Taking SIPP lump sum as income

ognum

It has been suggested that my friend takes the lump sum ( he has no need of the cash at present) as income for the next 7-8 years.

Please can the experts tell us the advantages and disadvantages of this?

We understand that as far as inheritence is concerned it crystallises the fund in small sections so in the case of death the remaining uncrystalised fund can be taken in cash.

We also understand that this will allow the remaining fund to continue to grow and provide a larger pension when the whole fund is crystallised.

I guess the disadvantage is that he will not have access to a lump sum?

Other than that please can you tell me any other advantages and disadvantages?

Are there advantages to the company managing the SIPP if the TFLS is taken as income?

BLB53

I am a bit confused.

Would it not be much simpler to take the 25% tax-free lump sum and, if not required for the time being, invest it in a savings account or even better a S&S ISA?

Linton

Or delay taking the lump sum until he does need cash, assuming that the pension is currently sensibly invested. There doesnt seem much point in taking it out of one tax protected environment and moving it to another.

mania112

Delaying taking benefits is always the preference if you don't need the cash at this time.

The investments will continue to grow and offer preferable death benefits than if you were to crystallise.

jamesd

What is he trying to gain by doing this instead of taking income from the rest of the pension pot and putting the lump sum into a S&S ISA where it can increase the future tax free income he can get from it? He does know that he can get an income from the 75% using income drawdown, leaving the money invested, and doesn't have to buy an annuity, I hope?

If you want income, take it from the pension pot first, not from places outside the pension pot. Unless there is some tax threshold to worry about. The other places don't have pension restrictions, so taking money out of the pension will increase flexibility later.

Income drawdown is the sensible way to do this if he needs the income.

If he wanted the income and if there was a tax issue then staged drawdown (gradually taking lump sums and increasing amounts of income) can be tax efficient. But it sacrifices the availability of the lump sum and that's more likely to be a bad idea for most people, not a good one.

If he does do this, be sure he asks for 25% from part of the whole pension pot, not say £10,000 from a £100,000 pit. You're allowed to take less than 25% but if you do you can't then take out the remainder up to 25%. So he might accidentally take only 10% and have £90,000 under pension restrictions instead of £75,000.

Fabius

You are looking at phased capped drawdown as opposed to capped drawdown. The latter crystallises the full fund, provides a pension commencement lump sum of up to 25% of the fund, and allows the rest to be drawn down as an income whilst remaining invested, subject to the limits imposed by HMRC (but broadly aiming to generate the equivalent to having purchased a single life annuity. This limit is recalculated at every third policy anniversary). The former does a similar thing with crystallisation in stages, and with annuity purchase an option for the 75% as well.

Phased Capped drawdown and/or Capped drawdown suits those with the need for flexibility and the capacity for uncertainty of future income (as a number of factors can affect the income being received). Once crystallised, the funds that remain invested to provide an income remain in the tax efficient environment but if you die and the fund is paid out of the scheme it is taxed at 55%. This tax doesn't apply if alternative death benefits are chosen by a spouse (but will apply on their death if they don't take an annuity).

We understand that as far as inheritence is concerned it crystallises the fund in small sections so in the case of death the remaining uncrystalised fund can be taken in cash.

Exactly correct. By phasing, the minimum amount needed to generate the required income is crystallised and is provided as a mixture of tax free lump sum and either annuity or capped drawdown. Uncrystallised funds are paid to the nominated beneficiary (which can be a trust, speak to a STEP member will writer) without liability to tax.

We also understand that this will allow the remaining fund to continue to grow and provide a larger pension when the whole fund is crystallised.

Sort of, if you are phasing then you won't really provide a larger pension per se as you are always going to be having mini-crystallisations. The remaining fund will grow in capped or phased capped drawdown, the significant benefit of phased is that it offers the highest amount of continuing flexibility that enables each tranche of yearly income to be structured according to your circumstances at that time.

I guess the disadvantage is that he will not have access to a lump sum?

Is this right? Each year he accesses 25% of the amount crystallised to provide maximum tax efficiency of income, with 25% of the uncrystallised fund available at any time in an emergency if it must be taken. But you go into phased drawdown having determined that it is highly unlikely that you will need any lump sum. It's a prerequisite for any adviser really.

Other than that please can you tell me any other advantages and disadvantages?

Advantages as above. Also, as well as your circumstances being taken into account each year when structuring income, the market situation is taken at the time, avoiding the possibility of crystallising the whole fund at a single point in time. Of course this can work against you.

Disadvantages:
It is complicated and you need to be able to understand it. This tends to get harder as you get older. There will often be the need for a separate bank account that effectively receives your annual income on day one and then pays your current account a monthly 'salary'.
You need to be disciplined, I have had several people come back cap in hand after four months of a year because they have accessed the funding account described above to buy something unnecessary and expensive! This is an adviser's worst nightmare.

It is costly, and can be a fair bit more than capped drawdown in my experience. There is no real advantage to the IFA/SIPP manager, they will earn more fees but will do more work for it so a bit of increased profitability but it certainly isn't a cash cow for either of them. There will be additional review fees for the elements of income that are provided through capped drawdown because many companies charge per arrangement rather than per policy. You should be using an adviser that charges a fixed annual review fee or an hourly charge for this kind of work (rather than an arbitrary % of assets)

Really, I can't ever see a scenario where phased can be viable for a fund of less than about £350,000 but that can be significantly higher depending on circumstances. 4-5 years into the arrangement your annual SIPP fees could easily be £2,500, with advice on top. But don't let that put you off, just be aware of it, the benefits of tax efficiency and flexibility could easily offset this, as could the total income that you draw over your lifetime as a result of this strategy.

Hope that helps, pick me up on any other specifics that you have.

bilbo51

Thanks for that Fabius.

Are you an IFA? You certainly sound like one from that very detailed and helpful post.

If so, you should add a signature saying so.

ognum

Thank you to everyone for your very helpful comments, I will pass them on.

We like to check out advice given, I guess that is because in the past when dealing with probate for close relatives I have been aware that some of the advice has maybe not been advantageous.

jamesd

Fabius wrote: »

Phased Capped drawdown and/or Capped drawdown suits those with the need for flexibility and the capacity for uncertainty of future income

It does not, except compared to annuity purchase. The spending of the capital for income removes the availability of the capital and severely reduces future flexibility. The alternative of taking the income from the 75% while reinvesting the 25% within the ISA or other tax wrapper preserves substantially more flexibility.

Fabius wrote: »

the significant benefit of phased is that it offers the highest amount of continuing flexibility

It does not.

Fabius wrote: »

that enables each tranche of yearly income to be structured according to your circumstances at that time.

The alternative of using non-phased capped drawdown offers substantially more flexibility than this. The income taken from the remaining 75% can be adjusted from nothing up to the GAD limit and any part of the 25% can be taken at any time.

Fabius wrote: »

But you go into phased drawdown having determined that it is highly unlikely that you will need any lump sum.

Agreed.

Two reasons for not using phased drawdown are need of access to capital and a desire for maximum flexibility.

If an IFA was to recommend phased drawdown with a claim that it offered the greatest amount of flexibility, and the customer suffered detriment as a result of needing the capital or income for one year greater than could be provided by the remaining lump sum plus available income, I'd recommend a complaint against that adviser, because that claim of greatest flexibility is untrue. Those are two major situations where taking an income from 75% from the start preserves more flexibility than phased drawdown.

An IFA engaged in selling this solution with a "maximum flexibility" claim is engaged in mis-selling in all such sales.

The tax benefits can make that loss of flexibility worth accepting and it can be an excellent solution when that's appropriate.

jamesd

ognum wrote: »

Thank you to everyone for your very helpful comments, I will pass them on.

What we really lack is knowing why there is a desire to do this. What's the objective here?

Unless there is some tax need, either leaving all of the money in the pension or taking the full 25% at the start is likely to be a better solution, adding life assurance to cover any need for a non-spouse to inherit outside a pension if desired.

So far we just don't know what problem is being solved here and it's impossible to say whether it's a good or bad idea without knowing that.

ognum wrote: »

Are there advantages to the company managing the SIPP if the TFLS is taken as income?

Yes, potentially. There may be extra charges each year.

There has to be a good reason to do this based on the circumstances of the individual. It's not the optimal solution for either flexibility or some forms of tax efficiency but can be the best solution if there is a need for more income now and taking the income all from the 75% would cause some income to be taxed at 40$ or 50% instead of a lower rate.

If there's no need for income and no need to avoid some income going into a higher tax band then it's probably the wrong solution.

Fabius

The alternative of taking the income from the 75% while reinvesting the 25% within the ISA or other tax wrapper preserves substantially more flexibility.

Tell me, how many years does it take to invest 25% of at least £350k into an isa? Meanwhile the income /gains generated are subject to tax. As is the fund in drawdown on death, 55% tax anyone?

I've never set up a phased drawdown arrangement for anyone who isn't already using their isa allowance from an existing collective investment portfolio.

If you agree with my statement about not needing a lump sum why then attempt to destroy my post by ignoring the fact that I stated that as a pre requisite for phased drawdown?

The drawdown regime has been changed by the Government on numerous occasions since as recently as 2006. Why would you think that crystallising 100% of benefits into that regime at a single point in time would offer the greatest flexibility?

I am a highly qualified pension specialist (CII exams J04,5 and AF3 plus many others) and I spent 3years in the pension complaints department of the Financial Ombudsman Service.