Settle an argument?

[LHRFlightman]

Pensions and tax.

You're a higher rate taxpayer and retire with a pension worth £2,000 a month.

Do you pay tax at 40% on that £2,000? ie you're left with £1200 each month?

One third of my office says yes, one third no, and one third want to kill themselves if the answer is yes.

Cheers

[AllyM]

No. In retirement you still have a tax free allowance and then it will be scaled.

So 0% then 20%. If £2k per month is all you have then it will never be more than basic rate.

Edited by AllyM on Thursday 3rd January 11:36

[Over over under steer]

No, you'll be paying at 20% after allowance.


Regardless of that, you'd not be taxed at 40% of the whole value due to allowance.

[NickCQ]

Unless you have other income you aren't a higher-rate taxpayer on £2k / month.
This is a great benefit of pension saving, which is that you can defer income when you have high marginal tax rate to a time when it's lower.

[roadsmash]

One third of your office are silly.

[Sheepshanks]

How can people be capable enough in whatever they do to be higher rate tax payers yet not have any idea whatsoever how it works?

[33q]

You will pay about £200 tax per month

[Sheepshanks]

33q said:

You will pay about £200 tax per month

Those retiring late in the tax year may be in for a brief shock!

[Countdown]

Sheepshanks said:

How can people be capable enough in whatever they do to be higher rate tax payers yet not have any idea whatsoever how it works?

I think it's quite easy to be super-brainy at X and yet be a complete noob at Y.

One of my kids could quote chapter and verse on Family Law and yet doesn't know what any of the warning lights on her dashboard mean.

My son knows ridiculous amounts about cybersecurity but would struggle to do basic DIY.

Horses for courses

[vindaloo79]

If commencing receipt of pension payments during the same tax year as the individual has already reached the HRT threshold then they may be liable for the higher rate until new tax year April 6th.

[Ginge R]

LHRFlightman said:

Pensions and tax.

You're a higher rate taxpayer and retire with a pension worth £2,000 a month.

Do you pay tax at 40% on that £2,000? ie you're left with £1200 each month?

One third of my office says yes, one third no, and one third want to kill themselves if the answer is yes.

Cheers

It depends on what your ‘big picture’ is or will be. After your personal allowance, you are going to be at least liable for tax - but in the following order: first, earned income (benefits in kind, pension income*, rental income*, some state benefits, trading profits from employment income - but not if you’re retired, obvs etc), second, interest and savings (bank and building society interest, interest distributions from funds such as liable OEICs and unit trust investments, offshore bond gains), third, dividends (well, dividends) and then fourth and finally, life policy gains from onshore bonds and the taxable part of any redundancy payments. That’s not exhaustive. Bear in mind, you’ll have the state pension at some point, pushing more of your £2000 a month into the tax exposed segment. But, if you have other income, you might find you get taxed more, on a larger segment of it.

• some excluded.

[JulianPH]

LHRFlightman said:

Pensions and tax.

You're a higher rate taxpayer and retire with a pension worth £2,000 a month.

Do you pay tax at 40% on that £2,000? ie you're left with £1200 each month?

One third of my office says yes, one third no, and one third want to kill themselves if the answer is yes.

Cheers

As has been said, the answer is no.

Making the assumption you have no other taxable income:

• You cannot retire on £2,000 a month and pay 40% tax (as you are not in that tax band)

• Nearly half of this pension would be tax free in any event (personal allowance)

• The balance (if the tax free cash (PCLS) has not been taken) would effectively be taxed at 15% (75% of the basic rate of tax)

• So the effective rate of tax on this pension income would actually be c. 7.5%

• If you have other taxable income (including the state pension) that uses up your personal allowance this pension income would effectively be taxed at 15% (if you have not taken the tax free cash)

• If you have other taxable income that uses up your basic rate tax band this pension income would effectively be taxed at 30% (same assumption as above)

So basically, this income would never be taxed at 40% (given the above assumptions). This is why pensions are such good tax wrappers/relief's.

[rfisher]

What options are available to avoid hitting the 40% threshold if you are close to it?

So typically this may become an issue after several years on an index linked DB scheme when you then start to receive state pension.

Presumably it's possible to invest in VC projects, donate to charidee etc.?

[Tegriffic]

10 minutes on the gov web site explains exactly how tax works. Most people in your office are probably representative of a majority of the population and have no clue about even thier own pensions.

Most people I doubt even know about the tax relief available and how much difference that can make to what age they could retire. They just assume the employer is paying so that’s that.

I recently had to explain to a 38 year old that the £57K on her pension statement was its value, not the annual income which is how she had understood it. I mean, what can you do ?

My advice is forget talking to your office colleagues and get clued up. You might find it changes the whole way you approach your finances.

[CaptainSlow]

Tegriffic said:

10 minutes on the gov web site explains exactly how tax works. Most people in your office are probably representative of a majority of the population and have no clue about even thier own pensions.

Most people I doubt even know about the tax relief available and how much difference that can make to what age they could retire. They just assume the employer is paying so that’s that.

I recently had to explain to a 38 year old that the £57K on her pension statement was its value, not the annual income which is how she had understood it. I mean, what can you do ?

My advice is forget talking to your office colleagues and get clued up. You might find it changes the whole way you approach your finances.

+1

I agree, people need to look into this far more than they do.

In hindsight, I should have increased my contributions significantly 10 years ago.

[DanL]

rfisher said:

What options are available to avoid hitting the 40% threshold if you are close to it?

So typically this may become an issue after several years on an index linked DB scheme when you then start to receive state pension.

Presumably it's possible to invest in VC projects, donate to charidee etc.?

Just out of curiosity, why would you want to? You only pay 40% on the amount over the threshold so you’d still be seeing more money than before, and you’re presumably looking to enjoy your retirement... This is why you’ve been saving up, no? Now is the time to reap the benefit, surely?

[Dr Mike Oxgreen]

rfisher said:

What options are available to avoid hitting the 40% threshold if you are close to it?

The most obvious way is to pay more into your pension. Tax is calculated after your pension contributions have been deducted, so you could use additional contributions to reduce your exposure to the higher rate (and possibly avoid it altogether).

When you retire and start drawing your pension, many people will become basic rate taxpayers once again, so you will have avoided tax at 40% while you were contributing and then you'll be paying at 20% when you're drawing down.

Pensions are sometimes thought of as "tax free", but of course they're not. They are merely tax-deferred.

Edited to add: Reading your post again, you probably meant avoiding higher rate tax during retirement, in which case my argument doesn't apply. To avoid higher rate tax after you retire, you should probably take the whole of your 25% tax-free lump for starters and invest it in an ISA. Doing that will reduce the pension you receive from the remaining 75% of your pension pot (and hence reduce your 40% tax exposure), but you could then draw down the ISA manually over the years and receive that as a tax-free income.

Edited by Dr Mike Oxgreen on Friday 4th January 14:57

[Sheepshanks]

DanL said:

rfisher said:

What options are available to avoid hitting the 40% threshold if you are close to it?

So typically this may become an issue after several years on an index linked DB scheme when you then start to receive state pension.

Presumably it's possible to invest in VC projects, donate to charidee etc.?

Just out of curiosity, why would you want to? You only pay 40% on the amount over the threshold so you’d still be seeing more money than before, and you’re presumably looking to enjoy your retirement... This is why you’ve been saving up, no? Now is the time to reap the benefit, surely?

I was thinking that as well - I hope I'm paying 40% tax when I retire!

[JulianPH]

Sheepshanks said:

DanL said:

rfisher said:

What options are available to avoid hitting the 40% threshold if you are close to it?

So typically this may become an issue after several years on an index linked DB scheme when you then start to receive state pension.

Presumably it's possible to invest in VC projects, donate to charidee etc.?

Just out of curiosity, why would you want to? You only pay 40% on the amount over the threshold so you’d still be seeing more money than before, and you’re presumably looking to enjoy your retirement... This is why you’ve been saving up, no? Now is the time to reap the benefit, surely?

I was thinking that as well - I hope I'm paying 40% tax when I retire!

I was going to try and address this earlier, but got caught up with other things.

If you are in retirement, completely financially secure, do not have to work another day in your life and are mortgage and debt free I think that having an annual income that put you in the higher rate tax band is a problem most people would love to have to 'suffer'!!!

You cannot control the taxation of your pension income (it will always be taxed as income at the appropriate level). So you can't avoid hitting it (as such) only mitigate it.

VCT's and EIF's can claw tax back (but at an often high investment risk), placing the maximum available back into a pension is limited, but more efficient without having to take higher risks.

Me? With a defined benefit pension I would swallow the tax hit (after all I benefited from the tax credit), acknowledge how fortunate I was to have not had to worry about the management of my pension and what my retirement income would be, and be highly thankful my pension was index linked.

With a money purchase scheme I would do some different things. Firstly, I would withdraw the 25% tax free cash. I would set this aside (putting everything I could into an ISA each year) and start taking my taxable pension income. When the state pension kicked in and added to my taxable income I would reduce my drawings to stay within the lower tax level(s).

I would then top up my income by taking tax free returns of capital from my 25% tax free lump sum (not touching what ever I had got into an ISA).

When I had exhausted this I would take tax free income from my ISA (followed by tax free capital withdrawals).

So:

• Retirement 10 years before state pension age (first assumption)

• £1m pension fund (for a round figure that could be relevant)

• Withdraw £250k tax free (the maximum)

• Income (at 4%) = £30k a year (a sensible amount to allow for inflation over the long term)

• Tax free cash moved into an ISA every year to state pension age (as this money than remains tax free)

• State pension and indexation of private pension now hitting higher rate tax band (as per the original example - and ussuming the higher rate tax band does not rise in line)

• Reduce taxable pension income by the amount needed to stay in the basic rate tax band and replace with tax free ISA income (and capital withdrawals, if needed)

• As your personal allowance and the higher rate tax band increase with inflation rebalance your income accordingly (at all times)

Of course, you can only do this if you have control over your pension (which a DB scheme does not usually facilitate).

So, a long but simple answer that usually will only apply to a money purchase pension/SIPP.

[DanL]

Thanks Julian - very informative!

My question is - what benefit does reducing your tax bill bring? Is it extending the time that the pension will be paid out, allowing more money to be passed on to children by having a larger estate than you might otherwise, or something else?

I thought (perhaps incorrectly) that money in a pension scheme provides for a pension, but isn’t something you can pass on (except maybe some pension benefit to a spouse if you die first), which is why I couldn’t see a reason for not taking the maximum benefit possible, regardless of the tax band implications...