13 – Anticipating pension growth and BCE 5A

I’ve made a change to how I plan ahead and decide how much I can spend each year as a pensioner.  My default used to be to assume relatively conservative growth at “inflation +3%” and to plan to reduce my pension & ISA so that by age 77 I will be down to a certain value (about half of what it is now, enough for the spending of an octogenarian, and enough to pay a few years of care home fees). (You can see this with the graph on my page “6 – Models” where the green line is the asset value.)

I noticed that if I assumed “inflation  +4.5%” growth with the same spend profile, then the effect was to give me roughly constant assets.  That’s constant in today’s money, but considering inflation it’s going to be higher than now. 

I anticipate that the second method (long term hope to keep assets constant, while being slightly more optimistic on growth) is going to be easier to manage.  I know that if I only get “inflation +3%” then the original scenario is there as a backup. 

I have also modelled using the level of growth that I have seen over the last 25 years:  “inflation +8%”.  This is probably rather optimistic but I want to anticipate the tax implications that might come up.  The tax implications are something I’m still getting my head around but “BCE 5A” at age 75 is becoming a real prospect and taking more pension (to minimise or avoid BCE 5A) pushes me into the 40% bracket, and at the same time I will have more than I’d planned in taxable investments.

One issue with BCE 5A is that it compares my assets in drawdown to the value that was originally put into drawdown, seemingly with no allowance for inflation.  I had asked Pensionwise about the inflation and they had said it was included, but the more examples I look at online I only ever see a comparison to an uninflated figure.  Consider BCE 5A is about 20 years away, that’s a lot of inflation, so I might be compared to a real value only 50% or 60% of what I put in.  I’ll have used up all my LTA by my mid 60’s, I think, so BCE 5A at age 75 will have its full impact.  I’ll have to investigate more to be sure.

As a bit of an aside, I don’t really understand the principle of BCE-5A. By the time I’m 60 I’ll be very close to using 100% of my LTA, and then will stay at that percentage. Imagine if I pay myself the natural yield then the capital sum will be growing in line with inflation, which seems a sensible approach considering it might have to last me 40+ years from now. But in that case I’ll be charged 25% on the growth in the capital, and so I’m not sure what I’m being penalised for.

Anyway, accepting the rules as they appear, it seems that my options are:

1. Keep withdrawing enough to cover my spend, paying 20% marginal income tax.  At age 75, the growth in drawdown will be taxed at 25% (I will have used up about 100% of my LTA by then), and after that withdrawals will still be at 20% income tax:  25%+20%=45%.  This option also could mean leaving money in the drawdown pot, to be inherited, so overall tax for me and my heirs of 25%+0%, 25%+20% or 25%+40%.

2. Review in my 60’s and early 70’s, and get the drawdown value down by withdrawing extra and paying 40% income tax.

3. Withdraw the maximum now at 20% income tax, more than I currently allow myself to spend (well, to spend and to put in an ISA), and therefore have to put it in a taxable investment.  Total tax (income tax and capital gains tax) would be 20%+10%=30%, but some would be 20%+0% and perhaps some might be 20%+20% depending how I have to juggle things and whether I later start paying myself at 40% marginal tax.  At the same time, move the maximum into ISAs every year.

There’s a watch-out on option 3.  The Capital Gains Tax rates of 10% and 20% seem to be targets for the Treasury and rates might increase to match income tax.  But for now, even if I have to pay 20% on capital gains, option 3 looks no worse than the other options.

Indeed, over the time span I am planning, all sorts of things could change: whether any new wealth taxes do or don’t include pensions or ISAs; what new income tax rates might be needed to recover from covid; whether IHT includes the last few years of gifts or a lifetime of gifts; etc.. It looks like I’ll be able to get my taxable assets into ISAs over several years, even if I get optimistically high growth, so for now I’m going to try option 3.  In a few years I can consider paying myself more pension and paying 40% marginal tax, and hopefully managing to avoid CGT while I do that.  In the end, paying BCE 5A is pretty undesirable but not that much worse than the other options, and it’s probably a nice problem to have.