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LTA and tax

rms789
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LTA and tax

#234424

Postby rms789 » July 6th, 2019, 3:51 pm

Having saved for a long time into my pension and had the benefit of good investment returns I have a fund of £1.7m with lifetime protection of £1.25m. I'm 57 and am thinking of taking the 25% TFLS of the 1.25m and moving the balance into flexi income drawdown. Does this crystalise the whole of my pot and would the tax be 25% of the amount moved to drawdown? Is there a more tax effiecient way of accessing the fund?

I got totally confused trying to understand HMRC website so thank you in advance for any help

DrBunsenHoneydew
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Re: LTA and tax

#234439

Postby DrBunsenHoneydew » July 6th, 2019, 5:07 pm

rms789 wrote:Having saved for a long time into my pension and had the benefit of good investment returns I have a fund of £1.7m with lifetime protection of £1.25m. I'm 57 and am thinking of taking the 25% TFLS of the 1.25m and moving the balance into flexi income drawdown. Does this crystalise the whole of my pot and would the tax be 25% of the amount moved to drawdown? Is there a more tax effiecient way of accessing the fund?

I got totally confused trying to understand HMRC website so thank you in advance for any help


You could just crystallise £1.25M and take 25% of that tax-free. That would use 100% of your protected LTA.
The decision is whether you need to take income from the "Excess 450k" or not. The "LTA exceeded" tax is only paid when you draw something out from that part of the Fund, or reach age 75 or die, whichever comes first. If you're a 40% taxpayer in retirement there would be no difference whether you took lump sums or income - the same tax would be paid either way.
On the other hand, you could simply draw more from the "75% of LTA" part and leave the excess to grow for now. Who knows what rules will apply in future?

runnygum
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Re: LTA and tax

#261590

Postby runnygum » November 2nd, 2019, 4:33 am

Good question and almost exactly what I was going to ask.

My thoughts were to do similar to above.
Take the £1.25M 25% TFLS and the balance to drawdown and leave the remainder above the LTA in the SIPP for now.

I would take up to the 20% tax rate which is £46k or so annually as income.

The remainder will be subject to an RPI limit increase over time, so one day will allow small amounts to be taken annually up to the new limit? (I assume so this is also a question) I also assume that each LTA increase over the £1.25M would allow another 25% of that increase tax free?

And/Or anyway the rules might/will change which may remove the LTA altogether. Especially after a decade or so when nobody cares and considering there is an annual limit which takes care of things in any case. (The LTA is a pointless measure and makes no logical or rational sense.)

Anyway, rambling will now end with me asking if this all sounds a sensible way to proceed (currently)?

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Re: LTA and tax

#261623

Postby ffacoffipawb64 » November 2nd, 2019, 9:48 am

runnygum wrote:Good question and almost exactly what I was going to ask.

My thoughts were to do similar to above.
Take the £1.25M 25% TFLS and the balance to drawdown and leave the remainder above the LTA in the SIPP for now.

I would take up to the 20% tax rate which is £46k or so annually as income.

The remainder will be subject to an RPI limit increase over time, so one day will allow small amounts to be taken annually up to the new limit? (I assume so this is also a question) I also assume that each LTA increase over the £1.25M would allow another 25% of that increase tax free?

And/Or anyway the rules might/will change which may remove the LTA altogether. Especially after a decade or so when nobody cares and considering there is an annual limit which takes care of things in any case. (The LTA is a pointless measure and makes no logical or rational sense.)

Anyway, rambling will now end with me asking if this all sounds a sensible way to proceed (currently)?


Once you use up 100% LTA that is it.

Even if LTA went up to £100 million you would still be liable to an LTA charge because you have no LTA left.

You would only pay no LTA charge if it were abolished.

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Re: LTA and tax

#261628

Postby Chrysalis » November 2nd, 2019, 10:46 am

If the drawdown portion grows faster than you extract it, then a further charge is payable on any growth at age 75.

The LTA may seem unfair and complex, but it raises revenue for the treasury as well as being a useful political signal regarding the limits to tax relief on pensions (although of course the majority of tax relief goes to higher rate taxpayers on the way in). It therefore makes both economic and political sense, and I don’t see any flavour of government abolishing it any time soon.

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Re: LTA and tax

#261630

Postby TedSwippet » November 2nd, 2019, 10:53 am

Chrysalis wrote:It therefore makes both economic and political sense, and I don’t see any flavour of government abolishing it any time soon.

It's certainly a political signal, and also both unfair and complex, but I think it is debatable whether it makes economic sense.

It tends to motivate moving to part-time work, reducing shifts, and retiring earlier than planned. Taken together, these effects might more than offset any money the government takes in from LTA breaches. I agree though that it's unlikely to disappear any time soon. And if it does for some reason, whatever replaces it will be worse.

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Re: LTA and tax

#261686

Postby Alaric » November 2nd, 2019, 2:46 pm

TedSwippet wrote:I agree though that it's unlikely to disappear any time soon. And if it does for some reason, whatever replaces it will be worse.


For defined contributions, by far the simplest approach would be to copy ISA rules and have a maximum annual contribution. For defined benefit schemes have the equivalent to that expressed as a monthly or annual additional accrual. An amount defined in £ for each month or year of service. Probably it should also vary by age or age band to allow for the time value of money.

You would avoid the current problem that higher earners with long periods of service and defined benefit schemes can be better off retiring or semi retiring than working because of LTA tax.

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Re: LTA and tax

#261689

Postby scrumpyjack » November 2nd, 2019, 2:55 pm

Yes it would be better to remove the cap but to limit the 25% tax free lump sum to say 100000.

There isn't any reason for it being unlimited. The objective should be to make reasonable pension saving attractive. Beyond that it becomes an unnecessary subsidy

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Re: LTA and tax

#261798

Postby ursaminortaur » November 3rd, 2019, 10:48 am

Alaric wrote:
TedSwippet wrote:I agree though that it's unlikely to disappear any time soon. And if it does for some reason, whatever replaces it will be worse.


For defined contributions, by far the simplest approach would be to copy ISA rules and have a maximum annual contribution. For defined benefit schemes have the equivalent to that expressed as a monthly or annual additional accrual. An amount defined in £ for each month or year of service. Probably it should also vary by age or age band to allow for the time value of money.

You would avoid the current problem that higher earners with long periods of service and defined benefit schemes can be better off retiring or semi retiring than working because of LTA tax.


There already is an annual limit of £40,000 applied to both DC and DB schemes and indeed, although the LTA limit is a problem, the main problems that doctors are having are actually being caused by the annual limit rather than the LTA since it too along with the LTA has been reduced too far and to exacerbate the problem Osborne introduced the complication of a taper on the annual allowance for higher earners reducing it for some all the way down to £10,000 per year.

https://www.theguardian.com/commentisfree/2019/jul/09/senior-doctors-nhs-pensions-standoff-consultants-extra-hours

Now, senior doctors are voting with their feet, either retiring early or refusing to work any extra sessions for fear of ending up having to pay for the privilege. The result – at time when more than 4.4 million people are languishing on NHS waiting lists for non-urgent care – is a perfect storm of excess demand and a dwindling consultant workforce. Patient safety is in jeopardy.

Osborne changed the law so that the very highest earners could no longer claim tax relief on £40,000 of pension contributions annually. Instead, the annual allowance now tapers down from £40,000 to only £10,000. Seems reasonable enough. But fiendishly complicated rules around how the taper is calculated mean high-earning doctors can suddenly hit a cliff-edge income where, unbeknown to them, tapering kicks in and additional earnings can trigger massive retrospective tax bills. Working longer hours may result in tax rates of more than 100% – you are literally increasing your workload for a pay cut.

No one would pretend that NHS consultants are not well paid, or that the tax quirks of those on six-figure salaries are a pressing issue in national life. But this is an example of fiscal reform having disastrous unintended consequences. Consultants who would be only too willing to help their trusts tackle backlogs of thousands of patients needing operations and assessments by working extra weekends, for example, are now too afraid to do so.

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Re: LTA and tax

#261809

Postby Alaric » November 3rd, 2019, 11:28 am

ursaminortaur wrote:There already is an annual limit of £40,000 applied to both DC and DB schemes and indeed, although the LTA limit is a problem, the main problems that doctors are having are actually being caused by the annual limit rather than the LTA since it too along with the LTA has been reduced too far and to exacerbate the problem Osborne introduced the complication of a taper on the annual allowance for higher earners reducing it for some all the way down to £10,000 per year.


Doctors are in a Defined Benefit Scheme I believe. It was not a "pension simplification" to change the limits on DB schemes from being based on the benefits (maximum pension two thirds of "final" salary etc) to being based on a cash limit of annual contributions and notional benefit value.

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Re: LTA and tax

#261823

Postby ursaminortaur » November 3rd, 2019, 12:38 pm

Alaric wrote:
ursaminortaur wrote:There already is an annual limit of £40,000 applied to both DC and DB schemes and indeed, although the LTA limit is a problem, the main problems that doctors are having are actually being caused by the annual limit rather than the LTA since it too along with the LTA has been reduced too far and to exacerbate the problem Osborne introduced the complication of a taper on the annual allowance for higher earners reducing it for some all the way down to £10,000 per year.


Doctors are in a Defined Benefit Scheme I believe. It was not a "pension simplification" to change the limits on DB schemes from being based on the benefits (maximum pension two thirds of "final" salary etc) to being based on a cash limit of annual contributions and notional benefit value.


As far as the LTA is concerned it is a difficult sell to have a higher limit for DB pensions than for DC pensions when nowadays so few have access to DB pensions. As it is the 20 times multiplier used to calculate the value of the DB pension for the LTA test is often criticised. Of course when the LTA was introduced at £1,500,000 or rose to £1,800,000 it wasn't really a problem for any but a very small number of people. And the same went for the annual allowance which was introduced at £215.000 and rose to £255,000. The real problems have only occurred since the Coalition and Conservative governments have radically slashed these limits causing them to impact many more modest earners.

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Re: LTA and tax

#261837

Postby TheRIT » November 3rd, 2019, 2:04 pm

ursaminortaur wrote:As far as the LTA is concerned it is a difficult sell to have a higher limit for DB pensions than for DC pensions when nowadays so few have access to DB pensions. As it is the 20 times multiplier used to calculate the value of the DB pension for the LTA test is often criticised. Of course when the LTA was introduced at £1,500,000 or rose to £1,800,000 it wasn't really a problem for any but a very small number of people. And the same went for the annual allowance which was introduced at £215.000 and rose to £255,000. The real problems have only occurred since the Coalition and Conservative governments have radically slashed these limits causing them to impact many more modest earners.


Those of us with DC pensions and no DB pension to fall back on already go into retirement carrying significant sequence of returns risk. (Sure we could buy an annuity to put a 'floor' under our spending but the rates today are derisory making the LTA problem below even worse). Then on top of that SoRR the tax system via the LTA also works against us. DB pensions have a x20 multiplier so a DB pension using up 100% of a £1.055M LTA gives an annual pension of £57,750. How does a DC pension compare:
- the 4% rule is the much talked about rule of thumb for drawdown. It was however based on a historic 50% US stocks:50% US equities US investor and showed that in 4% of cases our pensioner would run out of pension in less than 30 years. So historically there is confirmed sequence of returns risk yet against the LTA it's the equivalent of a x25 multiplier meaning a maximum annual pension of £42,200 before the LTA would be exceeded.
- Wade Pfau also did a study for a historic UK investor. He found that for a 50% global equities:50% global bonds, 30 years and no drawdown failures the drawdown rate was closer to 3.26%. That is effectively a x31 multiplier meaning a maximum annual pension of £34,393 before the LTA is exceeded.

So for the same £1.055M LTA the DB pensioner gets £57,750 where the DC pensioner prudently gets £34,393!

Personally I think the LTA is a ridiculous rule as it effectively punishes those who invest well. I can understand limiting contributions but punishing good stuff happening in the pension wrapper seems like the workings of a madman. The favouritism of DB over DC is just another example of it.

ursaminortaur
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Re: LTA and tax

#261865

Postby ursaminortaur » November 3rd, 2019, 3:52 pm

TheRIT wrote:
ursaminortaur wrote:As far as the LTA is concerned it is a difficult sell to have a higher limit for DB pensions than for DC pensions when nowadays so few have access to DB pensions. As it is the 20 times multiplier used to calculate the value of the DB pension for the LTA test is often criticised. Of course when the LTA was introduced at £1,500,000 or rose to £1,800,000 it wasn't really a problem for any but a very small number of people. And the same went for the annual allowance which was introduced at £215.000 and rose to £255,000. The real problems have only occurred since the Coalition and Conservative governments have radically slashed these limits causing them to impact many more modest earners.


Those of us with DC pensions and no DB pension to fall back on already go into retirement carrying significant sequence of returns risk. (Sure we could buy an annuity to put a 'floor' under our spending but the rates today are derisory making the LTA problem below even worse). Then on top of that SoRR the tax system via the LTA also works against us. DB pensions have a x20 multiplier so a DB pension using up 100% of a £1.055M LTA gives an annual pension of £57,750. How does a DC pension compare:
- the 4% rule is the much talked about rule of thumb for drawdown. It was however based on a historic 50% US stocks:50% US equities US investor and showed that in 4% of cases our pensioner would run out of pension in less than 30 years. So historically there is confirmed sequence of returns risk yet against the LTA it's the equivalent of a x25 multiplier meaning a maximum annual pension of £42,200 before the LTA would be exceeded.
- Wade Pfau also did a study for a historic UK investor. He found that for a 50% global equities:50% global bonds, 30 years and no drawdown failures the drawdown rate was closer to 3.26%. That is effectively a x31 multiplier meaning a maximum annual pension of £34,393 before the LTA is exceeded.

So for the same £1.055M LTA the DB pensioner gets £57,750 where the DC pensioner prudently gets £34,393!

Personally I think the LTA is a ridiculous rule as it effectively punishes those who invest well. I can understand limiting contributions but punishing good stuff happening in the pension wrapper seems like the workings of a madman. The favouritism of DB over DC is just another example of it.


Small correction the 4% rule was based on back testing historic US returns as you state but the 4% initial withdrawal (uprated by inflation for subsequent year's withdrawals) was the maximum that could be withdrawn which never in those historic backtests resulted in the money running out within 30 years.

https://www.investopedia.com/terms/f/four-percent-rule.asp

The 4% rule was created using historical data on stock and bond returns over the 50-year period from 1926 to 1976. Before the early 1990s, experts generally considered 5% to be a safe amount for retirees to withdraw each year. Skeptical of whether this amount was sufficient, financial advisor William Bengen conducted an exhaustive study of historical returns in 1994, focusing heavily on the severe market downturns of the 1930s and early 1970s. Bengen concluded that, even during untenable markets, no historical case existed in which a four percent annual withdrawal exhausted a retirement portfolio in less than 33 years.

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Re: LTA and tax

#261868

Postby TheRIT » November 3rd, 2019, 4:07 pm

ursaminortaur wrote:Small correction the 4% rule was based on back testing historic US returns as you state but the 4% initial withdrawal (uprated by inflation for subsequent year's withdrawals) was the maximum that could be withdrawn which never in those historic backtests resulted in the money running out within 30 years.

https://www.investopedia.com/terms/f/four-percent-rule.asp

The 4% rule was created using historical data on stock and bond returns over the 50-year period from 1926 to 1976. Before the early 1990s, experts generally considered 5% to be a safe amount for retirees to withdraw each year. Skeptical of whether this amount was sufficient, financial advisor William Bengen conducted an exhaustive study of historical returns in 1994, focusing heavily on the severe market downturns of the 1930s and early 1970s. Bengen concluded that, even during untenable markets, no historical case existed in which a four percent annual withdrawal exhausted a retirement portfolio in less than 33 years.


I believe that statement is only true if our US resident increased their equities % to 75%. For a 50% equites:50% bonds 4% of periods failed (as I mentioned). I believe this is the table from the analysis:
Image
Happy to be proven wrong.

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Re: LTA and tax

#261884

Postby ursaminortaur » November 3rd, 2019, 5:22 pm

TheRIT wrote:
ursaminortaur wrote:Small correction the 4% rule was based on back testing historic US returns as you state but the 4% initial withdrawal (uprated by inflation for subsequent year's withdrawals) was the maximum that could be withdrawn which never in those historic backtests resulted in the money running out within 30 years.

https://www.investopedia.com/terms/f/four-percent-rule.asp

The 4% rule was created using historical data on stock and bond returns over the 50-year period from 1926 to 1976. Before the early 1990s, experts generally considered 5% to be a safe amount for retirees to withdraw each year. Skeptical of whether this amount was sufficient, financial advisor William Bengen conducted an exhaustive study of historical returns in 1994, focusing heavily on the severe market downturns of the 1930s and early 1970s. Bengen concluded that, even during untenable markets, no historical case existed in which a four percent annual withdrawal exhausted a retirement portfolio in less than 33 years.


I believe that statement is only true if our US resident increased their equities % to 75%. For a 50% equites:50% bonds 4% of periods failed (as I mentioned). I believe this is the table from the analysis:
Image
Happy to be proven wrong.


As your table states the figures it uses are for the range January 1926 through December 2009 and hence are not from Bengen's original paper or other papers such as the Trinity study conducted at around the same time.

The statement about "no historical case existed in which a four percent annual withdrawal exhausted a retirement portfolio in less than 33 years" is from Bengen himself

http://www.retailinvestor.org/pdf/Bengen1.pdf

It is clear from Figure l(a) that an "abso- lutely safe" (to the extent history is a guide) initial withdrawal level is 3 per- cent, in that it ensures that portfolio longevity is never less than 50 years. (This is also true for withdrawal rates as high as approximately 3.5 percent.) However, most clients would find such a low level of withdrawals unacceptable. Assuming a minimum requirement of 30 years of portfolio longevity, a first- year withdrawal of 4 percent [Figure l(b)], followed by inflation-adjusted withdrawals in subsequent years, should be safe. In no past case has it caused a portfolio to be exhausted before 33 years, and in most cases it will lead to portfolio lives of 50 years or longer.

And see Figure 1b which is for 50% stocks and as the accompanying text says

Figure l(b), featuring an initial withdrawal of four percent, begins to show the effects of some financial events. However, these effects are comparably mild; no client enjoys less than about 35 years before his retirement money is used up.

He does compare that in the article also with other stock allocations and in particular with a 75% stock allocation and concludes that an allocation closer to 75% generally results in a better portfolio longevity but the longevity in both 50% and 75% stock allocations are never less than 30 years.

The "0-percent stocks" bar and "25- percent stocks" bar are consistently shorter than the others, confirming what we already know - the superior returns of stocks versus bonds are essential to maximizing the benefit from a portfolio. Too few stocks in the portfolio shortens the minimum portfolio life. Perhaps even more important is the observation that the 50/50 stock/bond mix appears to be near-optimum for generating the highest minimum port- folio longevity for any withdrawal scheme. This is particularly clear in the 4-percent, 5-percent, and 6-percent with- drawal groups, which are peaked like roofs at the 50-percent stock level.

Does that mean that a 50/50 mix is optimal for all situations during retire- ment? Not at all. Note in Figure 2 that for all withdrawal percentages, the bars for 50-percent stocks and 75-percent stocks are very close in heightma year or less apart. From the perspective of the highest minimum portfolio longevity, that means you give up very little by increasing stocks from 50 percent to 75 percent of the portfolio.

But do you gain anything in return? To answer that question, consider Figure 3 (a), which shows 4-percent with- drawal rate applied to a portfolio con- sisting of 75-percent stocks and 25-per- cent bonds. Compare this to Figure l(b), which is also drawn for a 4-percent with- drawal rate, but at a 50/50 stock~ond mix. Clearly, the heavier weighting in stocks in Figure 3(a) has produced some fairly significant improvements. Fully 47 scenario years result in portfolio longevities of the maximum of 50 years, while only 40 scenario years attained that pinnacle in the earlier chart. The only penalties occur in portfolio year 1966, which is shortened by one year, from 33 to 32 years, and in 1969, which is shortened from 36 years to 34. All the other scenario years have equal or greater longevity.
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Sorting this all out, I think it is appropriate to advise the client to accept a stock allocation as close to 75 percent as possible, and in no cases less than 50 percent. Stock allocations lower than 50 percent are counterproductive, in that they lower the amount of accumulated wealth as well as lowering the minimum portfolio longevity. Somewhere between 50-percent and 75-percent stocks will be a client's "comfort zone." An asset allocation as high as 75 percent in stocks during retirement seems to fly in the face of conventional wisdom - at least the wisdom I have heard. But the charts do not lie - they tell their story very plainly.

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Re: LTA and tax

#261900

Postby Alaric » November 3rd, 2019, 7:17 pm

ursaminortaur wrote: But the charts do not lie - they tell their story very plainly.


In a world of 1% interest rates how much reliance can be placed on a chart advocating 50% Bonds if it had been drawn up when interest rates were 4% or higher?

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Re: LTA and tax

#261938

Postby runnygum » November 4th, 2019, 6:05 am

None Id suggest..

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Re: LTA and tax

#261939

Postby runnygum » November 4th, 2019, 6:08 am

ffacoffipawb64 wrote:
Once you use up 100% LTA that is it.

Even if LTA went up to £100 million you would still be liable to an LTA charge because you have no LTA left.

You would only pay no LTA charge if it were abolished.


What about if you withdraw 50%? Is the LTA fixed in stone at that point?
(ie) As soon as you do a crystallisation event, the LTA is fixed permanently irrespective of future values?

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Re: LTA and tax

#261968

Postby scrumpyjack » November 4th, 2019, 9:04 am

Afaiaw you then have 50% left of the LTA and the next BCE would be compared to the then LTA

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Re: LTA and tax

#261969

Postby TedSwippet » November 4th, 2019, 9:07 am

runnygum wrote:What about if you withdraw 50%? Is the LTA fixed in stone at that point?
(ie) As soon as you do a crystallisation event, the LTA is fixed permanently irrespective of future values?

You use up the LTA in percentage-sized chunks. Say you have £1.25m and the LTA is at £1m. Crystallising £500k uses 50% of the LTA and leaves you with £750k uncrystallised. You have 50% of the (future) LTA remaining. If the LTA then increases to £1.5m, you could take out the remaining £750k without LTA penalty.

Of course, this example is contrived. The LTA will take more than a decade to rise from £1m to £1.5m through inflation linking (and that's if the government doesn't tinker further with it, highly unlikely given the history here), and in that time your £750k will have grown anyway, probably by more than inflation and so with a worse LTA penalty than you were facing at the start.


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