying higher rate tax.
I’m relying on my bet that the tax free amount will stay frozen rather than disappearing. It’s impossible to know but I think that’s the most likely outcome.
One important point – you say ‘your heirs’ will pay IHT on pension assets after April 2027. I saw no mention that of the fact that there is no IHT between spouses, so if you’re married/civil partnered then IHT only becomes an issue on the second death. Chances of both partners dying before age 75 is much lower than of one, and if one dies early the survivor knows they should get cracking with gifting and spending!
Like PC, think that a continued freeze rather than nominal lump sum reduction is most likely. I also think that further tax increases on investments are more likely to be directed at unsheltered assets than pensions (given the IHT changes already announced). At least in the short term. Perhaps more far reaching reforms will be attempted at some point. But, what do I know.
This article is timely as spouse’s pension has recently shot past the level at which the LSLA is exceeded. I can’t quite bring myself to take the lump sum out though. I just can’t be doing with GIA hassle. (I already have low coupon gilts outside shelters, I really shoudn’t hold more).
@Stephen Francis that sounds like an investment bond, is it?
Good reasons to take it now are:
1) you’ve planned for decades to use tax free lump sum to pay off your mortgage as you enter retirement
2) you planned to gift cash to your children now rather than after you die – so they can get on the property ladder etc etc
3) you planned to retire and upgrade your house with new bathrooms, new kitchen with lump sum
4) you can put lump sum cash in premium bonds and ISA to have 1-3 years cash bucket/emergency fund
5) many many other reasons – you’ve spent your working life planning around the rules/advice given about the importance of saving into your pension
I’ve decided not to take my tax-free lump sum yet, but this threat did make me consider it. Taking it now doesn’t fit with my plan to spend my unprotected funds first. Also after looking into it I think that the government won’t remove the tax-free lump sum because there are too many in the public sector who would be impacted.
“But long-serving public servants, even on relatively modest wages, could be affected by a cap in the lump sums generated from generous DB pensions. This measure, in particular, is almost ‘laser-targeted’ on affecting public sector workers.”
https://insights.lcp.com/rs/032-PAO-331/images/LCP-How-to-avoid-an-%E2%80%98Omnishambles%E2%80%99-Budget-version-two-2025.pdf
Must be a fair chance this will be RR’s last budget and, given the weeping episode, perhaps she won’t mind.
With all her talk about promoting growth I reckon she will major on that which she will present in such a way as she hopes will provide a positive context for the tax hits.
She may put NI on pension payments but doubt it as this would steer money into ISA’s.
For pension stuff, my bets are on reducing the annual pension contribution to say £30k. Reducing the scope of salary sacrifice (this was hugely advantageous to me especially as my employer kicked back their NI), scrapping the NI exemption for pensioners still earning. Not sure why she would touch the pcls.
My circs: mid 60s, just over the LTA limit, drawing pension, and just into the 40% tax bracket most years.
I’ve withdrawn all my tax free cash and invested it in a similar set of global trackers in a general investment account.
Left to compound outside the pension wrapper, growth gets taxed at 24% (CGT). A bit more paperwork on the tax return if my investments were to pay dividends (most don’t).
Inside the pension wrapper, growth gets taxed at 40% upon withdrawal. The investment is also a bit less liquid. And, post 2027, if I fall off my perch it also gets clobbered heavily for IHT *and* income tax.
Pretty easy decision to withdraw the cash.
@getting minted. I really don’t understand the logic of that argument re public sector pensions. Public sector pension schemes haven’t had a compulsory lump sum since the reforms of 2007/8 – so only people with membership from the older (now closed) schemes would be affected anyway. And it would be pretty easy (and usual practice) to protect the benefits from earlier schemes anyway – as has been done with previous pension reforms. Many people (private sector included) have protected tax free cash levels exceeding 25%, for example, or have protected minimum pension access ages below 55.
So, no, its not a measure ‘laser focused on public sector pensions’. (not to mention, you’d need a pension of over £33k pa to be getting a compulsory LS of over £100k, and most are nowhere near that). And tbh the compulsory lump sum is generally well below the maximum 25% level, and the commutation rates are poor value.
It would potentially affect those in DB schemes whose AVCs can be taken as part of the tax free lump sum (which includes LGPS and many private sector DBs, but not the unfunded public sector schemes).
@alchemist, it only gets clobbered for income tax if you die after, say, 2035.
I can see an argument for keeping it in the wrapper before that.
And if you have a spouse still alive it won’t be clobbered for IHT until they die, if they can’t get rid of it before that (but that goes for your GIA too of course).
@getting minted – I just read the article you linked with the quote about ‘laser focused on public sector pensions’. Its talking about the pension tax relief on contributions, not the lump sum allowance. And in relation to that, its quite right – its both practically and politically difficult to withdraw higher rate tax relief on pension contributions because of the impact on certain parts of the public sector (senior doctors, largely – but we have them to thank for the abolition of the LTA too)
Building on Vanguardfan’s comment about the hassle of using a GIA account:
What’s the second simplest thing to hold in a GIA, after low coupon gilts, from a tax admin perspective?
I think I could handle something like BRK.B if it meant I only needed to watch out for capital gains tax.
@alchemist (9)
You say that your GIA investments don’t pay dividends. Is this correct? Even if they are Accumulation units/shares, I understand that there is a potentially taxable dividend payment even though it is reinvested by the fund manager. This was certainly the case when I held unsheltered unit trust accumulation units many years ago (in the era of dividend tax credits).
@alchemist – further to DVs comment, are you able to share which global trackers these are that don’t pay dividends? I don’t *think* I’ve ever come across such a product, but would be interested to be proved wrong on this..
Possibly you are talking about other investments besides those global trackers?
My wife is 56. All her SIPP contributions have received basic rate tax relief but, with other sources of income, she won’t have a huge amount of headroom before paying higher rate tax which we clearly want to avoid . If that were to happen, contributing to the pension in the first place may prove to have been a bad decision because she could have kept the money post basic-rate tax instead.
The headroom will reduce further once she starts drawing the state pension in 12 years or so. We are therefore planning to withdraw what we can to keep her income taxed at only the basic rate even though we have no real need for the money.
I can’t work out if we’re doing this right !
@Vanguardfan #12
Here’s the full quote from that article:
“As discussed earlier, given the relative immaturity of DC saving in the UK (which is the dominant form of provision in the private sector), a cut in the lifetime limit on tax-free cash would be unlikely to affect the large majority of pension savers. But long-serving public servants, even on relatively modest wages, could be affected by a cap in the lump sums generated from generous DB pensions. This measure, in particular, is almost ‘laser-targeted’ on affecting public sector workers.” (Page 18)
https://insights.lcp.com/rs/032-PAO-331/images/LCP-How-to-avoid-an-%E2%80%98Omnishambles%E2%80%99-Budget-version-two-2025.pdf
@SoonToBeEarlyRetiree #2 Thanks! Sounds like a good call.
@PC #4 I suspect you’re right that the allowance will just be frozen, but, as you say, I can’t be sure!
@VanguardFan #5 You’re right of course, no IHT on inheritance by spouse, I should have added that.
I also should have added that there would be some tax to pay on an inherited under 75 pension if the pension was above the old LTA.
In both cases though, the logic stays the same I think.
There are those who are likely to have to pay 40% tax on any future pension withdrawals and also be in the situation whereby on death (from 2027) 40% of any remaining pension will, on death, go in Inheritance Tax as opposed to their beneficiaries, it seems to me to be a no brainer to remove the 25% tax free amount now and give it to your family (if that was the original intention) before Rachel Thieves Budget whereby anything might happen, which of course is likely to be for the worse.
@getting minted – I missed that bit, the article seemed focused largely on tax relief on contributions. In relation to lump sum reduction I still disagree, for all the reasons I gave above. (Though I suppose it depends what the writer means by ‘relatively modest wages’. You’d have to be on £66k final salary with 40 years in a pre 2007 pension to be getting over £100k, in most of the schemes. Or £88k for 30 years, etc etc)
@tetromino, from a purely admin POV, the simplest thing to hold is cash or money market funds. They just spin off taxable interest. Certainly not the most tax efficient option though.
As for BRK.B, its the CGT element that is the headache. A bit of extra taxable dividend income (or interest) is neither here nor there.
@Vanguardfan #10
It may depend on how many remain in the old schemes where a lump sum is compulsory and how many in the new schemes would opt to take the lump sum. If the government is clumsy on this they could have more public sector strikes and/or more senior staff retiring early. Any opt-outs for this would need to apply to both public and private sector pensions and would reduce the tax taken. I’m hoping that they think it’s too difficult to end the tax-free lump sum.
Not a decision I face yet but have started to mull it over, hence some half-formed thoughts…
If you’ve already achieved the maximum tax-free cash due to the size of your pension, meaning it’s 25% or less of your pot, won’t future inflation alone erode the value of the tax-free element in real terms going forward, assuming it remains frozen at £268,275? That might be a reason to take it early, if you’re going to take it as a lump sum.
If I was making the decision today, I’d be leaning towards taking it and putting it in a mix of index-linked gilts, global equities and commodities, which should be taxed at a lower rate than future pension income.
My main reservation would be potential pension rule changes in the next couple of decades which might offer an opportunity (even if fleeting; 12-month window) to do something more efficient. Few could have anticipated the pension rule changes in the past 25 years, and like it or not, we may have a new (radical) party in power soon. However, the trend is towards a less generous system.
I wouldn’t be panicking to act pre-Budget as experts tend to agree any change will be signposted in advance.
If we’re in a bubble and equities halved from today, suddenly you could have headroom in your tax-free amount again. However, if already extracted and invested in equities outside the pension, capital gains tax won’t be an issue for a while.
The pension wrapper is attractive for simplifying transactions and paperwork, but not a huge factor.
@Matt, seems sensible, but there are various other factors to consider to be optimal. It may be worth considering one-off advice from a tax planner who can forecast your situation (as a couple) over your lifetime to spread out taxable income and minimise the overall take. Alternatively, if you prefer DIY, I’ve seen a few recent YouTube videos with case studies featuring UK couples that might help.
@Matt (16)
There is an attraction for your wife to withdraw what she can from her pension at basic rate while she can. However, if she has no immediate use for the money and invests it in a GIA or savings accounts, over time the income and capital gains from the investments will only add to the problem of potentially breaching the higher rate tax threshold. If any excess over immediate requirements can be fully invested in an ISA, then there is no problem. If left in a SIPP, access to the income can be done in a controlled manner, but only if any headroom is still left.
Matt (#16) raises an important issue. Promoting pension contributions (above the “free” amount from employer) for basic rate tax payers early in their careers is arguably gross mis-selling / mis-advice these days given the way tax rates are now, and the way that the 40% threshold gets ever lower in real terms. The alternative of investing through an ISA would either be same outcome (if one isn’t a higher rate tax payer in retirement) or much better (if one ends up in the higher rate band in retirement).
Tetramino #13. I’ve taken out the sipp lump sum recently. Saw no downsides in my specific situation and the possible upside if the rules are changed etc… Opened a GIA for the first time. As well as short term gilts (that will fund ISAs over the next 2-3 years) , I also put a small amount in a barbell strategy that minimises dividend income : 50 – 50 in a gold ETC and in SMT (Scottish Mortgage Inv. Trust) . Gold for the all goes pear-shaped situation & SMT for the Trump’s a genius & AI turns out to be true case.
May be not this time round, but eventually, I think the large amounts now in ISAs will make the Treasury envious. They have been running now for more than 25 years in one form or other – some folk have got quite chunky holdings – there are “ISA Millionaires” apparently. Some sort of overall cap on ISA holdings might appear similar to the pension cap idea
Great post @The Engineer – welcome to the team!
If I was over 55 I would absolutely take the Tax-free lump sum now. I’m well over the LSA, and I’m going to be a higher/additional rate tax payer in retirement – now that I kind of HAVE to draw down my SIPP. Prior to the IHT changes – I would have just drawn down what kept me in the 20% tax bracket – and left the rest to my heirs. Now I’m going to be paying 40%-45% on it (plus NI?!?!?). So to my mind: growth in pension taxed at 45% + IHT. Growth outside pension taxed less than that +IHT, because some component would be CGT.
@Mr Optimistic – I too worry that she’ll make salary sacrifice NI-able. That may prompt me to stop working. My employer also kicks back employer NI, so to my mind I’m just reducing my tax rate from 62%/47% to a more reasonable 37% (sometime in the future) on a chunk of my income.
If they make pension income NI-able – if they could just wait till I’m old enough to draw the whole thing down in one go, before implementation, that would be great!
@Vanguardfan – “its both practically and politically difficult to withdraw higher rate tax relief on pension contributions because of the impact on certain parts of the public sector” – why not just have different rules for the public sector? We already do (see, High Court judges and the LTA). And since the govt both pays the wages and collects the tax bill, they could just make them whole.
This whole article (which imho is great) is a classic example of making life difficult for clever people who have worked hard and saved quite a bit (or are saving quite a bit). They now have to spend a silly amount of time moving pots of cash about from one bucket to another. What a waste of resources and this is just for the people who have a pension pot around 1M and a bit of other monies in other pots. Imagine what it’s like for the top 2% who pay most of the tax revenue. Eventually people who can move will simply say enough is enough I am moving country its easier than juggling all this money around based on this years budget (we have so little steady as she goes now government). This will have obvious consequences from tax income and the managed decline could become a rout. Hopefully not but its such a silly state of affairs which has been self induced in many ways through austerity (in low rate times), Brexit and the fact that many people want something without paying or waiting for it. The number of places we can now put cash (low rate gilts, premium bonds, ISAs) means that there are places but for the ultra rich this is frankly peanuts. I wish they could set a budget for 5 years stick to it and remove the politics I mean put 2p on income tax and then we can all spend time thinking about making more money rather than trying to avoid paying taxes.
Very fortunately I reached 55 recently.
No hesitation for taking the lump sum. Seemed like total no-brainer.
Am choosing accumulation units or funds & ETFs in GIA accounts – hadn’t relalised may still be subjected to dividend tax. Will have to do more research. Hope not true.
To get a true idea of what may come in this or next years budget regarding LTA’s etc, one needs to read the thoughts of Torsten Bell. He is the one advising Reeves on this budget and probably will be for the foreseeable. Would not be surprised if he was the next chancellor. Would keep the ‘far left’ part of the party happy.
Don’t be lulled in to a false sense of security by thinking that any revenue raised by making changes to the LTA is not worth bothering with. It is not always about the ‘money’ for these people, it is about hitting people that have been prudent enough to save this amount of money vs the ones that haven’t. They see this as ‘unfair’.
The argument they use is that they are “protecting” soon to be retirees from themselves so that they don’t run out of money in their retirement even though the truth is that all is needed is a rebalance of ones portfolio by using the tax free allowance for your low coupon gilts etc and filling ones ISA each tax year.
I took my tax free allowance before last years budget, topped up two years worth of ISA’s (my wifes too so that is £80K taken care of) and the rest is in short dated low coupon gilts. Next April another £40k will transfer into our ISA’s leaving £148k still in the low coupon gilts some of which maybe used for income until the following years ISA requires topping up.
You won’t find a (“he blew his tax free allowance on a”) Ferrari on our driveway.
@ Algernond – https://monevator.com/income-tax-on-accumulation-unit/
https://monevator.com/?s=tax+on+accumulation+units&id=74717
It very much is true. But your friends at monevator have a few articles on that to help you.
I suggest you switch to income versions of funds asap.
@finumus – the practical difficulties apply to any DB pension, and yes, there are still some outside the public sector. Politically not so much. Also fiscally, if public sector pension suddenly lose a significant amount of funding due to reduced tax relief that would be a big problem. The issue is who would pay the shortfall – employees, employers or govnt? (yes I know the first two are ultimately govnt too but different accounting)
Yes, it had occurred to me that DB pensions could be subject to some different rules about contributions. But didn’t get further than the thought.
The current Pensions Minister authored the paper below in 2019. The section “Fairer pensions tax relief” outlines his thoughts on the tax free lump sum, and suggests capping it at £40k. As he is now helping the Chancellor with the upcoming budget, I would suggest the probability of changes in this area is quite high (although I would be very surprised if it was immediately reduced to £40k). I am taking the tax free lump sum now, don’t want to be caught on the wrong side of any changes that do occur.
https://www.resolutionfoundation.org/comment/how-wealth-taxes-can-raise-billions-more-without-scaring-any-horses/
@all — Just as a heads-up, a few more comments on this one than usual are getting flagged as spam. I think I’ve retrieved them all, but if you’re wondering where your comment is maybe you’ll find it’s now in the thread. Not sure exactly why it’s happened, as often there’s no links and in at least a couple of places the posters aren’t new.
Perhaps spammers have been focussing on the lifetime allowance a lot and the filter is trained accordingly? I guess that would make sense.
But please don’t let this stop you commenting — I am on top of it, keep ’em coming. 🙂
I think it is worth pointing out that if you have already taken some tax-free cash, it is not necessarily straightforward to work out what remains of your £268,275 LSA. The actual amount that you are allowed to take is initially calculated from the proportion of the former Lifetime Allowance that you have used. This was notified to you when you crystallised a pension and on subsequent P60s. On recent P60s the amount of LSA deemed to have been used is shown. However, this calculation is based on the assumption that you took the full 25% of the value of the crystallised pension as PCLS.
There are at least two reasons why this may not be the case: e.g. you chose to take less than your maximum PCLS entitlement (particularly relevant for DB pensions); it was an older pre-2005 pension that had a different tax-free cash entitlement.
However, if it is advantageous to you, it is possible to calculate your remaining LSA entitlement based on the actual cash taken earlier. To do this it is necessary to apply for a Transitional Tax-Free Amount Certificate (TTFAC) from one of your pension providers. Naturally, it is necessary to have full written evidence of the cash previously taken, and I believe it is essential to obtain the TTFAC before accessing any further tax-free cash or crystallised any further pensions. It is not clear to me whether the TTFAC needs to be issued by one of the pension providers that has already paid tax-free cash or can be the provider that you now want to pay you tax-free cash. Presumably, if the rules allow, the latter may be the simpler option.
Surely the main issue is whether the Chancellor could enact such legislation to curtail PCLS immediately on budget day (or at midnight) or if there’d have to be a delay. The latter seems more likely to me, since platforms and pension schemes would need notice to update their systems. Much more likely that any such change would apply from 6th April, potentially with some kind of protection in place for those turning 55 before a certain date. For that reason, it seems more reasonable to me to wait until budget day before making any moves if you weren’t otherwise going to withdraw a PCLS.
In general, it seems that most tax changes would require notice to allow platforms, payroll providers etc. to update their software (other than straightforward increases in existing rates like the CGT change last year), so you might as well ignore budget speculation and see where it all falls on the day.
Happy to hear contrary opinions if anyone more in-the-know that me can explain how such big changes could be implemented straight away with no notice to pension schemes and platforms.
I took mine in Oct 2024, then thought better of it and repaid it under a 30-day cooling off period offered by AJ Bell in November 2024.
In Dec 2024 HMRC ruled that there is no cooling-off period for this type of transaction, and said they would pursue future cases. They’ve said nothing about past ones though.
So I, and an estimated 6,000 others, are in complete limbo, wanting to take the lump sum but not knowing whether, if we do, we’ll be deemed to have done it twice and/or broken other rules.
F*** About and Find Out, I suppose, but it is incredibly frustrating and worrying. I have 2012 protection and in the worst case could lose £300,000 over this.
I would love to be able to wind back the clock and not repay. With fully-utilised ISAs and actuarially likely to live beyond April 2027, I see no downsides to not taking it.
Super article, thanks @TE
Although not quite to the lofty heights of bumping up against the LSA, nevertheless we fire end this FY. This makes the TFLS decision pretty straightforward with a scenario quite similar to TA’s catfood model. Having landing places for the TFLS of about 40% of my SIPPs (conveniently the total of my ii SIPP); no brainer to pull this out in advance of the budget. Simply a risk I don’t have to take.
An additional implication to those eloquently expressed elsewhere, is that selling this sum to cash (some went to topping up an ISA but not reinvested yet) is another way of further derisking a bubbly portfolio ref: TA’s excellent piece on Tuesday.
(H/T to ii – they made this very easy and very quick)
If you combine Premium Bonds (almost instant access cash), low coupon gilts, and CGT-free Jimmy O’Goblins buried in your back garden or vaulted at, for example, the Royal Mint, you can presumably devote ISAs entirely to equities if that is your taste in investment. And ditto for your spouse.
Pay to put the grandchildren through medical school … whatever helps to arrange that your children and grandchildren will prosper not only for their own sake but just in case you or your widow might need their financial help in future.
Of course a socialist government will attempt to tax you more, even if only for “peanuts” – their joy presumably lies in exercising their resentments not really in rescuing the public finances.
@Rhino et al
Income units of ETFs can have excess reportable income too. For example, VWRL declared ERI of $0.0215 per share in 24/25 tax year. Clearly, it takes quite a few shares before it becomes significant.
See https://www.vanguardinvestor.co.uk/investing-explained/general-account-tax-information and scroll down to the section marked Reports to Participants (current and previous years) where you will find various reports (Excel format).
The VWRL info I quoted above can be found in the Vanguard Funds plc section, report titled VF plc Excess Reportable Income: 30 June 2024, cell K306.
@Curlew, Rhino et al.
Is it really worth bothering with reporting every miniscule amount? A friend of mine doesn’t bother reporting *anything* of this nature to HMRC, despite, for example, trousering £180k from Tesla shares (five years ago) and £30k from Rolls Royce (five minutes ago). Absolutely zero comeback from HMRC. If they don’t chase fellows such as these, are they going to be bothered if there’s a fiver that’s been underpaid?
One thing I’m not clear on is:-
If you have taken the tax-free amount, what is the best asset allocation outside the SIPP vs inside?
Option 1- Logic dictates that since everything in the SIPP will now be in drawdown and eventually taxed on withdrawal, better to put bonds in SIPP (lower growth) and equities outside. Once the equities are safely in ISAs (after a few years of siphoning them from the GIA), they’ll grow tax free, so it makes sense to put the highest growth portion there.
Option 2 – The counter argument is that until you can get everything out of the GIA and into the ISA, there will be a bigger capital gains tax, so best to allocate it to bonds.
(FYI I’m not suggesting changing overall asset allocation equity vs bonds – in practise there will likely be a mix of equity and bonds in the SIP)
In the end, I went with option 2 and put the tax free amount into an index-linked gilt ladder and will use this for tax-free spending in the few years. But I do worry that I’m missing out on future tax free growth by not taking option 1.
No it doesn’t, please keep non-constructive political points off these non-political threads. (Ditto Rachel “Thieves” earlier in the thread, and ditto anyone who wants to express my view of the previous ten-year long administration that helped put us in this position in the less than flattering terms I’d use in the pub…)
I’ve left your comment in because the top two-thirds were useful, especially the point about children and future needs. We do seem to be edging back towards that kind of feudal outlook re: wealth and inheritance, especially if you consider how ‘cascading’ Boomer wealth is meant to be the salve for (some of) the younger generation.
@GG – very hard to say whether its worth bothering or not. Some significant sums that your friend hasn’t paid any tax on there. I don’t know how HMRC go about policing that? I did once get pulled up by them many years ago in my early twenties for claiming job seekers when unemployed but not accurately declaring my savings. It was a very unpleasant experience.
From a cynical perspective it seems highly plausible that they would go after the benefits end of the spectrum rather than HNW individuals.
One year I did bother going into the weeds of incorporating ERI calculations into my tax return, but I only did that once! It was painful. I do declare dividends on Acc units, but that’s as far as I go now. I also overestimate any CGT (i.e. pay more than I should) on Acc units as the calcs to deduct tax already paid on the dividend component are also too painful. Long and short of it – never buy Acc units in a GIA. I still have it on my TODO list to see if there is a broker who will exchange Acc for Inc units without triggering a disposal, so no CGT implication. I’ve heard HL may do it – IWeb won’t.
Frequent reader but first time commenter. The article focuses on the effective tax rates of any growth inside the pension wrapper. However, I was confused by how this was phrased and had to re-read it multiple times. To be clear if anyone else was also confused: the entire withdrawal (beyond the 25% tax free lumpsum) will be treated as income and taxed i.e. includes the entire pension sum, both the original contribution as well as any growth thereof.
It may not have been the author’s intention to imply otherwise at all and it may just have been me who was confused but wanted to comment in case helpful for anyone else!
My worry is maybe a limit on what you can contribute to ISAs once they hit a limit e.g. once an ISA is over £100k, no further contributions. Politically, this would be pretty painless and easy to implement. This would affect me, so not keen, but what is the rationale for potentially unlimited ISAs?
On SIPPs, maybe introduce RMDs, say 4% of the SIPP balance on April 5th each year from SP age? Though this may not be necessary now they’re subject to IHT so people should be spending them down anyway, though it would bring tax revenues forward rather than having to wait which would be attractive.
OT, but remember that it’s UK clocks back one hour at 02:00 BST on Sunday 26 October.
Personally, I always say, “Forward at the front of the year, back at the back of the year”, eschewing the potential doubt of springing forward or springing back, and falling back or falling forward.”
Just saying, as they say 🙂
@Curlew (40)
Accumulation units of ETFs can also have excess reportable income (ERI). For example, the accumulating version of VWRL, that is VWRP, had an ERI of $2.0630 per unit, as shown in cell K18 in the Vanguard spreadsheet you reference. I assume that this amount combines the equivalent of the dividend distributed in VWRL plus the extra ERI of VWRL. Comparing the overall figures does not match exactly but is close.
Arguably, given the requirement to report ERI for unsheltered foreign-resident income ETFs in any case, it is actually easier to report the composite ERI for accumulation ETFs. This is the reverse of the conventional wisdom to only hold income units in your GIA. This certainly still applies for OEICs.
I’ve done a fair amount of analysis on this topic recently, using a cashflow modelling tool to model a range of cases to answer this question (about whether to take a tax-free lump sum early) and a closely related one (about when it makes sense to stop saving into a DC Pension) for another Personal Finance channel.
From this analysis, a significant factor in the decision – at least for some cases – was the effect of the notorious “fiscal drag”, which is worth flagging both because of its significant effect, and because it hasn’t been mentioned in the debate. In summary, fiscal drag has the potential to put pension withdrawals into a higher rate tax band than an individual might be in now, when the pension withdrawals are made in (say) 10-20 years’ time. Within this, the biggest potential bugbear (at least for those higher earners with sizeable pension pots) is the £100,000 threshold where the Personal Allowance starts to be withdrawn and the marginal tax rate moves up to 60% from 40%. Whilst the government (currently) has plans to end the freeze on indexing the Basic and Higher Rate tax bands from 2028, there is no current plan to start indexing the £100,000 threshold, which has been fixed since it was introduced in 2010 (15 years ago!).
The compounding effect of inflation means that, whilst many will think they are well away from needing £100,000 (gross) income to fund expenses now, that may not be the case in 10 years’ time. After all, at current inflation rates (3.8%), it would only take 5 years before the PLSA’s Comfortable Retirement for a couple (currently £60,600pa) would need a gross taxable income over £100,000 to fund from a single, main earner’s retirement pot with the LSA already used up. So not too far away for many.
Whilst it’s clearly hard to predict the future tax regime 10-20 years from now, there has so far been little or no public debate about indexing the £100,000 threshold, and this seems unlikely to happen soon given current fiscal pressures on the government.
So, if you’re someone currently paying higher rate tax on earnings, saving into a pension to receive higher rate tax relief, whose pension savings are sizeable and whose taxable income (including pension withdrawals) in retirement in 10-20 years’ time might need to exceed £100,000 to fund planned retirement spending, it’s something to consider in your plans. For those potentially affected, and to the point of The Investor’s article, taking a lump sum early and reinvesting in an ISA/GIA can help reduce the amount of tax on pension withdrawals incurred at the effective 60% rate later in retirement.
I’m 63 and thinking of taking the maximum tax-free allowance and buying an annuity with it.
My logic is:
a) the maximum TFA will be reduced either now or sometime soon
b) annuity rates are currently competitive
c) TFA will be taken from equities in my pension that are currently close to record levels
I would welcome any comments on whether this seems a sensible option.
Excellent article, and it is a real conundrum. It’s complicated further if you’re thinking seriously about relocating to another country as we are. The advice is always to take a TFLS before moving as it won’t be recognised as such later. Also we thought it might be useful to fund a house purchase to avoid having to put things in storage on selling our UK house. The other side of that is that income from SIPPs is generally quite straightforward in terms of tax in other jurisdictions whereas ISAs are of course not recognised abroad, and would be subject to CGT and dividend tax. So it’s something I’ve been thinking about but haven’t as yet made a decision. (Other than to change any Acc funds in the ISA to income.)
@Brod – I just had a relative from Canada staying with us, their ISA equivalent has much lower contribution limits and they also have RMDs on their SIPP type vehicles. I only had a few years where I was able to use the full ISA allowance so I think that would be an easy target, either in terms of annual contributions or a lifetime contribution limit.
Though as he said, the reason we agonise over this stuff is that we have choices, choices that often did not exist in the past, and that also do not exist for the majority of people today.
@Dave Hedgehog
The contrary view is that we already have the Lump Sum Allowance – current value £268k. It is already coded into pension platforms etc. So in theory reducing it to say £100K could be done quickly via a simple change. This assumes no kind of protection is implemented for those not quite 55, or whose plans are based on the existing value. An immediate reduction without protection would be very disappointing (and I think is unlikely to happen) but I do not think it can be totally ruled out on the basis of implementation complexity alone.
I’m desperately hoping the PCLS is left untouched. It’s formed a key part of my financial planning for a couple of decades, so changing it now would seem grossly unfair. (Even wealthy people deserve fairness.) I’m already having to wait an extra 2 years to access most of my pensions because I’m 3 months too young, and I fear I’ll be too young to make use of any transitional protection too.
I’m also sceptical of how much tax would be raised by lowering it. If it went to £100k, then if I still took £268k in one go I’d pay an extra £80k tax, I think – but I wouldn’t actually do this. My behaviour would change. Instead of taking it and spending it – on things that incur VAT or Stamp Duty and stimulate the economy – I’d keep it hoarded in my pension for many more years.
@DavidV (48)
In reference to accumulation units and the first sentence of my comment, and echoing the Spartans to the Macedonians: too
Very good article with lots of considerations for calculations that will need an enhanced version of AI agents in the future – Hopefully, there will come a Finance-AI agent(s) which will be useful to portray these calculations and give answers at the click of a button.
Nice article The Engineer. Thank you.
@Larsen
One great element of the Canadian equivalent of ISAs (TFSAs) is you appear to be able to carry over unused allowance to future years, and unlike ISAs not all allowing flexible withdrawal you can repay withdrawn amounts in following years as part of this rolling over mechanism.
It would be an unexpected and welcome outcome if as a result of this tinkering with pension and ISA allowances expected in the budget that we end up with some form of allowance rollover. It would seem to benefit those less well off better than the current system as well, since they could accrue allowance underused in lower earning years and hopefully make use of it when earning more later on.
@ Hapshade – thanks, you prompted me to look at the TFSA in more detail. The flexibility does seem like a very good feature, I note the maximum contribution in 2025 ( without unused allowance from previous years) is 7000 CAD, about 3800 GBP.
@Prince B: “taking the maximum tax-free allowance and buying an annuity with it.” That would be converting a tax-free sum into a partly-taxed income stream (unless your other income is so low that the annuity paid no tax).
On the other hand if you bought an annuity with some of the non-TFLS money in your pension then the annuity would all be taxed (same proviso) while the TFLS might generate tax-free income and capital gains if you invested it suitably.
I withdrew the last of my TFLS recently. It’s surprisingly hard to say where it’s gone except that I suppose much of it went on decoration and repairs to our house, most of the balance to repaying part of a debt, and a little bit to savings.
We’ve long underspent the common rule that you must expect to pay 2% per annum of the value of your house on its upkeep. That’s been catching up with us in the last couple of years. Can’t grumble: it’s a result of decisions that were reasonable at the time.
For a potential £268k PCLS person like you – for me the comparison is
1. Most likely – £268k still available tax free, but growth all taxable at 40% if left in pension, or more likely 40%IHT + 40% Marginal tax. Outside about 0%-25% tax probably – reducing as ISA allowances become available.
2. Less Likely – £268k limit reduces to £100k – so the remaining £168k is now taxable at 40-60-45% – or more likely it will never be withdrawn – so effectively 100% for you – or 40% IHT + 40% Marginal Tax.
For people with say £150k – its an interesting dilemma – normally for this sort of thing I would hedge – and take £75k – however in the case of a risk of the allowance dropping to £100k – the hedge is £125k. I guess the same approach might apply to £268k too – i.e. take £184k
@ukdw yes I think this is right that 1. is the most likely, because it’s already been frozen, but ..
I’m thinking more of minimising 40% income tax by withdrawing my PCLS bit by bit over 20-25 years – that is each year I crystallise what I need for that year so that 25% of it is tax free and the rest is taxed at mostly 20% but probably a little bit at 40%.
If I take it out all in one go I need to find a tax free home for it, to be in the same position as leaving it in my SIPP.
I’m not sure what the right answer is – so much of this is a guess.
My attitude is to prevent the Government tinkering with the rules to my detriment (which always seems the case). I therefore took the 25% tax free lump sum immediately. In a similar vein, many years ago, I contracted out of SERPS because I suspected (correctly) that some future government would renege on the second pension ‘guarantee’. A bird in hand…
What I hadn’t realised until too late is that the MPAA is triggered by taking drawdown type money out, not by taking a PCLS alone. Thus if one is over 55 and has spare ISA allowance, it should be possible to move 80k out of pension, put the 20k PCLS into an ISA, leave 60k in the drawdown pot without withdrawing any of it (double each if spouse’s ISA allowance is available too) and still have the ability to put upto 60k/year new money into the pension (subject to pension recycling rules). Thus, in later years, one can potentially fill the combined limits of 80k with just 60k of new money and do everything very tax efficiently. I gather that taking an annuity also doesn’t trigger the MPAA. This isn’t advice and may be a misinterpretation of what I was told, so do you own research. But the potential to start to bleed out some of the PCLS into ISA whilst still doing One More Year might be very attractive to some.
This might be right up @Finumus’ street?
@Hapshade: whilst not quite what you are referring to, there are flexible ISAs (eg. Barclays) that allow withdrawals and repayments. These can be utilised with an offset mortgage to draw down around tax year end to refill the ISA and then repaid back to the mortgage in the new tax year. There was a Monevator article that mentioned this some time back. Potentially a way to build up tax free capacity ahead of taking the tax free lump sum.
Separately – I have been working on the basis that with 2 DC pensions I would take 25% from each, but does anyone know if I could take 40% from one (say) and leave the other intact? Thanks
@Gary Gosling (62)
Why do you conclude that the second pension ‘guarantee’ has been reneged on? All SERPS/S2P accruals up to 2016, when the New State Pension was introduced, have been honoured. Entitlement under both the old system (i.e. basic state pension plus SERPS/S2P) and new system (i.e. New State Pension less deductions for contracting out) is compared and the higher amount paid. If this exceeds the New State Pension (as it does for me) the extra is paid in the form of a ‘Protected Payment’. Anecdotally my impression is that those now receiving the highest state pensions are those who never contracted out.
@ChuckieB (#64):
Separately – I have been working on the basis that with 2 DC pensions I would take 25% from each, but does anyone know if I could take 40% from one (say) and leave the other intact?
No, each is treated as a standalone pension and TFLS is per pension subject to the overall cap.
@Alan: Thank you
@ChuckieB
Yes ISA flexibility is something I look for and can be very useful for a range of scenarios. It’s a shame so many ISA providers don’t offer it on any/some of their accounts. Even fewer Stocks and Shares ISAs have it vs cash. Even then, many don’t seem to realise such a feature exists even if they do have it for their ISA.
Use it or lose it allowances are certainly punishing to the less well off without the assets to fill the ISA and flexibly withdraw and repay within a tax year, so I appreciate it’s wishful thinking to hope for some rollover allowance as part of a carrot if we are headed to lower ISA allowances.
On TFSA, while I’m quite some way off being able to claim this (30s basic rate taxpayer so a good while of accumulating left to do and hopefully income growth along the way), I’d probably be minded to claim it while such an allowance was available. I’d be fearful of rule changes that came in at just the wrong moment or other situations where a large influx of cash might be useful to pay off large sums like a mortgage. My current thinking is I’m also hedging for some scenario where the state pension may not exist in its current form, or at all (on that front I’ve upped my contributions as much as I can afford. I’m working with 10% employer plus NI payover and 15% personal, via salary sacrifice). I only have DC pensions to play with, although CDC schemes might change the outlook depending on how or if it’s implemented outside of Royal Mail. Certainly all can change at any time, but with current information that’s how I’d approach it.
Also discovered some interesting quirks from having a birthday on the start of the tax year. To touch on LISAs for example, this means I actually get a lower allowance vs someone born any other day of the year. I think this influences my approach to being cautious over rule changes that might be negative!
@Hapshade
Yes, where you are born in the tax year is interesting, most of our life is academic year based.
I’m a march baby, so it’s feel like I get a bonus tax free allowance /tax year for draining my SIPP etc. Also If I recall correctly I got an “extra” year’s NI credit when doing my O levels, and 2 more in 6th form – which was nice…
Repeating what has been stated earlier – people paying 20% tax need to be very careful about how much they pay into pensions, there’s too much risk for poor returns after tax v ISA etc. and besides you’ll kick yourself later when you are paying higher tax.
I found being born in March handy too. I retired a few years before 55 – so didn’t have any earnings – so took a whole years worth of tax allowances as soon as I hit 55, then started a new lot of drawdowns the next month.
Also took maximum PCLS – putting in my request a few days before my Birthday – as at the time I was worried about a possible drop to £40k that the Libdems had suggested. It didn’t happen – but I have never regretted taking the PCLS as soon as I could.
Very timely article for me, thank you – long time reader, recent subscriber, now my first time commenting. A lot of what’s here and the excellent comments from others really resonate, thanks again.
I’m seriously considering taking the 25% tax free PCLS from my SIPP ahead of the budget statement. This LS is about £40k, and I intend to use it to pay down some of the mortgage in the next 6 months when I move from 1.5% to 4% interest.
I also have a DB pension, with an automatic lump sum that I will claim in 2-3 years. The fact the DB lump sum will be around £120-130k is the main reason for considering pulling my SIPP TFLS now. Basically as a hedge against a £100k cap being implemented. I can get the SIPP TFLS out now and make good use of it. I won’t trigger MPAA, so can also continue to add uncrystallised funds while still working.
Due to the fiscal drag of frozen allowances, I’ll also likely be a higher rate tax payer within a few years of retirement. Add in the upcoming IHT changes, I’ve now modified my overall approach. Re-prioritising the balance of pot values and asset allocations across SIPP, ISA, PB and GIA, drawing as much out of SIPP at 0% or 20% into ISA, PB or gifting.
I’m really not sure they will scrap or modify the TFLS – but what I am certain of are the steps I can realistically make today, against current rules, to reduce my exposure to policy shocks whilst optimising tax efficiency where I can. Bird in the hand, and all that.
Thanks for all the positive comments – much appreciated. Quite daunting writing for the Monevator crowd!
@FrequentReader #45 Sorry it wasn’t clear. Yes anything beyond the tax free lump sum will be subject to tax, but I would leave that untouched inside the pension until I need it.
@Nearly There #63 Yes, important point for anyone wanting to make further contributions – I should probably have mentioned it.
I’m wondering why Reeves has decided to delay budget announcements till the very last minute, which isn’t normal. Perhaps shortening the time to April for people to react……
@Jalfrezi — I think she probably hoped things would pick up a bit, versus the low chance of getting much worse from this low base (thanks to Brexit / Covid / Russia / Trump / and, um, her last Budget! 😉 )
As things stand inflation is looking a little bit better and Budget speculation plus wider global moves have brought gilt yields down a bit. We might even get a BoE rate cut in December, though that’s too late for even this late Budget.
On the other hand the economy remains in a moribund state. Productivity (already bad) is reportedly going to be downgraded by the OBR.
TLDR: we were a recovering economy that voted to make itself poorer in 2016 (amongst other motivations of course), that’s happened, and we needed a lucky run to ward off the costs. But as it happened we’ve had a really unlucky run (Covid, Russia, Trump) so nothing good has happened.
Like Mr McCawber in David Copperfield I guess Rachel Reeves was hoping something good would turn up. But nothing has.
Eventually things should get better (well, unless Reform get in and do something economically crazy, versus the nailed-on political crazy that would come) if only because we’ve been rolling around on the mat for so long. Eventually the economy will finish readjusting to Brexit frictions (eventually meaning another 10-15 years I’d guess) and might find a few benefits.
In the meantime we just need to suck it up, and if of a selfish mind hope it’s not our pension, ISA allowance, income tax break, welfare payment, or triple-locked pension that she’s eyeing up.
Thanks for the interesting article as currently wrestling with this decision myself. I’m at about the max LSA, likely retiring in approx 2-3 yrs.
Moved my all my ‘bond’ allocation in SIPP to gilt ladder earlier this year to provide defined income stream for first 9 years so reducing SORR. So could take TFC and effectively move some of those gilts into GIA with minimal tax impact sitting outside of SIPP. But then leaves mainly stocks in SIPP, reducing SORR protection, and will want to drawdown more from SIPP in first 6 years of retirement before DB & state pensions kick in and I then start spending largely from ISAs. So need to think that through more.
For anyone looking at trying to model scenarios, I highly recommend LateGenXer’s excellent Retirement Tax Planner (https://lategenxer.streamlit.app/Retirement_Tax_Planner). For my situation, seems minimal difference in retirement net income between taking TFC now or holding off and taking later. So minded to take it now …… few weeks to decide ….
@FiscalFrenzy – thanks for the tip on that LateGenX link, this looks to be very useful. I had a quick play about there with the standard parameters. Interestingly you can set your retirement country to Portugal which results in a forecast tax bill for us of £181k as against £58k for staying in the UK. Of course in real life tax rates etc are not going to remain static for the next 40 years but it does highlight the huge benefit we have in ISAs. In the PT scenario our ISAs would be converted to GIAs with the requisite tax becoming payable. In the UK scenario we would be tax free up until state pension age.
I’m still 10 years or so away from this ‘problem’, but its certainly something I’m paying close attention to.
Current plan is to withdraw if allowed, and use the ISA allowance of 20k, fill up premium bonds of 50k each for me and the boss, and spend the rest recklessley.
Of course the opportunity and figures might be gone or completely different by then…