Does it make sense to take the TFLS now or defer it as long as possible?

It is pretty hard to beat a tax free principle on your investments.

It is also affected by how much marginal tax you pay over the bulk of your pension draw downs.

If you want to "die with zero", then your plan should be aiming to get all the money out of the pension fund with minimum taxes.

For deferring your LS, you need to figure out what your marginal tax rate will be when you actually tax the money. Depending on the pension, you will have a long term tax band.

Assuming 5% return, if you leave the money in the fund for 10 years, you get 50% growth. You then have to take the money out.

20% marginal tax
(assume withdrawn over multiple years)

100k -- growth -> 150k -- withdraw -> 120k

40% marginal tax

100k -- growth -> 150k -- withdraw -> 90k

Lump sum (Shares)

100k -- growth --> 150k --> capitals gains tax -> 133.5k

Lump sum (ETF)

100k -- growth -> 150k -- exit tax --> 131k

The thing is that the marginal tax rate is payable on both the investment gains AND the principle.

Exit tax and CGT is only on the gains. The LS means no tax on the principle.

For 20 years, it is better. Assuming doubling your money in 20 years.

20% marginal tax
(assume withdrawn over multiple years)

100k -- growth -> 200k -- withdraw -> 160k

40% marginal tax

100k -- growth -> 200k -- withdraw -> 120k

Lump sum (Shares)

100k -- growth --> 200k --> capitals gain -> 167k

Lump sum (ETF)

100k -- growth -> 150k -- exit tax --> 162k

If you have a marginal rate of 20%, it is starting to balance at this point.

You need a long time and/or high interest to overcome the tax on the principle relative to zero tax on the principal for the LS.

It also matters what your margin rate is likely to be for the long term.
 
On second thoughts, the analysis in the previous post only relates to deciding if you should take the full 25% (or 200k) of the lump sum.

The answer is that you should take, at least, up to the 200k limit.

Deferring the moment you take the lump sum depends on lost investment gains only, since you still get the tax free lump sum.

Consider two options for a 100k lump sum, take it now, or wait 5 years. Again, assuming 5% interest.

Take it now (ETF)

Lump Sum: 100k -- growth --> 125k -- exit tax --> 115.5k (post exit tax)
Remaining: 300k -- growth --> 375k -- tax free -> 375k (pre-income tax)

Take it now (shares)

Lump Sum: 100k -> growth --> 125k -- CGT --> 116.75k (post CGT cash)
Remaining: 300k -- growth --> 375k -- tax free -> 375k (pre-income tax)

Leave it

Remaining: 100k -> growth --> 125k -- tax free --> 125k (tax-free lump sum)
Remaining: 300k -- growth --> 375k -- tax free -> 375k (pre-income tax)

The effect is around 116k post tax by taking it early vs 125k post tax for waiting 5 years.

The 75% that stays in the ARF still grows tax free but you have the option to withdraw it.

I think the case where it is worth taking it early is to use up your tax free allowance and 20% income tax cutoff allowances.

For example, if someone retired at 55, they would have zero income for 10 years if they waited until 65. If they took an ARF, they could withdraw 20k tax free every year for 10 years (and another 24k at 20% per year).

Taking it early means you lose tax-free gains on the lump sum portion, but can avoid some income tax on the other 75%.

The optimal strategy depends on how efficiently you think you can convert funds in your pension/ARF into post-tax money. It likely depends heavily on exactly what you think your marginal tax rate will be over the retirement.

I think the ideal would be to convert your pension into an ARF in as many steps as possible. Make sure you have an income of at least 20k so that you can withdraw that money tax free.

ARFs and vested PRSAs can have pretty heavy tax if you aren't transferring to your immediately family on death. That may need to be factored in too depending on beneficiaries.
 
In real terms, the maximum TFLS benefit is worth less and less every year. Provided you've a pot of 800k, isn't that reason enough to access the lump sum as soon as you can? Your tax free 200k at age 50, will "only" be worth in the region of 130-150k by the time you're 65.
 
nest egg said:
In real terms, the maximum TFLS benefit is worth less and less every year. Provided you've a pot of 800k, isn't that reason enough to access the lump sum as soon as you can? Your tax free 200k at age 50, will "only" be worth in the region of 130-150k by the time you're 65.
Click to expand...

Good point. I was assuming it tracked inflation, though it seems it is stable (so reducing over time due to inflation).

Assuming an 800k pension and 5 years @ 5%.

Take it now (ETF)

Lump Sum: 200k -- growth --> 250k -- exit tax --> 231k (post exit tax)
Remaining: 600k -- growth --> 750k -- tax free -> 375k (pre-income tax)

Take it now (shares)

Lump Sum: 200k -- growth --> 250k -- CGT --> 233.5k (post exit tax)
Remaining: 600k -- growth --> 750k -- tax free -> 375k (pre-income tax)

Leave it (20% marginal)
Lump Sum: 200k -- growth --> 250k -- tax free (200k), 20% (50k) --> 240k
Remaining: 600k -- growth --> 750k -- tax free -> 375k (pre-income tax)

It is the same effect if you wait 10 years.

Take it now (ETF)

Lump Sum: 200k -- growth --> 300k -- exit tax --> 262k (post exit tax)
Remaining: 600k -- growth --> 900k -- tax free -> 900k (pre-income tax)

Take it now (shares)

Lump Sum: 200k -- growth --> 300k -- CGT --> 267k (post CGT)
Remaining: 600k -- growth --> 900k -- tax free -> 900k (pre-income tax)

Leave it (20% marginal)
Lump Sum: 200k -- growth --> 300k -- tax free (200k), 20% (100k) --> 280k
Remaining: 600k -- growth --> 750k -- tax free -> 375k (pre-income tax)

You can pay 20% of the gain if you leave it in the pension pot, but pay CGT rate or exit tax if you withdraw it.

So, at the end of the day, it looks like waiting is still worth it. I still think making use of unused tax credits could be worth it.
 
Also consider what you can do with the 200k in your earlier years than your later...travel, enjoy experiences, help your kids for their house deposit if they are at the right life stage etc. So it is not just the financial element, but if you can defer what you would spend the money on.
 
You must log in or register to reply here.
Back
Top