Deliberately losing FP2016 after BCE 1 "for the win"?

[TedSwippet]

A recent post has set me thinking.

I hold FP2016, and my plan is to crystallise my pensions through BCE 1 exactly on the £1,250k LTA to net the optimum PCLS. However, timing this is really tricky -- I have three pension providers to deal with, and all want things done on paper with 'wet signature', by post and with multiple to-and-fro -- and I doubt I will get it spot-on. Meanwhile the pension assets bob around in value. The penalty for overshooting the LTA is pretty significant, so undershooting is by far the better of the two error cases.

Let's say I aim, miss slightly, and at the end of the day I use 98% of my LTA. That leaves me with £25k of 'headroom' which I can perhaps use later on to help duck under the spiteful age 75 BCE 5. Very minor help though in the grand scheme of things.

However, an alternative idea beckons. Suppose I now put £2,880 into a new pension. I am not earning, so that would be the maximum I can contribute. Starting a new pension will nullify my FP2016, meaning that I now have 2% of £1,030k so £20.6k of LTA remaining(?). But... with basic rate tax relief paid in the scheme I hold £3,600 in the pension. I also currently j-u-s-t sit in higher rate tax, so assuming that I can claim an additional 20% tax relief on the contribution(?), that £3,600 costs me £2,160. On drawing it, even at higher rate tax I would get back £2,520 for an immediate £360 win on the round-trip (not life-changing, but it pays for my gym for the year). Repeat as necessary until all the remaining LTA is used up, maybe four or five years. And a bigger win if/when I fall back entirely into basic rate tax.

Am I missing anything here, based on the rules as they stand today? Is my interpretation of how FP2016 is nullified after BCE 1 correct? Can a non-earner paying 40% tax claim this back fully on a non-earner's pension contribution? Any maths errors? Is this idea just plain nuts?

[mearnsfool]

You do not have any earned income to claim the extra tax relief on.

[TedSwippet]

You do not have any earned income to claim the extra tax relief on.

It has to be earned? I understand that you can only put in up to your earnings or £2,880 as an annual input allowance, but it wasn't clear to me that full tax relief couldn't still be claimed on that input. Maybe I missed something here.

If yes, that will probably hole this below the waterline. While there is a win for either basic or higher rate tax at both ends of the activity, basic rate tax relief on the way in and higher rate on the way out is of course a net loser, to the tune of 10%.

Oh well.

[ursaminortaur]

You do not have any earned income to claim the extra tax relief on.

It has to be earned? I understand that you can only put in up to your earnings or £2,880 as an annual input allowance, but it wasn't clear to me that full tax relief couldn't still be claimed on that input. Maybe I missed something here.

If yes, that will probably hole this below the waterline. While there is a win for either basic or higher rate tax at both ends of the activity, basic rate tax relief on the way in and higher rate on the way out is of course a net loser, to the tune of 10%.

Oh well.

I don't think that is correct. Unfortunately most of the information on the web assumes that if you are a higher rate tax payer you are in that position because you have large relevant earnings so doesn't explicitly deal with this situation.

However this link from Aegon appears to cover it

https://www.aegon.co.uk/support/faq/Understanding-our-products/retirement-products/taxation/higher-rate-taxpayer-how-do-i-get-the-extra-tax-relief.html

You probably already know that the government tops up your pension by adding basic rate tax relief of 20% to all your personal contributions (up to the maximum of 100% of your relevant UK earnings or £2,880 if this is greater). But did you know that, if you pay income tax at higher than basic rate - either as a UK or Scottish taxpayer, you’re entitled to extra tax relief on top of this?

You can claim this by either:

contacting your local tax office and getting your tax code adjusted
claiming the extra tax relief at the end of each tax year through self-assessment

[TedSwippet]

I don't think that is correct. Unfortunately most of the information on the web assumes that if you are a higher rate tax payer you are in that position because you have large relevant earnings so doesn't explicitly deal with this situation. However this link from Aegon appears to cover it ...

Thanks. As you say, it's hard to find direct evidence that the full 40% is recoverable on non-earnings £2,880 contributions. The linked paper sort-of infers that it is. And a close read of self assessment forms certainly suggested to me that a contribution of that type would flow through so that the additional 20% relief would be credited.

I guess one way to confirm this would be to run through a dummy HMRC online self-assessment as if I had made this contribution, to see how it shakes out in HMRC's software. Not that HMRC software is any real yardstick of accuracy these days, of course...

As for alternative plans, I could instead delay crystallising a portion of my pensions for a time. Say I am at 95% of the LTA and I crystallise 70% of my pensions. I still have 5% of the LTA as headroom, but now only 30% of the assets are generating growth that goes towards consuming it. That will considerably flatten the glide-path to the inevitable collision with the LTA, at which point uncrystallised pensions flip from tax efficient to tax millstone so that it is better not to have one. Doing this should make it easier to hit the LTA as closely as possible without exceeding it.

It is an unfortunate and sad reflection of the idiocy of UK pension tax policy that these sorts of machinations should be possible or desirable.

[ursaminortaur]

I don't think that is correct. Unfortunately most of the information on the web assumes that if you are a higher rate tax payer you are in that position because you have large relevant earnings so doesn't explicitly deal with this situation. However this link from Aegon appears to cover it ...

Thanks. As you say, it's hard to find direct evidence that the full 40% is recoverable on non-earnings £2,880 contributions. The linked paper sort-of infers that it is. And a close read of self assessment forms certainly suggested to me that a contribution of that type would flow through so that the additional 20% relief would be credited.

I guess one way to confirm this would be to run through a dummy HMRC online self-assessment as if I had made this contribution, to see how it shakes out in HMRC's software. Not that HMRC software is any real yardstick of accuracy these days, of course...

As for alternative plans, I could instead delay crystallising a portion of my pensions for a time. Say I am at 95% of the LTA and I crystallise 70% of my pensions. I still have 5% of the LTA as headroom, but now only 30% of the assets are generating growth that goes towards consuming it. That will considerably flatten the glide-path to the inevitable collision with the LTA, at which point uncrystallised pensions flip from tax efficient to tax millstone so that it is better not to have one. Doing this should make it easier to hit the LTA as closely as possible without exceeding it.

It is an unfortunate and sad reflection of the idiocy of UK pension tax policy that these sorts of machinations should be possible or desirable.

Although I agree about the idiocy of the now relatively low level of the LTA I'm not sure I would worry quite so much about exceeding it by a small amount. You have fixed protection so aren't contributing money to the pension so any chance of exceeding the LTA is just down to growth or the vagaries of the market. If you do exceed the LTA there will be charge of 55% but this is just on the excess so you will still have 45% of the excess which you wouldn't have had if you hadn't exceeded the LTA.

[TedSwippet]

Although I agree about the idiocy of the now relatively low level of the LTA I'm not sure I would worry quite so much about exceeding it by a small amount. You have fixed protection so aren't contributing money to the pension so any chance of exceeding the LTA is just down to growth or the vagaries of the market. If you do exceed the LTA there will be charge of 55% but this is just on the excess so you will still have 45% of the excess which you wouldn't have had if you hadn't exceeded the LTA.

That's certainly a valid way of looking at it. I don't worry hugely about going slightly over the LTA, but it is still better avoided.

At my LTA, if markets move upwards just 1% between my starting to action full crystallisation at the LTA and it happening -- entirely possible given the slowness in the processes of the various providers here (although a 1% or larger drop is of course also possible!) -- I could lose £3,125 in deadweight LTA penalty that I could have kept had crystallisation happened spot-on the LTA. Not life-changing, but it would fund a very nice holiday. And I would sooner keep this than let the government have it.

[ursaminortaur]

Although I agree about the idiocy of the now relatively low level of the LTA I'm not sure I would worry quite so much about exceeding it by a small amount. You have fixed protection so aren't contributing money to the pension so any chance of exceeding the LTA is just down to growth or the vagaries of the market. If you do exceed the LTA there will be charge of 55% but this is just on the excess so you will still have 45% of the excess which you wouldn't have had if you hadn't exceeded the LTA.

That's certainly a valid way of looking at it. I don't worry hugely about going slightly over the LTA, but it is still better avoided.

At my LTA, if markets move upwards just 1% between my starting to action full crystallisation at the LTA and it happening -- entirely possible given the slowness in the processes of the various providers here (although a 1% or larger drop is of course also possible!) -- I could lose £3,125 in deadweight LTA penalty that I could have kept had crystallisation happened spot-on the LTA. Not life-changing, but it would fund a very nice holiday. And I would sooner keep this than let the government have it.

If the penalty is £3125 then your excess over the LTA would be £5681.82 and after paying the penalty you would be left with £2556.82 more than you would have if you hit the LTA spot on.

[TedSwippet]

If the penalty is £3125 then your excess over the LTA would be £5681.82 and after paying the penalty you would be left with £2556.82 more than you would have if you hit the LTA spot on.

Not quite correct figures. The penalty is 25% of the amount above the LTA. The remainder is then taxed at marginal rate.

Suppose my pension rises by 1% during but crucially before crystallisation. That's a £12,500 gain, so that amount above the LTA. Pay 25% in LTA penalty, so £3,125, and then 40% tax on withdrawals of the rest, £3,750, for a total tax take of £6,875 and £5,625 pocketed.

Compare to that 1% rise happening after crystallisation. Here the gain falls into the re-invested 25% PCLS and the remaining drawdown element. So £3,125 taxed as capital gain at 20% say, and £9,375 taxed as income at 40% on withdrawal for a total tax take of £4,375 and £8,125 pocketed.

The LTA penalty leaves me with £2,500 less than in the comparison case, and is purely down to inability to micro-manage crystallisation timing. The loss widens to £3,125 if I can squeeze the capital gain from the 25% PCLS into the £11.7k annual CGT allowance. 25% of even small percentages of the LTA amount to usable amounts of actual cash.

A simple way to view this is: below the LTA, you get 25% of all the gains tax-free; above it, the government gets the entire 25% for itself instead. Put differently, once you hit the LTA the tax rate on the 25% PCLS rises abruptly from 0% to 100%. Definitely worth making the glide path more shallow by crystallising most but not all the pension when approaching the LTA, then.

[ursaminortaur]

If the penalty is £3125 then your excess over the LTA would be £5681.82 and after paying the penalty you would be left with £2556.82 more than you would have if you hit the LTA spot on.

Not quite correct figures. The penalty is 25% of the amount above the LTA. The remainder is then taxed at marginal rate.

Suppose my pension rises by 1% during but crucially before crystallisation. That's a £12,500 gain, so that amount above the LTA. Pay 25% in LTA penalty, so £3,125, and then 40% tax on withdrawals of the rest, £3,750, for a total tax take of £6,875 and £5,625 pocketed.

Compare to that 1% rise happening after crystallisation. Here the gain falls into the re-invested 25% PCLS and the remaining drawdown element. So £3,125 taxed as capital gain at 20% say, and £9,375 taxed as income at 40% on withdrawal for a total tax take of £4,375 and £8,125 pocketed.

The LTA penalty leaves me with £2,500 less than in the comparison case, and is purely down to inability to micro-manage crystallisation timing. The loss widens to £3,125 if I can squeeze the capital gain from the 25% PCLS into the £11.7k annual CGT allowance. 25% of even small percentages of the LTA amount to usable amounts of actual cash.

A simple way to view this is: below the LTA, you get 25% of all the gains tax-free; above it, the government gets the entire 25% for itself instead. Put differently, once you hit the LTA the tax rate on the 25% PCLS rises abruptly from 0% to 100%. Definitely worth making the glide path more shallow by crystallising most but not all the pension when approaching the LTA, then.

I was assuming you had just applied the 55% rate directly to taking it as a lump sum - this is equivalent to a tax charge of 25% followed by 40% tax on drawdown for a higher rate tax payer in retirement. (1 -25/100) x (1 - 40/100) = 45% left ie 1 - (55/100)

Either way you are still better off having an excess to be charged than not having any excess since you get to keep 45% of the excess.
Note if you take the excess as a lump sum the excess charge of 55% is all that is charged the lump sum is tax free.
https://www.telegraph.co.uk/finance/per ... e-tax.html

In essence if you take money above the LTA as a lump sum you pay just the 55pc tax charge and no additional tax. If you take it steadily, as income, you pay a 25pc tax charge and then you also pay your usual rate of income tax.

The problem with the LTA doesn't arise when you just go over it by these small amounts but when you exceed it by a fair amount since that indicates that you might have been better off contributing less and investing that money elsewhere.

[TedSwippet]

Either way you are still better off having an excess to be charged than not having any excess since you get to keep 45% of the excess.

Agreed, except that this is not the comparison I am interested in.

The issue is around the timing of crystallisation relative to a posited short-period 1% rise in markets, something well within the range of normal volatility. At or beyond the LTA, if the 1% rise comes before crystallisation can be completed the tax result is noticeably worse than if it happens afterwards. This occurs because the tax rates inside the pension LTA penalty zone are considerably above those that apply entirely outside pensions. Beyond the LTA, a pension is a tax ball-and-chain that it is better to escape than to live with.

[ursaminortaur]

Either way you are still better off having an excess to be charged than not having any excess since you get to keep 45% of the excess.

Agreed, except that this is not the comparison I am interested in.

The issue is around the timing of crystallisation relative to a posited short-period 1% rise in markets, something well within the range of normal volatility. At or beyond the LTA, if the 1% rise comes before crystallisation can be completed the tax result is noticeably worse than if it happens afterwards. This occurs because the tax rates inside the pension LTA penalty zone are considerably above those that apply entirely outside pensions. Beyond the LTA, a pension is a tax ball-and-chain that it is better to escape than to live with.

Ok but it seems a strange comparison to make.

[TedSwippet]

Ok but it seems a strange comparison to make.

It is the comparison that you need if trying to quantify potential losses due to pension provider lead time and possible delays when crystallising a pension that has hit the LTA.

Of course, there could well be a 1% drop rather than a 1% rise during any crystallisation delay. That would mean missing out on a chunk of tax-free PCLS, but the loss to inefficiency there is less than the loss to LTA penalty from a 1% rise. Start the paperwork and then get down on your knees and pray for markets to drift nowhere but sideways for a week or two, seems to be the general best approach.

Perhaps I am not exploring all the options fully. I have seen it suggested that HL can help you micro-manage the timing once the paperwork is in place. Get all that squared away and then phone and tell them "now!" when the day/hour/minute arrives. It could be that one or more of my providers (none is HL!) might be able to do the same thing. I should probably check more carefully with them. Or worst case I guess that I could sell to cash on the day/hour/minute of hitting the LTA and front-run the re-invested PCLS from other money for the duration of crystallising. Either way, I am sure that I am an 'edge case' relative to their normal work.

[Chrysalis]

To go back to your original question, I’d be surprised if you can get 40% tax relief on the non-earners pension contribution. Only because I know that the 20% tax reclaim is given irrespective of whether you have actually paid tax. I may be wrong though, and would be interested to know the answer to the question.

On the LTA issue, I tend to agree with ursaminotour, that it is not worth putting a lot of effort into avoiding (particularly if you don’t really need to draw from the pensions). You are still net better off taking the growth after the LTA is breached than not having that growth, surely? (And since you are not contributing any more, it is all ‘free’ growth - the decisions that are relevant in terms of whether further contributions are worthwhile have already been taken).

[ursaminortaur]

To go back to your original question, I’d be surprised if you can get 40% tax relief on the non-earners pension contribution. Only because I know that the 20% tax reclaim is given irrespective of whether you have actually paid tax. I may be wrong though, and would be interested to know the answer to the question.

But in this case the OP has paid the tax it is just that the tax was paid on non-relevant rather than relevant earnings.

[TedSwippet]

On the LTA issue, I tend to agree with ursaminotour, that it is not worth putting a lot of effort into avoiding (particularly if you don’t really need to draw from the pensions). You are still net better off taking the growth after the LTA is breached than not having that growth, surely?

Yes, of course some growth is better than no growth.

But assuming that there is some growth over time -- this would be the expected case, after all -- you are net better off by a considerably larger amount if you crystallise a pension at the LTA before that growth occurs, rather than afterwards. That way you get to keep at least 65% of this growth rather than just 45% of it.

I am not sure what is is about this that could appear unclear.

[Chrysalis]

@tedswippet - only if you are assuming the same growth in both cases. If, by leaving the SIPP untouched and gaining more growth, presumably you may come to a point where the additional growth makes up for the higher tax hit?

[TedSwippet]

@tedswippet - only if you are assuming the same growth in both cases. If, by leaving the SIPP untouched and gaining more growth, presumably you may come to a point where the additional growth makes up for the higher tax hit?

I am assuming the same growth in both cases. Perhaps I am missing something in your comment, but I am not sure how I could be 'gaining more growth' by leaving the SIPP untouched. The markets just do what they do, irrespective of whether or not I crystallise my pensions (although I have long suspected that markets actually watch and wait until I make a large move before either crashing or taking off furiously!)

Specifically, I'm assuming that the markets will grow by some percentage and that they will do so regardless of whether or not I crystallise my pensions, and that after crystallising I will hold assets that reflect the same fixed set of proportions of those markets that I held before crystallising the pension. In other words, I will take the 25% PCLS and put it straight back into the funds that were sold down inside the SIPP to provide it, just now outside the SIPP, and move the rest into drawdown while again using the exact same funds.

The superficial view of my reasoning is that if I left everything in the SIPP then all future growth in it will be taxed at 55% when withdrawn, because all of it pushes the SIPP value that much further above the LTA. Whereas if I crystallise at the LTA then it splits into two parts, the PCLS and the drawdown portion, but both give me a tax rate well below 55%.

The 25% PCLS part held outside the SIPP will be subject to a blend of assorted annual income and capital gains taxes that will be lower than 55%, and likely considerably lower. This is a virtual mathematical certainty since aside from the silly 60% bubble bracket (which I plan to mitigate or avoid entirely), all tax rates outside of a SIPP are below 55%. And the growth on the remaining 75% still in the SIPP can now be drawn at normal income tax rates without incurring any LTA penalty because I have now jumped the first LTA hurdle (and providing all the growth is drawn, no spiteful LTA penalty at age 75 and the second LTA hurdle either), so also at a tax rate well below 55%.

There is an argument that if everything were left in the SIPP it could grow inside a tax-deferred environment that would provide an edge over holding some of those investments outside of the SIPP and so taxable annually once crystallised. However, it will take a long time for that to overcome an around 20% tax headwind from the 55% LTA penalty relative to crystallising at the LTA, particularly since the capital gains taxes on the PCLS part can be either wrapped into the annual CGT allowance or just simply deferred by not selling. I ran some projections a while back, and the duration to break-even seemed to take me to around age 95. I may not need to draw income from the SIPP just yet, but I certainly will before age 95!

[Chrysalis]

Thanks for th explanation. I think I am more or less convinced by your argument. It is indeed something I need to try to understand as I am likely to be in similar position at some point, but complicated by the major part of the LTA being taken by a DB pension, and I do not want to pay any LTA excess charge from the DB. By your reasoning the best course of action is to crystallise as early as possible after I draw the DB pension and then continue to withdraw any (nominal?) growth.
Although a further complication arises if the SIPP does not need to be spent and is intended for beneficiaries.

[JohnB]

Surely you can avoid all uncertainty over the numbers by selling at the time of your choosing, and then crystallising the cash, which will remain unchanged during the process. But being out of the market is a bigger risk (and having 2 sets of dealing charges) seems more annoying than the slim risk 55% tax on a few% of your pot.