Understanding how to draw down tax free out of pension

Understanding how to draw down tax free out of pension

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nickfrog

Original Poster:

20,871 posts

216 months

Tuesday 21st January 2020
quotequote all
Please kindly sense check my understanding of what I think I can do:

Say I have a £500k pot at the age of 55 and retire. And say I only need £20k a year out of my capital as my £12.5k allowance is taken up by other income from property rental and my wife would be mirroring what I am doing.

Can I "crystalise" (perhaps that's not the right word) £80k in year 1, take 20% of it tax free and leave the £60k balance invested like the £420k uncrystalised?

The thinking is that I would like to do that every year until at least 67 and that the £480k leftover will grow (hopefully) and at least partially offset for the money I take out.

So for instance in year 2 and assuming 2% growth I would crystalise another £80k out of my now £489,600 to take another £20k tax free. And so on...

I am ignoring inflation for simplicity...

Edited by nickfrog on Tuesday 21st January 14:21

mikeiow

5,286 posts

129 months

Tuesday 21st January 2020
quotequote all
nickfrog said:
Please kindly sense check my understanding of what I think I can do:

Say I have a £500k pot at the age of 55 and retire. And say I only need £20k a year out of my capital as my £12.5k allowance is taken up by other income from property rental and my wife would be mirroring what I am doing.

Can I "crystalise" (perhaps that's not the right word) £80k in year 1, take 20% of it tax free and leave the £60k balance invested like the £420k uncrystalised?

The thinking is that I would like to do that every year until at least 67 and that the £480k leftover will grow (hopefully) and at least partially offset for the money I take out.

So for instance in year 2 and assuming 2% growth I would crystalise another £80k out of my now £489,600 to take another £20k tax free. And so on...

I am ignoring inflation for simplicity...
re: bold bit - yes, absolutely, and pretty well what I have done with some of my main pot within Aviva.

Obviously providers are all different, and indeed even Aviva will have multiple different funds and schemes (partly through acquisition), but mine (your £80k in the above example!) remains within the same funds.
Aviva will just say (for example!) "you have £480K, £80k of which is in drawdown" - indeed, I don't think I *can* chose different investments for that 80k (not that I wanted to).
I could, of course, chose to move it elsewhere to a different provider, where it would remain in a drawdown state.

Note that as soon as you touch a penny of anything in drawdown, you invoke the MPAA, & can then only deposit up to £4k pa into any pension scheme.

HarryW

15,150 posts

268 months

Tuesday 21st January 2020
quotequote all
I’m in a similar (but different!) position to this.
I’d be very interested in informed responses as I’ve yet to find any clear guidance on line for this flexible draw down and how it actually works in practice.

nickfrog

Original Poster:

20,871 posts

216 months

Tuesday 21st January 2020
quotequote all
mikeiow said:
Note that as soon as you touch a penny of anything in drawdown, you invoke the MPAA, & can then only deposit up to £4k pa into any pension scheme.
Thanks Mike. My wife's half is with Aviva so that's good to hear. Hopefully Aegon offer the same facility for me.

Re the above quote, is that part of the recycling rules? I thought is was £7.5k pa for some reason. Not really a problem either way as I guess I can't claim relief on it if I don't pay tax anymore.

mikeiow

5,286 posts

129 months

Tuesday 21st January 2020
quotequote all
HarryW said:
I’m in a similar (but different!) position to this.
I’d be very interested in informed responses as I’ve yet to find any clear guidance on line for this flexible draw down and how it actually works in practice.
I guess to hear detail of the "in practice" bit, you might want to share which provider you use.

For me, Aviva (with "membersite"), it was a matter of filling in a pretty straightforward (albeit 10 pages long - lots of space!) document - my details, did I have guidance (yes - Pensionwise), say how much I wanted to do a "partial income drawdown" for, confirm I wanted NO income, a bank account to sent funds to, & sign at the bottom.
VERY straightforward.
Not at the stage where I want to draw any of the drawdown pot - that would be another bit of the form, from what I can see - either picking ad-hoc payments or a regular one.

mikeiow

5,286 posts

129 months

Tuesday 21st January 2020
quotequote all
nickfrog said:
mikeiow said:
Note that as soon as you touch a penny of anything in drawdown, you invoke the MPAA, & can then only deposit up to £4k pa into any pension scheme.
Thanks Mike. My wife's half is with Aviva so that's good to hear. Hopefully Aegon offer the same facility for me.

Re the above quote, is that part of the recycling rules? I thought is was £7.5k pa for some reason. Not really a problem either way as I guess I can't claim relief on it if I don't pay tax anymore.
I don't think the MPAA isn't directly part of the "recycling rules", it is just a rule on pension investments.
See https://www.moneyadviceservice.org.uk/en/articles/... for more on MPAA

The recycling rules are explained at https://www.pensionsadvisoryservice.org.uk/about-p...

Essentially they want to avoid you taking that £20k out of your pot as tax-free, then investing it straight back to the pension fund to get more pension fund tax benefits. Provided you are not changing what you do significantly, I very much doubt there would ever be a problem.

Note, I am not a tax man or an advisor (just someone with a overly keen interest in pensions at this point in my life hehe

nickfrog

Original Poster:

20,871 posts

216 months

Tuesday 21st January 2020
quotequote all
mikeiow said:
(just someone with a overly keen interest in pensions at this point in my life hehe
You and me both! I'll be honest, it's a great feeling.

Stay in Bed Instead

22,362 posts

156 months

Tuesday 21st January 2020
quotequote all
That's not how it works.

Year 1
Uncrystallised fund £500,000
Crystallise £80,000
Tax free cash £20,000

Year 2
Uncrystallised fund £420.000 x 1.02 = £428,400
Crystallised fund £60,000 x 1.02 = £61,200
Crystallise £80,000
Tax free cash £20,000

Year 3

Uncrystallised fund £348,400 x 1.02 = £355,368
Crystallised fund £121,200 x 1.02 = £123,624
Crystallise £80,000
Tax free cash £20,000

Etc

You will run out of uncrystallised funds well before age 67 so will need to access taxable crystallised funds.

nickfrog

Original Poster:

20,871 posts

216 months

Tuesday 21st January 2020
quotequote all
Cheers. Yes, a bit of a flaw in my thinking, however what you say makes sense indeed. Will xls it.

anonymous-user

53 months

Tuesday 21st January 2020
quotequote all
Great thread as I am also looking into this as a keen pension watcher of 56 smile

Am I right in thinking that once you've used up all the uncrystallised funds, then any subsequent drawdown from the crystallised pot will be taxed at your marginal rate? I also assume that you apply your full personal allowance (assuming no other income) first so that a £20k drawdown would only have £7.5k (20-12.5) taxed?

Stay in Bed Instead

22,362 posts

156 months

Tuesday 21st January 2020
quotequote all
garyhun said:
Great thread as I am also looking into this as a keen pension watcher of 56 smile

Am I right in thinking that once you've used up all the uncrystallised funds, then any subsequent drawdown from the crystallised pot will be taxed at your marginal rate? I also assume that you apply your full personal allowance (assuming no other income) first so that a £20k drawdown would only have £7.5k (20-12.5) taxed?
Yes.

The pension arrangement must assess income tax under PAYE, and they will be given a tax code to use by HMRC. If you have no other income, your personal allowance will be utilised for the pension.

anonymous-user

53 months

Tuesday 21st January 2020
quotequote all
Stay in Bed Instead said:
garyhun said:
Great thread as I am also looking into this as a keen pension watcher of 56 smile

Am I right in thinking that once you've used up all the uncrystallised funds, then any subsequent drawdown from the crystallised pot will be taxed at your marginal rate? I also assume that you apply your full personal allowance (assuming no other income) first so that a £20k drawdown would only have £7.5k (20-12.5) taxed?
Yes.

The pension arrangement must assess income tax under PAYE, and they will be given a tax code to use by HMRC. If you have no other income, your personal allowance will be utilised for the pension.
Great, many thanks.

I think I need a new spreadsheet too to work out the correct timing and amounts of drawdown to minimise the tax over the next 20 years. I will no doubt re-invest some of the drawdown so need to work that out against the growth of the pension pot that I'll be forgoing.

Fun game this smile

williaa68

1,527 posts

165 months

Tuesday 21st January 2020
quotequote all
Can I please add a supplemental question to this?

Assuming (approximately) the same lump sum of £500k initially and 6 lots of 20k withdrawals which works to pretty much move the whole pot into drawdown, is the money in drawdown but not actually taken as income still IHT free if left until 75? ie can one effectively withdraw the tax free lump sum and leave the balance invested as an IHT hedge until 75?

mikeiow

5,286 posts

129 months

Wednesday 22nd January 2020
quotequote all
williaa68 said:
Can I please add a supplemental question to this?

Assuming (approximately) the same lump sum of £500k initially and 6 lots of 20k withdrawals which works to pretty much move the whole pot into drawdown, is the money in drawdown but not actually taken as income still IHT free if left until 75? ie can one effectively withdraw the tax free lump sum and leave the balance invested as an IHT hedge until 75?
If you die under 75, yes, it is passed on tax-free.
If after you are 75, then they pay income tax on it.
From https://www.aviva.co.uk/retirement/pensions/aviva-... (which explains a few scenarios)

Remember there is another LTA check at age 75....I read somewhere that whilst relatively few hit the LTA normally, this second test is likely to catch out far more who may have had growth in their pots......

JulianPH

9,912 posts

113 months

Wednesday 22nd January 2020
quotequote all
nickfrog said:
Please kindly sense check my understanding of what I think I can do:

Say I have a £500k pot at the age of 55 and retire. And say I only need £20k a year out of my capital as my £12.5k allowance is taken up by other income from property rental and my wife would be mirroring what I am doing.

Can I "crystalise" (perhaps that's not the right word) £80k in year 1, take 20% of it tax free and leave the £60k balance invested like the £420k uncrystalised?

The thinking is that I would like to do that every year until at least 67 and that the £480k leftover will grow (hopefully) and at least partially offset for the money I take out.

So for instance in year 2 and assuming 2% growth I would crystalise another £80k out of my now £489,600 to take another £20k tax free. And so on...

I am ignoring inflation for simplicity...

Edited by nickfrog on Tuesday 21st January 14:21
Yes.

mikeiow said:
williaa68 said:
Can I please add a supplemental question to this?

Assuming (approximately) the same lump sum of £500k initially and 6 lots of 20k withdrawals which works to pretty much move the whole pot into drawdown, is the money in drawdown but not actually taken as income still IHT free if left until 75? ie can one effectively withdraw the tax free lump sum and leave the balance invested as an IHT hedge until 75?
If you die under 75, yes, it is passed on tax-free.
If after you are 75, then they pay income tax on it.
From https://www.aviva.co.uk/retirement/pensions/aviva-... (which explains a few scenarios)

Remember there is another LTA check at age 75....I read somewhere that whilst relatively few hit the LTA normally, this second test is likely to catch out far more who may have had growth in their pots......
It is always completely IHT free, though not always completely tax free.

The 75 (age) rule is one about income tax, not IHT (as Mike has said).

Death at 75 onwards means your benefices will have to pay income tax on your pension in exactly the same way you would have. Death prior to this means it is tax free (IHT and Income Tax).

The LTA is a different test altogether (any gain above this is subject to a further tax penalty) and Mike is right in highlighting this.

If this throws anything up just give me a shout here, on the IM Sticky, or via a PM (as you prefer).



nickfrog

Original Poster:

20,871 posts

216 months

Wednesday 22nd January 2020
quotequote all
JulianPH said:
Yes.
Actually Julian the assumption in my OP was wrong as I didn't realise the rate of depletion of my crystalisation headroom was much quicker than I thought and I would run out way before 67 as highlighted by SBI.
To not pay any tax until 67 while starting to crystallise at 55, I would need £520k to start with, a yearly growth of 5% and take £14,000 a year which is my new working assumption. Which means selling off a property at 55 which is no biggie as this would limit CGT exposure on that asset.

JulianPH

9,912 posts

113 months

Wednesday 22nd January 2020
quotequote all
nickfrog said:
Actually Julian the assumption in my OP was wrong as I didn't realise the rate of depletion of my crystalisation headroom was much quicker than I thought and I would run out way before 67 as highlighted by SBI.
To not pay any tax until 67 while starting to crystallise at 55, I would need £520k to start with, a yearly growth of 5% and take £14,000 a year which is my new working assumption. Which means selling off a property at 55 which is no biggie as this would limit CGT exposure on that asset.
If you would like an actuarial projection with different growth rate assumptions then just give me a shout. smile


nickfrog

Original Poster:

20,871 posts

216 months

Wednesday 22nd January 2020
quotequote all
JulianPH said:
If you would like an actuarial projection with different growth rate assumptions then just give me a shout. smile
Cheers Julian but now all encapsulated in xls and can move all the levers at will. laugh

williaa68

1,527 posts

165 months

Wednesday 22nd January 2020
quotequote all
This is a helpful thread so thank you for starting nickfrog. I had always thought I wouldnt draw on my SIPP as part of my IHT planning (noting that it is tax rather than IHT that is avoided until 75). However I hadnt realised I could take out the tax free element while leaving the remaining element to compound. If Ive got my maths right then starting with a 750k and assuming 4% growth (big if i accept) I should be able to take 18k a year tax free until I'm about 70 and still end up with more in the pot at the end than at the beginning.

nickfrog

Original Poster:

20,871 posts

216 months

Wednesday 22nd January 2020
quotequote all
You shouldn't be far off £1 million by the time you're 70 on that basis.