Bit of a complicated one this, or it is to me anyway. I have a deferred final salary pension which matured at age 60 (July 2015). I can take up to 2.25 years pension payment as a tax free lump sum with a corresponding drop in annual pension.
I intend retiring at the end of March 2020 and my original plan was to start drawing the pension at that time.
The pension is index linked and at 2018 stands at £18,048 per annum. I would be able to draw just over £40,600 as a tax free lump sum but I would also receive the backdated pension payments from age 60. This would be 4.75 years pension so would work out at £85,700. As I would no longer be working this would be taxable but would take into account my £11,000 personal allowance, then £35,000 at 20% and the remainder at 40%. I work this out as a tax bill of 20% of £35,000 (£7,000) and 40% of £39,700 (£19,880) so I would receive the £85,700 less at total of £26,880 in tax. Giving me, with the tax free lump sum, £99,420 as a tax paid lump sum. However, I would also receive the monthly pension payments which, after taking the tax free lump sum, would be reduced to around £14,600 which would also be taxed at 40% in the 2020/21 tax year.
The alternative which I had intended doing, although a change in the reasoning behind it mean I no longer have to but it appears to me that it might be advantageous anyway, is to draw the pension from May 2018.
As it is index linked the pension at July 2015 stood at £17,870 and I can draw a tax free lump sum of £40,200 which will reduce the annual pension down to £14,500. I would also receive the backdated payments from July 2015 to April 2018 which works out to £49,100 followed by the annual payment of £14,500. This would mean that in the 2018/19 tax year I would receive £63,600 from the pension but as I am still working all of this would be taxed at 40%. My thought was to put this into another pension plan to get the tax relief on it but find that there is an annual limit of £40,000 so I would still be paying 40% on £23,600. While still working the following pension payments would also be put into this scheme. At retirement I should then have in excess of £60,000 in this scheme so I could then, assuming there is no minimum time limit on withdrawals, draw 25% of this tax free and the remainder as a lump sum as and when required at a figure that would at least keep me below the 40% tax threshold. I understand this si what is referred to as a draw down scheme, it isn't so much a pension scheme I require, more like a tax deductible savings account.
My calculations, although I did manage to confuse myself greatly, seemed to suggest that this latter option would result in a greater tax paid lump sum in 2020 than waiting until then to draw the pension. Am I right and are there any other options? As I have the paperwork here ready to send back to commence drawing the pension as of 1st May 2018, do I send them in? My calculations seem to suggest I should but if there are other options or pitfalls that I haven't noticed they need to be taken into account then maybe I shouldn't. Are there any other (legal) ways of reducing the tax liability further?
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