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LTA and crystallisation timing

Chrysalis
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LTA and crystallisation timing

#111306

Postby Chrysalis » January 17th, 2018, 2:33 pm

My brain aches trying to work out how the LTA works and the implications for when and how to crystallise benefits. Perhaps fools can help.

The situation is this. Currently working aged early 50s. I have a DB pension which will continue accruing benefits while I work. I will take it at aged 60 when it will likely be worth in the region of 75-85% of the LTA.

I also have a SIPP currently worth about £170k. My best estimate is that I will probably breach the LTA at some point (might squeak under if I quit work soon, draw my pension early and/or we have a market crash). It’s very unlikely that I will need to draw down the SIPP for my own needs, and at the moment intend to gift the funds either as income during life or to my heirs when I die.

My question is this. How important is timing of crystallisation of the SIPP to the amount of LTA, and other taxes, I or others might pay? Which is the better strategy: crystallise at 55; crystallise when I take my DB pension at 60, crystallise if I become terminally ill, or never crystallise? Or something else??

My current thought processes (which are almost certainly wrong in some aspect!) are like this.
1. If I crystallise at 55, then if I breach LTA at 60 when I take the pension I will have to pay LTA charge from the DB scheme, which I think means I have to pay it on income (25% of the excess?) Is that correct? My feeling is that this should be avoided as I’d like to maximise my guaranteed pension income. Am I correct that no further tests against LTA would be done after 60, so growth in the SIPP isn’t taxed again? (apart from as income on withdrawing).

2. If I crystallise at 60 after I take the pension, any LTA charge could be paid from the SIPP. How does that work in practice? Again, once fully crystallised, is that it? Can the SIPP just be left to grow?

3. Don’t crystallise. At 75 the SIPP will be tested against the LTA and will probably exceed it more than it would at the earlier dates. If I didn’t draw from the SIPP at any point, I assume I’d pay the LTA at the income rate as a charge of 25%? What happens on death if the PCLS has never been taken by the time you die? Do your heirs simply lose that tax advantage? If I die before 75, the whole lot would be tax free apart from any LTA charge due so PCLS is irrelevant, but what about after 75?

I can’t work out whether, all else being equal, it makes a difference to crystallise sooner rather than later. I also don’t know if I’m correct in thinking that it’s better to pay the LTA charge from the SIPP and not the pension.

Any thoughts welcome.

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Re: LTA and crystallisation timing

#111395

Postby DrBunsenHoneydew » January 17th, 2018, 7:23 pm

Complex isn't it !

As you say, the SIPP would be assessed at age 75 if not crystallised by then and 55% of the excess taken as a lump sum out of your pot if you do nothing.
If you do crystallise before then, any excess tax can be paid as a lump at 55% or at 25% plus income tax on any regular pension from the 75% that isn't tax-free lumpsum (these are equivalent if you will then be at 40% income tax as 0.4x75+25=55). But despite that assessment, the pot will be reassessed again at 75 to check for further growth and taxed again if it grows and has not been drawn down.

I'd take the DB at 60 and wait to see exactly what % of the then LTA has been used up and decide on the SIPP thereafter.

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Re: LTA and crystallisation timing

#111443

Postby ursaminortaur » January 17th, 2018, 10:08 pm

DrBunsenHoneydew wrote:Complex isn't it !

As you say, the SIPP would be assessed at age 75 if not crystallised by then and 55% of the excess taken as a lump sum out of your pot if you do nothing.
If you do crystallise before then, any excess tax can be paid as a lump at 55% or at 25% plus income tax on any regular pension from the 75% that isn't tax-free lumpsum (these are equivalent if you will then be at 40% income tax as 0.4x75+25=55). But despite that assessment, the pot will be reassessed again at 75 to check for further growth and taxed again if it grows and has not been drawn down.

I'd take the DB at 60 and wait to see exactly what % of the then LTA has been used up and decide on the SIPP thereafter.


Given the employer contribution and the good conversion rate of x20 for valuing the DB pension I'd probably not be too worried about that going over the LTA limit. A 25% charge on the income from that excess is I think worth it.
Ideally to get the maximum pension you would want to maximise the DB pension part of your LTA and minimise the SIPP - the DB will provide more pension because of the x20 conversion rate used for the LTA test.
Hence I'd probably want to stop contributing to the SIPP and think about crystallising it at 55. So long as you drawdown any growth in the SIPP* sometime thereafter before the age of 75 (when there is another LTA test on pots in drawdown) will take that out of further LTA consideration. The LTA is supposed to start rising from this year onwards in line with CPI but hopefully your SIPP would be growing faster than that anyway. Arresting that growth as far as the LTA tests is concerned as soon as possible will leave the maximum amount of free LTA to accomodate your DB pension.

*Note since you will still be working you would probably just want to crystallise the SIPP by taking the tax free lump sum but not actually drawing out any income from the SIPP. Once you get your DB pension at 60 you might then be able to draw at least some of that SIPP out whilst still remaining a basic rate tax payer before you receive your state pension.

Note 2. With current annuity rates a £1million pound SIPP would produce much less pension that a DB pension (which would produce a £50,000 per year pension if no tax free lump sum was taken). However the DB pension would still win if you took the standard 4% safe withdrawal rate from the SIPP instead of going for an annuity.
Last edited by ursaminortaur on January 17th, 2018, 10:18 pm, edited 3 times in total.

Chrysalis
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Re: LTA and crystallisation timing

#111444

Postby Chrysalis » January 17th, 2018, 10:10 pm

Thanks. Yes I’d forgotten about the second test at 75 on previously crystallised benefits.
I still can’t work out what happens to the PCLS if not taken before death.

I think you’re right, the time to consider action is at 60. I guess at the moment, I’m trying to decide whether to stop all contributions into the SIPP. They are handy to reduce income tax and in particular to ensure I’m not hit with the child benefit charge. But not much point avoiding 40% (or I think 60% marginal for the CB charge) if it’s going to go anyway. Or maybe it’s better to continue to fund the pension now when I can, since no guarantees regarding future growth.

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Re: LTA and crystallisation timing

#111448

Postby Chrysalis » January 17th, 2018, 10:19 pm

@ursa, I wasn’t sure whether crystallising at 55 would have any upside. I suppose the smaller it is when crystallised the smaller the LTA charge overall.
I wonder if you know how a charge on the excess income for the DB pension would work? How is it calculated and paid?

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Re: LTA and crystallisation timing

#111452

Postby ursaminortaur » January 17th, 2018, 10:31 pm

Jabd2001 wrote:@ursa, I wasn’t sure whether crystallising at 55 would have any upside. I suppose the smaller it is when crystallised the smaller the LTA charge overall.
I wonder if you know how a charge on the excess income for the DB pension would work? How is it calculated and paid?


I think you would need to speak to your employer/DB pension provider to get the gory details.

The best description I could find online from a quick search was

http://www.cityam.com/251235/pensions-lifetime-allowance-savings-over-1m-face-tax

It is important to remember that the LTA tax charge is only on savings over the £1m mark, not your whole pot. And if your employer pays into your pension directly, asking them to stop may not lead them to compensate you with a higher salary. “If, as part of your remuneration package, your employer pays 10 per cent of your salary into your pension, they may thank you for opting out of the scheme and may then not agree to increase your salary by 10 per cent,” says Smith.
.
.
.
Members of DB schemes have things even better, Smith explains. For example, a DB holder in breach of the LTA by £100,000 would have the £25,000 tax charge divided by 20, with £1,250 deducted off their income each year. “It’s better to stay in the scheme, build up the bigger pension and incur the tax charge,” he says.


The extra £100,000 would be equivalent to an extra £5000 per year DB pension if not for the LTA charge (ignoring any tax free lump sum complications) but that would be reduced to an extra £3750 instead.
Last edited by ursaminortaur on January 17th, 2018, 10:40 pm, edited 1 time in total.

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Re: LTA and crystallisation timing

#111453

Postby Chrysalis » January 17th, 2018, 10:37 pm

Thanks again. I’ve just discovered that I asked this question in slightly different format just a couple of months ago....
A bit of googling has thrown up nicely worked examples showing how the charge gets paid as a reduction of pension. I still hate the idea of losing some of the pension but perhaps it is rationally better than taking the hit up front (since it’s spread out over anticipated life expectancy).

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Re: LTA and crystallisation timing

#111456

Postby ursaminortaur » January 17th, 2018, 10:44 pm

Jabd2001 wrote:Thanks again. I’ve just discovered that I asked this question in slightly different format just a couple of months ago....
A bit of googling has thrown up nicely worked examples showing how the charge gets paid as a reduction of pension. I still hate the idea of losing some of the pension but perhaps it is rationally better than taking the hit up front (since it’s spread out over anticipated life expectancy).


Yes the LTA is a real mess and reducing it down to £1 million is now causing it to hit lots of people.

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Re: LTA and crystallisation timing

#111565

Postby DrBunsenHoneydew » January 18th, 2018, 11:22 am

Jabd2001 wrote:Thanks again. I’ve just discovered that I asked this question in slightly different format just a couple of months ago....
A bit of googling has thrown up nicely worked examples showing how the charge gets paid as a reduction of pension. I still hate the idea of losing some of the pension but perhaps it is rationally better than taking the hit up front (since it’s spread out over anticipated life expectancy).

Don't forget that although the tax penalty is calculated as given above - as 1/20th of 25% per year, the reduction in pension is permanent - i.e. if you live to claim the pension for 30 years, you'll have paid 30/20ths. Which is why some prefer to pay as a lump sum one-off tax.

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Re: LTA and crystallisation timing

#111651

Postby TUK020 » January 18th, 2018, 3:37 pm

I have been working through a similar situation, and have also been confounded by the complexity.

Need to think about the rules on tax relief on pension contributions

I think (but am not at all sure) that the moment you have crystallised any portion of your pensions, you are limited to £10k annual contribution with tax relief benefits.
The moment you draw benefits beyond the tax free lump sum, you are then limited to £4k/yr.

So if you are in a DB scheme, and still accruing benefits, don't crystalize anything. (Unfortunately, I am now beyond this point)
If you think you are in danger of breaching LTA at some point in the future, stop personal contributions to your SIPP.

Once you have stopped accruing benefits, wait for market crash, crystalize SIPP, withdraw the tax free lump sum. Leave the remainder to compound for your heirs.

Cycle tfls into ISA

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Re: LTA and crystallisation timing

#111680

Postby DrBunsenHoneydew » January 18th, 2018, 4:49 pm

TUK020 wrote:I think (but am not at all sure) that the moment you have crystallised any portion of your pensions, you are limited to £10k annual contribution with tax relief benefits.
The moment you draw benefits beyond the tax free lump sum, you are then limited to £4k/yr.

So if you are in a DB scheme, and still accruing benefits, don't crystalize anything.

Not quite right. The 10k limit has reduced to 4k since last year. But it only applies to DC pensions so you can still pay into your DB even if you draw income from the SIPP. The restrictions are on paying more than 4K into a DC after you have started drawing income beyond the lump sum from a DC. The DB is not affected.

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Re: LTA and crystallisation timing

#111704

Postby ursaminortaur » January 18th, 2018, 6:04 pm

DrBunsenHoneydew wrote:
TUK020 wrote:I think (but am not at all sure) that the moment you have crystallised any portion of your pensions, you are limited to £10k annual contribution with tax relief benefits.
The moment you draw benefits beyond the tax free lump sum, you are then limited to £4k/yr.

So if you are in a DB scheme, and still accruing benefits, don't crystalize anything.

Not quite right. The 10k limit has reduced to 4k since last year. But it only applies to DC pensions so you can still pay into your DB even if you draw income from the SIPP. The restrictions are on paying more than 4K into a DC after you have started drawing income beyond the lump sum from a DC. The DB is not affected.


As DrBunsenHoneydew says the ability to build up extra benefits in a DB pension isn't affected.
But for anyone with DC pensions it is worth emphasing that the reduction in the annual allowance for DC pensions (also known as the MPAA - money purchase annual allowance) from £40,000 to £4000 only occurs once you take out more than just the tax-free lump sum.
Hence if someone were in the position of having both a SIPP and an occupational DC pension they could crystallise the SIPP and take the tax free lump sum but still continue to pay into the occupational pension and get employer contributions. So long as no taxed income were then taken from the SIPP the annual allowance would remain at £40,000.

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Re: LTA and crystallisation timing

#111732

Postby Chrysalis » January 18th, 2018, 7:32 pm

Yes, the nuance is that the annual allowance is reduced to £4K once you have made use of the pension flexibilities. So taking just PCLS is ok, and also taking a small pot (<£10k). Also buying a conventional lifetime annuity. It’s only once you draw income from a flexi-access drawdown fund, or take an UFPLS (both dreadful names, who was responsible for them???) that the reduced annual allowance comes into play.

I think, that if my objective is to maximise my beneficiary’s income, then it is worth foregoing the PCLS and leaving the whole lot undrawn, as it saves 40% IHT on the lump sum and beneficiary will just pay tax at marginal rate (basic rate or less if drawing income).


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