Fair warning: this post is for people who have reason to be concerned about both RMDs and the Lifetime Allowance. If you don’t have a Traditional 401k/IRA/etc. balance or you have no concerns about exceeding the LTA, you can skip on past – just focus on the one that affects you.
Also – this one gets into the weeds. Grab a cuppa first!
What are we dealing with?
Both the IRS and HMRC want to make sure they get paid eventually and ensure “rich” people don’t get too many tax advantages, they just have very different ways of doing it: the IRS has Required Minimum Distributions, while HMRC has the Lifetime Allowance.
In a nutshell:
- RMDs force you to withdraw an increasingly large percentage of your Traditional balance (401(k), IRA, etc.) from age 72 – this can be big enough to force you above the 20% basic rate, and with a big enough balance (somewhat over £1M at age 72), even into the higher 40% rate.
- The Lifetime Allowance means that if your total pension/SIPP value gets over about £1 million, HMRC gets extra tax, either when you take benefits or no later than age 75. This is a flat benefits tax, roughly working out to 25% (plus you or your heirs still have to pay normal income tax at some point)
These are not small differences – from a £1M portfolio at age 55, you can be looking at over a £1M difference in the value you pass on to your heirs, and a total tax burden that can be 4 times smaller than if you didn’t plan for them.
Conclusion up front: Every situation is different and there’s no one right answer. To minimize your total tax burden (and thus maximize your wealth), you want to try to do two things:
- Get RMDs under control – ideally eliminate them entirely. As long as you’re convinced that Roth conversions aren’t UK taxable, you can avoid UK tax on your Traditional balance entirely (but might pay some 10% and 12% US tax). Even if you can’t eliminate them completely, get them down enough so that you stay in the UK 20% bracket even with the RMDs
- If you need to worry about the LTA, try to get some money out of your pension early in retirement. This is a bit of threading the needle, trying to avoid the 25% LTA penalty but also preserving wealth out of the reach of the 40% inheritance tax.
For most people at comfortable but not “fat” levels of wealth, RMDs are probably the bigger concern, unless you happen to have almost everything in a Pension and very little, if anything, in Traditional.
For example, at a 5% growth rate, you’d need about £1.6M in pension and £600k in Traditional at age 75 before you would be paying more in the Lifetime Allowance penalty than in “forced” taxes on RMDs (about £200k each in taxes here, although you do get the RMDs to spend without any additional tax while the Pension will be subject to income tax if you take any out).
Good problems to have
Before we get into the potential pain associated with RMDs and the Lifetime Allowance, a quick reminder – both of these are very good problems to have! If you’ve retired at all early and made it to 72 with enough money in your Traditional balance to worry about RMDs, or made it to 75 with enough in your UK Pension/SIPP to worry about the Lifetime Allowance, you’ve done well. You’ve survived any sequence of returns risks and made it to the other side with a good chunk of change.
- The taxes associated with the Lifetime Allowance only apply to pension balances over £1,073,100, and they’re marginal. If you have £1,073,101 when you turn 75, you’ll pay about a 25% penalty on that £1.
- At a 4% Safe Withdrawal Rate, the £1,073,100 is enough for about £43k a year – after tax, that’s more like £39k a year – more than median UK household spending. Add in Social Security, State Pension, and any other savings, and you’ve got a comfortable living.
- If you have so much more than £1,073,100 that you’re paying a material amount of tax at 75, that’s honestly a pretty good bit of gravy. We’re really talking about managing taxes for generational wealth, significant charitable giving, or a lot of luxury/leisure spending after age 75 – not making sure you can put food on the table.
- RMDs will hit everybody with a Traditional balance when they turn 72, regardless of how big the balance is.
- But, even if we assume that your personal allowance is already full from State Pension and Social Security, you’ll only ever get into higher rate (40%) taxes from about a £470k balance at age 75 (assuming 5% real growth). And that’s just barely getting into the bracket, once you’re into your 90s.
- To have to pay higher rate taxes from age 72, you’d need a balance of over £960k. At that point, your RMDs alone are throwing off £37k a year and rising – even after tax, you’ve got a very comfortable retirement with RMDs plus Social Security and/or State Pension, at roughly £42k at age 72, rising to £66k at age 95 (5% growth). Add in any additional withdrawals or other savings, and you’re doing very well.
RMDs and the Lifetime Allowance have the same three basic strategies to minimize their impact:
- Contribute less: keeping balances low enough can completely avoid the Lifetime Allowance problem and keep RMDs to a manageable level.
- The obvious drawback is that you either have less money, or the money goes somewhere else, which will be less tax advantageous during the accumulation phase. For example, a Roth IRA doesn’t have RMDs, but contributions are post-tax. An ISA doesn’t have a Lifetime Allowance, but contributions are post-tax and gains are UK taxable as they arise.
- This is really only a useful option is you’re very close to the edge on the LTA and are picking where to put some marginal money.
- Grow less: within your intended asset allocation, preferentially hold your bonds, and any other asset classes you think are likely to grow more slowly, in your Traditional and/or Pension accounts. The earlier you do this, the bigger the impact (reduced compound interest in your Traditional or Pension accounts), but most people don’t have a large bond allocation early in the accumulation phase. Unless you have a large bond allocation, or large amounts saved outside of Traditional and Pension accounts so that they can be mostly or entirely bonds, this is a tweak, not a solution.
- Don’t change your asset allocation to be more bond-heavy just due to RMDs and the Lifetime Allowance – that’s the tail wagging the dog. But if you have bonds anyway, it makes sense to put them in your Traditional and/or Pension accounts.
- Withdraw aggressively
- In Traditional accounts, you can start this early with Roth conversions – as soon as your earned income puts you in a low enough income bracket that it makes sense (ideally 0%, but 10% or 12% may be reasonable, too). With a long enough time horizon, this can deal with almost any plausible Traditional balance and avoid RMDs completely, or at the very least make a big dent in them.
- In a Pension, you have to wait until age 55 (or 57, whenever you get access to your pension) before you can start withdrawing. We’ve seen that you can withdraw the entire Lifetime Allowance between age 55 and 75 while staying within the 20% basic rate tax bracket, either spending it or moving it to a different account to continue growing but without the worry of a Lifetime Allowance (probably an ISA). Of course, this doesn’t deal with any value above the Lifetime Allowance when you start, so isn’t a complete solution. It also has inheritance tax implications, since you’re potentially moving money from an account outside your estate (pension) into somewhere inside your estate and thus subject to 40% inheritance tax.
Which is worse?
This is a hard question to answer – I’ve been playing with a bunch of different scenarios, trying to make a concrete answer. The result: for the same amount of money, RMDs will likely incur more forced taxes. If, in the absence of RMDs and Lifetime Allowance concerns, you were on track to never pay taxes again, this can blow up that plan.
On the other hand, you do get those RMDs to spend – for example, if you wanted to spend £36k a year and had a Personal Allowance’s worth of State Pension/Social Security, the RMDs alone on a Traditional balance of £750k would make up the rest of the £23,250 spending in every year from age 72. The problem is that they make up way more income than you need in later years, and you have to pay tax on that – we’re talking an additional £40k/year more than you wanted, some of it taxed at 40%.
Exceeding the Lifetime Allowance causes you to pay extra tax without getting any extra money – effectively a 25%+ penalty on anything above the allowance. You still have to pay income tax if/when you or your heirs want the money, although your there’s no inheritance tax on the money in your pension.
Quick graph to illustrate – assuming a 5% growth rate, this shows both the 25% penalty on exceeding the Lifetime Allowance at age 75 and the total income taxes paid on RMDs from age 72. But remember – you’ll likely have to pay income taxes on something, whether it’s RMDs or pension withdrawals or a fat Social Security check, so this isn’t a straight comparison – the 25% penalty is in addition to income tax on whatever you’re using to fund your retirement. The only way out of paying income taxes on something are a lot of Roth conversions early on, which then become tax free on withdrawal.
For the same balance in Traditional vs Pension, you’ll always pay more income tax on RMDs than Lifetime Allowance penalty, but whether that’s a larger or smaller total tax burden depends on your overall financial picture.
So there’s no generic answer – let’s look at a few examples to try to illustrate how they could play out.
Bob, Polly, and Tracey are in similar situations:
- Age 55 and have just retired, with no plans for any future earned income
- Have £1,000,000 invested:
- Balanced Bob has £500,000 in his UK Pension and £500,000 in his Traditional IRA
- Pension Polly has £750,000 in her UK Pension and £250,000 in her Traditional IRA
- Traditional Tracey has £250,000 in her UK Pension and £750,000 in her Traditional IRA
- They have nothing in ISAs, Roth IRAs, or taxable accounts – the UK Pension and Traditional IRA will fund their retirement.
- They all expect to take State Pension and/or Social Security at age 68, in an amount equal to the Personal Allowance (£12,570). We’ll assume a 50/50 split, so only half is US taxable (US doesn’t tax social security paid to a UK resident, per the tax treaty).
- They will all experience steady 5% real returns in any invested balance, reflecting a moderate bond allocation in these accounts (we won’t model more bonds in one vs the other – it’s a small difference and the assumptions have a bigger impact than the strategy)
- They’re all American citizens living in the UK. They’re each married, but their spouse has no investments or income (for the sake of simplicity in illustration)
- They each want to spend £36,000 a year in retirement, for the rest of their lives.
- They all expect to live to age 95
- Tax brackets don’t change, and $1.40 buys a £
- Their house is paid off and not considered in the examples, but it fills their entire UK inheritance tax allowance, so anything not sheltered by a pension is taxed at 40%.
We’ll look at four strategies for Bob, Polly, & Tracey:
- Do nothing – don’t actively plan for RMDs or the Lifetime Allowance and let the chips fall where they may. They mostly split the withdrawals to fund their £36k expenses evenly between Traditional and Pension.
- Focus on RMDs – Heavy on the Roth conversions as soon as they retire (age 55), getting Traditional balance to zero ASAP
- Focus on Lifetime Allowance – Heavy on Pension withdrawals starting from age 55, trying to minimize LTA penalties
- Balanced – Try to split the difference between Roth conversions & Pension withdrawals and get the overall best outcome
And a couple of big tax assumptions – these are both hugely up for debate:
- Traditional to Roth conversions are taxed in the US but are tax-free in the UK
- UK Pension withdrawals are 25% tax free, 75% taxed in the UK (that is certain), and 100% taxed in the US (that is debatable), but UK tax on the 75% generates enough FTC so that no US tax is owed (typically true, but there are exceptions)
These aren’t just semantic issues, either – if Roth conversions are only taxed in the US and UK pension withdrawals are only taxed in the UK, there’s a potentially huge ability to move money and avoid both RMDs and LTA penalties. But I think these are reasonable, fairly middle of the road assumptions – you have to decide for yourself, or get professional advice.
There are also some simplifying assumptions in the calculations – no interest, dividends, or capital gains, and slightly simplified US tax calculations. The outcomes should be considered illustrative, not exact.
I’ll put a vignette for each outcome at the end of this post, if you’re really interested. But for those who don’t want quite so much detail, here’s the summary, with the best outcome for each of them in bold:
|Ending ISA + Roth|
|Ending Net Worth||Income Tax Paid||LTA Penalty Paid||Total Tax Paid||Inheritance Tax (40%)||Value to Heirs|
After Inheritance Tax
There are no Bob or Tracey LTA Focus scenarios, because there’s no LTA payable even when RMDs are the focus. Bob is very close to exceeding his LTA in the RMD Focus scenario, but doesn’t quite tip over, Tracey basically can’t get to a point of worrying about LTAs from her lower starting balance, without growth well above the 5% assumption (around 8% or so she might get close to the LTA).
There’s no Bob or Tracey balanced scenarios, because there’s nothing I can find that improves on the RMD focus. There might be an option deep in the weeds to optimize on US taxes, but we’re talking about paying a little more at 10% instead of 12% – a tiny difference swamped by uncertainty and assumptions in these models.
- All of these are successful retirements – Bob, Polly, and Tracey all wanted to spend £36k a year and were able to, plus pass on ample inheritances.
- You should not ignore RMDs – even Polly benefits from managing them, despite having a relatively low Traditional balance. If Bob or Tracey ignore RMDs, they get whacked with more money than they want, paying 20%, 40%, or even 60% tax on them.
- Focusing on the LTA while ignoring RMDs can wind up with a higher overall tax bill, even if you avoid or minimize the LTA penalty. Compare Polly’s LTA Focus to her RMD focus – her LTA penalty goes almost to zero, but her total tax paid is significantly higher due to her very high Pension withdrawals, taxed at 20%. Because her Pension has gone to zero, her estate pays a LOT in inheritance tax. After tax, her estate is more than £1M less than in her other strategies.
- You probably won’t have a choice whether your scenario is closer to Bob, Polly, or Tracey, unless you’re still in the US contributing to a Traditional account and deciding when you want to move to the UK. I wouldn’t let retirement tax withdrawal planning drive that decision! And it’s not clear which scenario is better – for the same total balance, a higher Pension balance makes it easier to shelter from inheritance tax and RMDs easier to deal with, a higher Traditional balance helps avoid LTA penalties.
- The apparent big advantage of a Pension in inheritance tax needs a caveat – a big ISA or Roth balance is subject to 40% inheritance tax, but not income tax when your heirs take it. A Pension doesn’t face that 40% inheritance tax, but is taxable income if your heirs take it – at whatever their marginal income tax rate is. They can choose when that is, though, whereas inheritance tax is assessed when you die.
- The calculus changes as the total balance increases above £1M, especially if a lot of that is in a Pension. LTA becomes more and more of a concern, but there’s also less you can do about it. Big Pension withdrawals can push you into the US 22% tax bracket, so Roth conversions don’t make much sense anymore. There’s still a balance to be struck, but it becomes a lot more difficult to optimize. I haven’t done a lot of scenarios with bigger balances because it gets a lot fuzzier (and all the Excel is already making my eyes go cross!)
- The calculus also changes a lot if Bob, Polly, and Tracey aren’t married and including their spouse on their US taxes – Roth conversions get a lot harder with only Single or Married Filing Separately US tax brackets, instead of Married Filing Jointly.
Some of the difference sin the scenarios are easier to see in graphs (balances on the left axis, annual tax on the right):
The differences in the tax curve really shows how differently these approaches behave – a simple withdrawal approach without Roth conversions has tax steady or exponentially increasing over time. A Roth conversion approach has all the tax up front, then driven to zero.
Obviously these are unrealistic scenarios with steady 5% growth – reality will be much choppier, and you won’t get that clean exponential growth in the Pension balance. Still, it shows just how small of a hiccup a even a moderate LTA penalty is (about £124k in both Polly scenarios)
That was a whole lot of words to say “it depends”! But really, it’s important you do pay some attention to this as part of your retirement planning and at least play out the scenarios. Some very rough guidelines that helped me arrive at the “best” scenarios:
- Big Pension withdrawals up front help in two ways – knock down growth in your Pension to help with the LTA and bridge your spending until US retirement accounts become available at age 59.5
- After those first few years, dropping Pension withdrawals way down helps overall. If you do need some Pension withdrawals to support spending, it’s better to spread them out. If you have enough after Roth conversions that you never have to touch your Pension again, that’s even better (and helps with inheritance tax planning).
- Start Roth conversions ASAP, for another two reasons – they help knock down Traditional growth to help with RMDs and, after 5 years, they give you a pot of tax-free cash to work with. In most cases, Roth conversions to fill the US 12% tax bracket were optimal – this makes sense, because it’s avoiding 20%+ UK tax on the RMDs
- It does make sense to continue Roth conversions all the way until you turn age 72, at least to fill the US Standard Deduction. It’s a small tweak, but saves a little tax compared to just getting Traditional to zero ASAP (moves money from 10% or 12% brackets to 0%)
- Accepting RMDs only makes sense if you can’t get your Traditional balance to zero by age 72 without going into the 22% US bracket – then you’re balancing 22% earlier vs 20% UK tax later.
After this detour into RMDs and the LTA, I will return to the overall withdrawal strategies series. I might do a few smaller standalone posts before going into Part 3, Putting it All Together – I could use a little break from too many Excel models 🙂
Bob – Do Nothing
- Starts with equal £500k balances in his Pension and Traditional. He can’t get to his Traditional balance until age 59.5, so starts with his Pension funding his spending, staying well within the 20% basic rate.
- At 60, he starts splitting withdrawals 50/50 between his Pension and Traditional, still safely within the 20% basic rate.
- When Social Security/State Pension kick in at 68, his withdrawals drop but overall income stays the same.
- At 72, RMDs kick in. They’re big enough from the beginning to fund his retirement, when combined with SS/SP, so he never touches his pension again.
- At 75, his remaining pension balance plus all his withdrawals to date are tested against the LTA – he comes in safely under, and pays no penalty (about £166k to spare).
- From 76 onward, his RMDs plus SS/SP are sufficient to fund his retirement, and he takes no further withdrawals from his Pension, or anything above RMDs on his Traditional.
- From age 76, RMDs are big enough they’ve pushed him into the 40% higher rate income tax band
- At 95, his RMDs alone are over £66k, plus £12k from SS/SP means he has taxable income of £79k a year, despite only wanting to spend £36k
- His pension has grown without any withdrawals since age 72, so by 95 it’s worth almost £1.4M – that can be passed to his heirs without paying inheritance tax. His traditional balance at death is about £534k, which is subject to inheritance tax. He also has £581k in savings outside his Pension & Traditional balance, probably in an ISA. That’s a total net worth of about £2.5M
- Over the course of his retirement, Bob paid £397k in UK income tax, mostly in the 20% band with a bit into 40% in his later years, pushing his annual UK tax up to almost £20k late in life.
Polly – Do Nothing
- Starts with £250k in her Traditional and £750k in her Pension, with Pension withdrawals to fund retirement. Comfortably in the 20% basic rate and using about £20k of LTA each year. When she can get to her Traditional balance at 59.5, she starts splitting withdrawals 50/50 between Pension and Traditional.
- When SS/SP kick in at 68, withdrawals drop, overall income stays the same, 20% basic rate.
- At 72, RMDs kick in. At first, they aren’t enough to keep up the 50/50 split, so she makes additional withdrawals. But as they ramp up, the RMDs alone exceed 50/50 from age 82, although she needs some Pension withdrawals to make up the rest of her spending needs.
- At 75, her pension balance is tested against the LTA. Since she started with more than Bob but withdrew only a little bit more (withdrawals from age 72 to 75), she’s got a bigger balance – about £1.1M, and has already used about £459k of the LTA on the withdrawals., so she has £493k above the LTA. She pays 25% tax on that, totaling £123k.
- At 95, Polly’s pension is worth about £2.3M, all of which can be passed to her heirs without inheritance tax. She has about £152k left in her Traditional
- Over the course of her retirement, Polly paid £195k in income tax, plus the £123k LTA penalty, for a total tax bill of £319k. She was never above the 20% basic rate and paid no US tax, but the LTA penalty takes a chunk.
Tracey – Do Nothing
- Starts with £750k in her Traditional and £250k in her Pension, initially funding spending from her Pension and then splitting 50/50 once she can access her Traditional balance.
- At age 64, she’s fully depleted her pension, and switches to withdraw all her spending from her Traditional balance.
- When SS/SP kick in at 68, withdrawals drop, overall income stays the same, still 20% basic rate.
- At 72, RMDs kick in and are immediately more than her £36k spending, even ignoring SS/SP. They start at almost £49k per year, and rise to £100k at age 93. This immediately pushes her into the 40% higher rate tax bracket, and by 87 she’s creeping into the 60% bracket where the personal allowance phases out. She starts moving the excess RMDs into an ISA first, and if she uses both her and her spouse’s ISA allowance, she can just about stay under the combined £40k annual limit ( a few years in her 90s where she’s less than £2k over).
- At 75, her pension balance is tested against the LTA, but its zero. She has more than £776k of LTA remaining anyway.
- At 95, Polly’s Traditional balance has been significantly reduced by RMDs, but is still about £799k, down from a peak of over £1.3M in her late 70s. She has amassed a large savings in her ISA, over £1.2M, for a total net worth of about £2M, fully exposed to inheritance tax.
- Over the course of her retirement, Tracey paid a whopping £668k in income tax, with every year from age 72 onward in the 40% bracket or higher.
Bob – RMD Focus
- Starts with £500k each in Traditional and Pension.
- From age 55, Bob does two things in parallel:
- Start a Roth conversion ladder, filling up his US taxes until he’s maxed out the 12% tax bracket (over £32k of conversions every year)
- Draw down his Pension to fund his retirement (£44k/year gives £36k after taxes on both the pension withdrawals and US tax on the Roth conversions)
- After 5 years of Roth conversions, Bob is able to start accessing those conversions
- So at age 60, Bob starts using tax-free withdrawals from his Roth account to fund his retirement spending
- He ramps up his Roth conversions, completely filling his US taxes to the 12% bracket (almost £76k/year)
- He’s not touching his Pension now, and will never touch it again, just letting it grow
- Because all his income is coming from the Roth balance, Bob has no UK taxable income at this point.
- By age 67, Bob has fully depleted his Traditional balance and converted it all to Roth, and is using that Roth balance to fund his retirement spending
- From age 68, SS/SP kick in, so Bob can slow down his Roth withdrawals proportionally
- This continues until Bob’s death at 95 – living off his Roth withdrawals and SS/SP, leaving his Pension to grow
- At age 75 his pension is tested against the Lifetime Allowance. Because of his 5 years of withdrawals at the beginning of retirement, he knocked the balance down just enough to avoid any penalty (with about £54k to spare to the limit)
- At 95, Bob has £2.2M in his Pension, which he can pass to his heirs tax free, and £688k in his Roth balance, which will be subject to inheritance tax.
- Over the course of his retirement, Bob paid only £99k in income tax.
Polly – RMD Focus
- Start with £750k in Pension and £250k in Traditional, but Polly is going to focus on RMDs, not the Lifetime Allowance
- She can’t completely follow Bob’s approach, because she won’t be able to convert enough from her Traditional to Roth to fund her retirement – she’ll need some Pension withdrawals to make up the difference.
- Her first 5 years are identical to Bob – pension withdrawals for income, Roth conversions to max out the 12% US bracket
- At age 60, they start to diverge:
- Polly starts taking some income from her Roth balance (£19k), but withdraws the remainder from her Pension
- She keeps converting to Roth while staying within the 12% US bracket – her Traditional is depleted by age 62.
- When SS/SP kicks in, she reduces her Pension withdrawals, but they’re still about £5k a year, along with £19k from Roth and £12k from SS/SP to make up £36k spending.
- She continues that pattern from age 68 until her death at 95, except that around age 91 her Roth balance runs out, so she switches all of her withdrawals to her Pension.
- At age 75, her Pension is tested against the Lifetime Allowance. With a balance of almost £1.2M plus about £386k used for previous withdrawals, she’s well over the LTA. 25% of the excess is levied as a tax, £125k.
- At 95, Polly has £2.7M in her Pension to pass along tax free.
- Over the course of her retirement, she paid even less income tax that Bob, just £90k, but that big LTA penalty pushes her total tax paid to £215k.
Tracey – RMD Focus
- Start with £750k in Traditional and £250k in Pension – makes sense that she’ll focus on RMDs, since LTA will almost certainly not be a problem (it’d take some great investment returns, about 8% annually for 20 years, just to hit it)
- She has essentially the same approach as Bob, it will just take Tracey longer to completely deplete her larger Traditional balance.
- Her first 5 years are identical to Bob & Polly – pension withdrawals for income, Roth conversions to max out the 12% US bracket
- At age 60, she follows Bob – shift to taking her spending from her Roth balance and increasing her Roth conversions to completely fill the 12% US bracket.
- At age 68, SS/SP come in, being used for spending and reducing the amount of Roth conversions (although still high, almost £70k/year)
- At age 72, she hasn’t quite depleted her Traditional balance, so starts taking some RMDs, but these are modest, starting at about £7k per year. She continues aggressive Roth conversions to fill the rest of the 12% bracket, after RMDs and SS/SP, while still drawing most income from her Roth balance.
- At age 75, she’s finished depleting her Traditional balance and RMDs stop. From here on out, she lives off her Roth balance plus SS/SP, leaving her relatively small Pension balance to grow.
- Her Pension is tested against the LTA at 75, but she was never in any real danger of exceeding the Lifetime Allowance, with more than £717k to spare. The 5 years of withdrawals up front just allowed her to bridge to access her Roth balance.
- At 95, Tracey has £384k in her Pension plus £2.3M in her Roth balance. That big Roth balance is subject to UK inheritance tax at 40%.
- Over the course of her retirement, she paid £151k in income tax, all at either the US 10 or 12% rate or the UK 20% basic rate.
Polly – LTA Focus
- Polly is the only one who winds up paying the LTA penalty above, so let’s try to avoid or at least minimize that
- She starts with £750k in Pension, £250k in RMDs
- She wants to get as much money out of her Pension as fast as she can, so any compounding takes place elsewhere, probably an ISA
- So she starts with £65k a year, paying 20% tax on a good chunk of that. She moves the proceeds into an ISA.
- In parallel, she starts Roth conversions, up to the 12% US bracket. LTA is her focus, but we don’t want RMDs to run away with her, either, and these don’t have any UK tax impact
- Once SS/SP starts at age 68, she scales back the Pension withdrawals a little bit, to stay in the 20% basic rate tax
- Counterintuitively, this means she can increase her Roth conversions slightly – since 25% of Pension withdrawals are UK tax free, but 100% are US taxable, while 100% of SS/SP are UK taxable, the £12,570 of SS/SP only results in a cut of £9,600 in Pension withdrawals – that gap can be used for Roth conversions while staying in the 12% bracket
- It all comes together at age 75 and 76:
- She’s used the entire LTA on withdrawals and paid a small £9k penalty on her withdrawals at age 74, but those withdrawals bring her Pension balance to £0 – there’s no further penalty.
- She finishes converting her entire Traditional balance to Roth – she had a couple of years of small RMDs starting at 72, but nothing big, although they did push her slightly into the 40% tax rate.
- She switches from dumping money from her Pension into her ISA and from her Traditional to Roth while funding her spending from her Pension, to funding her spending from her ISA, Roth, & SS/SP.
- From age 76, all her spending is from ISA, Roth, and SS/SP.
- At 95, Polly has £2.4M in ISA/Roth that’s all subject to inheritance tax.
- Over the course of her retirement, she paid £190k in income tax – much more than in RMD focus (that was £90k), because she’s just about maxing out the 20% basic rate every year until she turns 75, moving money from her Pension to her ISA and from her Traditional to Roth balance. She also paid £9k in LTA penalties, compared to £125k in RMD focus). Her total tax bill dropped from £215k in RMD focus to £199k, but now all her savings are subject to inheritance tax, instead of none of them.
Polly – Balanced
- This is really only a very small tweak from Polly’s RMD focus – the change is just to stretch out her Roth conversions from age 55 to 72, finishing just as RMDs come in. This allows more of those conversions to be taxed at 0% or 10% US rates, instead of 12%. It’s only a modest change, reducing income tax from £90k to £84k and final net worth increasing from by about £10k, still all in a Pension.