Whether to take a lump sum at 55

[Shelford]

Dear All
This is a great board and I've learned a lot from it.

My situation is that I will be leaving work in July next year at age 55. I'm trying to work out how best to manage the LTA limits which I have now exceeded by 200k if you include my DB pension at 20times the likely payout. Unfortunately I am not able to take out fixed protection so am working to the new £1.055m limit (I can explain why but it's too boring to read).

My circs are as follows:

DC SIPP: £1.053m, mix of equities and investment trusts
ISA: £160k, ditto
Fund and share account: 68k, ditto
Cash: £121k, 50% held in short term deposit accounts; 50% one year deposit account
DB pension: will be 10k at 60
Overall yield on investments is about 4.8%. Income in the last 12 months totalled 63k.

My wife is younger than me at 51 and is otherwise accounted for with her own pension. No mortgage other than a BTL of 140k. She keeps any income on this. We have three kids going through HE and secondary school. Their university fees are taken care of. In short, we are comparatively (very) well off.

The intention is to build my cash position through natural yield till July next year which, combined with further savings from my salary, should top the above cash total up by another 150k or so.

Allowing for two years cash buffer of 120k total. Until 60, I'm intending to take £60k per year at the end of each tax year, comprising 45k per year from SIPP, 5k from ISA and 10k per year from my cash savings/share account. This budget might go up in line with CPI if investment performance permits. I'd continue to top up my ISA each year assuming I do some part time work which is very possible. At 60, I will take the DB pension and lessen my SIPP withdrawals. I would use UFPLS to take lump sums each year till then.

I'd welcome advice and views on whether this is a sensible draw down approach and why you'd do something different. I won't take an annuity. The DB scheme terms make it sensible to hold off until I'm sixty before I take it. Some posters here in a similar position to me near or over the LTA have indicated they intend to take a TFLS from their SIPP in order to minimise the tax paid on sums withdrawn above the LTA. I'm not wholly sure I understand the logic of this or maths behind it but Would like to know more. HMRC doesn't make this area easy to understand.

We will need to pay off the BTL mortgage at some point but am in no rush. It is on a relatively low LTV and brings in some useful income for my wife.

Thoughts welcome!

Shelford

[Kantwebefriends]

You could drive down the LTA value of the DB pension by drawing it five years early.

It's quite possible that the stock markets will save your DC LTA problem for you.

[Alaric]

Until 60, I'm intending to take £60k per year at the end of each tax year, comprising 45k per year from SIPP, 5k from ISA and 10k per year from my cash savings/share account.

Arguably you should be prepared to run taxable assets down to zero before you take anything out of ISAs. So if your dividend/interest on the ISAs is £ 5,000, rather than withdraw it, sell £ 5,000 in your share account. Your spendable cash is the same, but more of your assets are tax sheltered. It's probably exploiting the CGT allowance as well.

[TUK020]

Allowing for two years cash buffer of 120k total. Until 60, I'm intending to take £60k per year at the end of each tax year, comprising 45k per year from SIPP, 5k from ISA and 10k per year from my cash savings/share account. This budget might go up in line with CPI if investment performance permits. I'd continue to top up my ISA each year assuming I do some part time work which is very possible. At 60, I will take the DB pension and lessen my SIPP withdrawals. I would use UFPLS to take lump sums each year till then.

You could consider on maximising the amount you pull out of the SIPP each year, while staying in the basic rate tax band. With UFPLS, this covers the whole 60k income per annum for the next 5 years.

Don't touch income from ISA (re-invest within ISA) until you have run down your taxable cash pile, and your SIPP harvest drops short.

[JohnB]

While ISAs are best for tax, unsheltered dividend income trumps pension income, with the former having a £2k allowance and 7.5% tax, the latter £12.5k and 20% and upwards tax (and lump sum of course)

So it does no harm keeping your unsheltered assets around 50k, as the 4k income from them is tax-free, and if you go higher with excess SIPP withdrawl, their future growth outside the SIPP is taxed less, just be careful to B&B the Capital Gains.

Of course with the OP having 3 kids, IHT not applying to pensions changes the attractiveness.

[ursaminortaur]

Dear All
This is a great board and I've learned a lot from it.

My situation is that I will be leaving work in July next year at age 55. I'm trying to work out how best to manage the LTA limits which I have now exceeded by 200k if you include my DB pension at 20times the likely payout. Unfortunately I am not able to take out fixed protection so am working to the new £1.055m limit (I can explain why but it's too boring to read).

My circs are as follows:

DC SIPP: £1.053m, mix of equities and investment trusts
ISA: £160k, ditto
Fund and share account: 68k, ditto
Cash: £121k, 50% held in short term deposit accounts; 50% one year deposit account
DB pension: will be 10k at 60
Overall yield on investments is about 4.8%. Income in the last 12 months totalled 63k.

My wife is younger than me at 51 and is otherwise accounted for with her own pension. No mortgage other than a BTL of 140k. She keeps any income on this. We have three kids going through HE and secondary school. Their university fees are taken care of. In short, we are comparatively (very) well off.

The intention is to build my cash position through natural yield till July next year which, combined with further savings from my salary, should top the above cash total up by another 150k or so.

Allowing for two years cash buffer of 120k total. Until 60, I'm intending to take £60k per year at the end of each tax year, comprising 45k per year from SIPP, 5k from ISA and 10k per year from my cash savings/share account. This budget might go up in line with CPI if investment performance permits. I'd continue to top up my ISA each year assuming I do some part time work which is very possible. At 60, I will take the DB pension and lessen my SIPP withdrawals. I would use UFPLS to take lump sums each year till then.

I'd welcome advice and views on whether this is a sensible draw down approach and why you'd do something different. I won't take an annuity. The DB scheme terms make it sensible to hold off until I'm sixty before I take it. Some posters here in a similar position to me near or over the LTA have indicated they intend to take a TFLS from their SIPP in order to minimise the tax paid on sums withdrawn above the LTA. I'm not wholly sure I understand the logic of this or maths behind it but Would like to know more. HMRC doesn't make this area easy to understand.

We will need to pay off the BTL mortgage at some point but am in no rush. It is on a relatively low LTV and brings in some useful income for my wife.

Thoughts welcome!

Shelford

You are going to be hit by the LTA excess charge so the best thing is to minimise how much you exceed the LTA limit.
I'd suggest at 55 crystallising the SIPP using flexible drawdown and taking out the 25% tax free lump sum rather than using UFPLS. The reason is that there is an LTA test when you crystallise the pension but no further LTA tests when you drawdown money. There is a final test when you reach age 75 but that is only on growth still held in that crystallised pot at that time calculated as

Value if crystallised pot at age 75 - ( Value of pot when crystallised - Tax free lump sum taken)

Since money drawn out isn't tested against the LTA that means that to avoid having to pay a further excess charge at age 75 on this crystallised pot you just need to withdraw the growth that has occurred before age 75.

In contrast if you use UFPLS then every time that you withdraw money from the SIPP there will be another LTA test using up a percentage of your LTA and then at age 75 there will be a final LTA test of anything still left uncrystallised. Hence all the growth from when you started drawdown using UFPLS until age 75 will be tested against the LTA and will thus increase your excess over the LTA and the amount charged.

Because of your DB pension you will be exceeding the LTA limit but this strategy should minimise how much you go over. Unfortunately you are pretty close to the limit now with your SIPP (LTA limit is £1.055m for 2019-2020) so even if you crystallise at age 55 pretty much all of your DB pension will be in excess when you come to take it and it is tested against the LTA. So with the excess charge your DB pension will probably suffer around about a 25% hit meaning your annual DB pension will be reduced to about £7.5k.
(The excess is reduced by 25% if the excess is paid out as taxable income by the DB pension or by 55% if paid as capital)

[Shelford]

Many thanks for your creative and thoughtful replies.

The consensus is to avoid taking income out of the ISA in such circumstances and then to minimise tax payments incurred by exceeding the LTA by either a) taking UFPLS each year or b) take The maximum TFLS when I retire next year and leave the remainder. Looking at the DB scheme terms for early retirement, it makes sense to leave taking this till I’m 60. I will mull both these two principal options carefully. It will make for a useful topic when I meet the pension wise person next year. IHT, something I’ve not had to consider to date, may be a factor.

There are some attractions to having what would be 250k in cash, which could then be used tax efficiently to bolster both my wife and my ISAs over next five years, whilst providing also a basic income till the DB kicks in.

[Chrysalis]

Could you say something about the early retirement reductions on the DB pension?
I am wondering if you've considered all the relevant factors. For example, taking the DB pension early will reduce its contribution to the LTA and you may save tax as a consequence. Similarly, drawing the DB pension when you have no other taxable income.
I'm just wondering if you may have ruled that out of consideration too soon.

I wouldn't expect Pensionwise to be able to say much about the detail of your LTA issues - its a complex issue and they can't provide individualised advice. A financial adviser may be able to help optimise your withdrawal strategy - since the tax penalties might be quite big, it could be worth your while paying for a review of your situation.

[djbenedict]

I'd suggest at 55 crystallising the SIPP using flexible drawdown and taking out the 25% tax free lump sum rather than using UFPLS. The reason is that there is an LTA test when you crystallise the pension but no further LTA tests when you drawdown money. There is a final test when you reach age 75 but that is only on growth still held in that crystallised pot at that time calculated as

Value if crystallised pot at age 75 - ( Value of pot when crystallised - Tax free lump sum taken)

Since money drawn out isn't tested against the LTA that means that to avoid having to pay a further excess charge at age 75 on this crystallised pot you just need to withdraw the growth that has occurred before age 75.

In contrast if you use UFPLS then every time that you withdraw money from the SIPP there will be another LTA test using up a percentage of your LTA and then at age 75 there will be a final LTA test of anything still left uncrystallised. Hence all the growth from when you started drawdown using UFPLS until age 75 will be tested against the LTA and will thus increase your excess over the LTA and the amount charged.

I found this a particularly clear and helpful comparison of these two approaches, just wanted to say thanks properly to ursaminotaur. It is indeed hard to find this spelled out anywhere.

[Alaric]

I am wondering if you've considered all the relevant factors. For example, taking the DB pension early will reduce its contribution to the LTA and you may save tax as a consequence. Similarly, drawing the DB pension when you have no other taxable income.

The tax arbitrage is that for Lifetime Allowance tests, the DB is always worth 20 times the annual amount. The annual amount is lower on early retirement to allow for the extra years that it will be paid. The other arbitrage is that utilising otherwise unused the personal allowance enables free of tax withdrawals.

Whether these options will continue to be available remains to be seen, as the current interaction of Lifetime Allowance rules and Personal Allowances can act as a taxation incentive to the higher paid and wealthier to retire early.

[ursaminortaur]

I am wondering if you've considered all the relevant factors. For example, taking the DB pension early will reduce its contribution to the LTA and you may save tax as a consequence. Similarly, drawing the DB pension when you have no other taxable income.

The tax arbitrage is that for Lifetime Allowance tests, the DB is always worth 20 times the annual amount. The annual amount is lower on early retirement to allow for the extra years that it will be paid. The other arbitrage is that utilising otherwise unused the personal allowance enables free of tax withdrawals.

Whether these options will continue to be available remains to be seen, as the current interaction of Lifetime Allowance rules and Personal Allowances can act as a taxation incentive to the higher paid and wealthier to retire early.

Since the SIPP is almost at the LTA limit anyway taking the DB pension early and suffering an actuarial reduction doesn't look like it would make much sense.
The actuarial reduction would vary from scheme to scheme but a 4% or 5% reduction for each year it is taken early wouldn't be unexpected. Hence taking the DB pension five years early would reduce yearly payments by about 20% to 25% which is pretty close to the reduction if it was left and the LTA access was taken from it when drawn at the normal retirement age. However since even with that reduced DB pension the SIPP would push the OP over the LTA then there would still be an LTA excess to pay. So the OP would end up paying more.

[Chrysalis]

Thanks ursaminotaur, I’m convinced
One further question. If the OP did not need to draw money from the SIPP (eg because he had enough in taxable accounts or other sources to live off at least until age 60) would it be better to draw the DB pension first before crystallising the SIPP? This would mean that the LTA excess could be taken from the SIPP pot, and only as and when income was drawn - presumably this would be more flexible than the excess tax being taken from the DB pension? And might result in less tax (depending on the amount of growth in the SIPP before crystallisation)?
Or am I again failing to think clearly?

[OLTB]

This would mean that the LTA excess could be taken from the SIPP pot, and only as and when income was drawn - presumably this would be more flexible than the excess tax being taken from the DB pension?

Hi Chrysalis

That would be the case if it weren't for the pesky LTA test on all pension schemes at age 75 irrespective of whether income has been drawn or not. They get you every way...

Cheers, OLTB.

[Chrysalis]

My point is that it would be more flexible, and might (depending on investment growth) be more tax efficient?

Trying to work this through from my own POV where I don’t need the SIPP income and the DB is a much higher proportion of the LTA. I am inclined to wait to 60, start the DB, then fully crystallise the SIPP. If I do that, is the LTA excess charge taken as a lump sum or is it taken from drawdown?

[OLTB]

My point is that it would be more flexible, and might (depending on investment growth) be more tax efficient?

Trying to work this through from my own POV where I don’t need the SIPP income and the DB is a much higher proportion of the LTA. I am inclined to wait to 60, start the DB, then fully crystallise the SIPP. If I do that, is the LTA excess charge taken as a lump sum or is it taken from drawdown?

You have the choice - if you take the lump sum option then the excess is paid to you less 55% tax, or, for the income option, the excess is taxed at 25% and then you get taxed at 40% PAYE (so 55% equivalent). An example:

Say excess is £100,000 over LTA - if lump sum option is taken (55% tax) then you end up with £45,000. If income option is taken, you get 25% tax deducted reducing the sum to £75,000 and then 40% tax PAYE on this £75k figure reduces the net income to £45,000. Same result either way.

Cheers, OLTB.

[Chrysalis]

Thanks. But why are you paying 40% tax on £75k? Confused.
Also, is all the tax due immediately? ie you have to withdraw all the excess above the LTA at the point of crystallisation? (in which case, why have income/lump sum options at all?)

[OLTB]

Apologies - I was assuming that you would be a 40% taxpayer (never assume!). It's certainly the case that 25% is deducted before you get the income. There's a link here https://www.pensionsadvisoryservice.org ... -allowance if that's helpful.

[ursaminortaur]

Thanks ursaminotaur, I’m convinced
One further question. If the OP did not need to draw money from the SIPP (eg because he had enough in taxable accounts or other sources to live off at least until age 60) would it be better to draw the DB pension first before crystallising the SIPP? This would mean that the LTA excess could be taken from the SIPP pot, and only as and when income was drawn - presumably this would be more flexible than the excess tax being taken from the DB pension? And might result in less tax (depending on the amount of growth in the SIPP before crystallisation)?
Or am I again failing to think clearly?

If the OP was already 60 and could therefore take the full DB pension or could find someway of taking the pension at 55 without an actuarial reduction* then it would make sense to take the DB first. The conversion factor used to convert income from a DB pension into the amount of LTA used up is a factor of 20 whereas the sustainable withdrawal rate for money from a DC pension to convert into income is a factor of 25 (the 4% rule). Hence you get more annual pension from a DB pension whilst using up less of your LTA meaning it would be better to take the full DB pension first and then crystallise the SIPP and pay the LTA excess from the SIPP.

However if the OP has to wait until 60 to get the DB pension without an actuarial deduction it is better to crystallise the SIPP at 55. Since if the SIPP isn't crystallised it will continue to grow during those 5 years and all that growth will make the LTA excess larger. (I'm assuming here that he achieves a reasonable growth and there isn't a worldwide financial crash, or that brexit or some other catastrophe doesn't destroy the value of the OP's SIPP which would obviously solve the OP's LTA problems but would be a bit of a pyrrhic victory).

* Some DB schemes may in special circumstances allow you to take the full DB pension that you have accumulated upto that point early without an actuarial deduction. You would need to check the scheme rules. For instance some schemes allow you to get the unreduced pension if you are made voluntarily redundant after age 55.

[Chrysalis]

Thanks again for clarity of thought ursaminotaur.
In my case, I’m still below the LTA and the SIPP is much the smaller proportion, about £200k. I’m not 55 for a couple of years so don’t have to decide until then. My gut feeling is to wait until 60 and take the DB first, but I find it hard to work out whether that is actually the best strategy financially.

[ayshfm1]

Divorce, pension share - wait a year ot two re-marry. Problem solved.