LTA Protection

kidmugsy

EdSwippet wrote: »

the traditional 7% annual growth assumption.

Stockmarkets never grow at a steady rate: it's not the nature of the beast. Assuming a steady rate might be passable for explaining to a thirty year old how much growth he'd get by age seventy, but it's potentially misleading when applied over just a few years.

kidmugsy

jamesd wrote: »

So far as downturns go, one way to exploit that is with staged drawdown, so even if it takes a while to happen there's still uncrystallised pot around to use.

If you crystallise when markets are down, your 75% can wait in the pension shelter for a recovery. Your 25% can be reinvested, e.g. in ISAs or tax-exposed, to wait for recovery. Using staging to await this happy circumstance seems a good idea to me.

It might almost invite high risk investing, at least for part of the portfolio. If you lose, the LTA problem evaporates: if you "win big" you don't mind the 55% tax.

kidmugsy

ffacoffipawb wrote: »

Large contributions were to be able to retire early at 55 comfortably. Reductions in LTA are scuppering that somewhat.

But you are contributing more than is necessary to avoid 40% tax. Why not just stop doing that?

Anyway, your fuss about LTA seems to me to be overdone. What are the chances of there being no large market setback between your 55th and 75th birthdays? Close to nil.


In your shoes I suspect I'd carry on milking the employer subsidy, avoid 40% tax, harvest those doles for your children, and stop making the problem worse i.e. stop over-contributing to a pension, and plan to draw your DB pensions early. Then just wait for a jolly downturn and bail out. As jamesd says, that needn't leave you short of income because you can phase in your crystallisation.

kidmugsy

You are contributing to a SIPP i.e. without any advantage of salary sacrifice or employer contribution, as part of a strategy of driving your taxable earnings down from £60k to £20k. That's unlikely to have been wise. I'd have used an ISA instead, for its greater flexibility before age 55, or directed the money to my wife's pension, unless she's looking at comparable problems. Anyway, wise or not in the past, you should now stop it. Really you must.

jamesd

EdSwippet wrote: »

If you have £900k by April next year, the traditional 7% annual growth assumption alone (no further contributions) gets you to £1.25m in just five years, so right about when you hope to retire.

You're right on those assumptions but it's very likely that there will be a market downturn of 20-40% in the relevant timespan which starts at age 55 in four years that will take the pot value below the LTA temporarily.

I'll assume CPI used to index-link the lifetime allowance is 2% to match the 7% growth assumption (UK market was 5%+ inflation long term).

year	year	LTA	pot	overby	dropneed
1	2016	1000000	900000	0	
2	2017	1000000	963000	0	
3	2018	1020000	1030410	1.02	1.01
4	2019	1040400	1102539	5.97	5.64
5	2020	1061208	1179717	11.17	10.05
6	2021	1082432	1262297	16.62	14.25
7	2022	1104081	1350658	22.33	18.26
8	2023	1126163	1445204	28.33	22.08
9	2024	1148686	1546368	34.62	25.72
10	2025	1171660	1654614	41.22	29.19
11	2026	1195093	1770437	48.14	32.5
12	2027	1218995	1894368	55.4	35.65
13	2028	1243375	2026974	63.02	38.66
14	2029	1268243	2168862	71.01	41.52

So stopping after a year seems likely not to result in difficulty staying within the lifetime allowance given the ability to time when to crystallise. Each £40,000 of additional contributions adds 4% of the one million Pound lifetime allowance and a little less than that to the drop target, ignoring growth in its value. Continuing to pay in £40k for an additional two years still leaves the drop requirement below 20% in year 5.

So I think it's fine for ffacoffipawb to continue pension contributions at the £40,000 level and just take a bit of care over how much to crystallise and when.

EdSwippet

kidmugsy wrote: »

Stockmarkets never grow at a steady rate: it's not the nature of the beast. Assuming a steady rate might be passable for explaining to a thirty year old how much growth he'd get by age seventy, but it's potentially misleading when applied over just a few years.

Yeah, I get that. Yet what other rate can we possibly use? OP intends to retire in four years. Projecting at 7% isn't unreasonable, it's just that the error bar is going to be larger. Probably a lot larger.

kidmugsy wrote:

Anyway, your fuss about LTA seems to me to be overdone. What are the chances of there being no large market setback between your 55th and 75th birthdays? Close to nil.

And this is where I think you make invalid projections. There will very likely be a downturn, but how much, how far, how fast, and in what asset classes? And why over a 20 year span, rather than the four year span the OP gave to retirement?

I have a 50/50 stock/bond portfolio, currently valued under the new reduced £1m LTA. In five years I expect it to be nudging £1.25m. At that point it would take a sustained 40% drop in stocks worldwide to remove the LTA penalty. More if bonds go up as stocks drop in the way they often do. Meantime I will have taken the PCLS and paid £63k in LTA penalty on the chunk over £1m with no chance of recovery. And that's if I don't shift my pension more towards bonds, something increasingly attractive as a way of tempering growth (just own stocks outside of a pension instead; the tax rate is lower than holding them in a pension).

I understand your arguments, but I don't feel convinced. Pouring cash into something in which you have to hope for a downturn for the optimal outcome just seems.... well... wrong.

jamesd wrote:

... but it's very likely that there will be a market downturn of 20-40% in the relevant timespan which starts at age 55 in four years that will take the pot value below the LTA temporarily.

See above.

I'm not saying there will not be such a downturn. But it would have to be at the severest end of your prediction, and come within a pretty short period, to offset the effect of losing £250k of LTA for someone three or four years out from retirement. Probability of that? Nobody knows.

Worst of all, the govt has neither confirmed nor denied that fixed protection will even be offered this time around. Which makes this all the more ridiculous.

jamesd

kidmugsy can use 20 years because it's unlikely that Ffacoffipawb is forced to crystallise the whole pot on a single date.

It doesn't take a drop at the severest end or close to that to stay wihtin the lifetime allowance. When writing about investing to newcomers I generally explain that they should plan for to or three drops of 20% a decade and one or two of 40%. Four years from now the required drop without adding £40k a year is just 5.6%. Adding another £40k for a couple of years raises the requirement to around 13% at age 55. That's not even enough to count as a stock market correction, which takes a 20% drop.

For simplicity lets assume that the defined benefit £240,000 doesn't change. That's 24% of the lifetime allowance that must be reserved for it and I'll assume that it doesn't go up by more than inflation for convenience.

Of the total £1,103,000 (1102539 rounded) pot in my spreadsheet, £240,000 is the DB part, leaving £863,000 of DC. Assume three more years of £40k a year and no growth on that for simplicity, that's another £120k by 5, total DC of £983,000.

Say Ffacoffipawb wants a lump sum and crystallises half of the pot, £491,500. Lifetime allowance now the 1,040,040 so that uses up 47.24% of the LTA. That £491,500 still in the pot is over the then-remaining usable 28.76% of the LTA, which is £299,219. For the £491,500 to be within that takes a drop of 39.12%. That's in the once or twice a decade sort of region but Ffacoffipawb now has plenty of money and is in no hurry.

Personally I'd not be inclined to push it that far and might instead go with 25% of the pot. That would leave £737,250 in the pot with 52.29% of the LTA available, £544,025. To get in under that takes a drop of 26.2%.

Still a bit over what a routine correction might deliver so maybe a bit less being taken would be nice. Unless Ffacoffipawb has a substantial lump sum need there's plenty of time and ample money, so all Ffacoffipawb needs to do is use UFPLS or gradual flexi-access movements while waiting for the market to move in the right direction.

Downturns are not strictly guaranteed but it is safe enough to plan on them turning up at least once in a ten to twenty year timespan.

Ffacoffipawb seems to have sufficient flexibility over timing and amounts even to pay in a total of £160,000 more without being in substantial danger of exceeding the lifetime allowance. Though personally I agree with kidmugsy that it may well be better to pay in only the higher rate income.

Switching to VCTs for the rest would decrease the potential wait and/or increase the amount of age 55 lump sum that could be taken without having to wait longer than a normal market correction's 20% drop territory. Say higher rate is £20,000 a year, that's £80,000 less in the pot and a reduction of 7.7% in the lifetime allowance in it at 55. That would allow crystallising 50% of the DC pot and needing a drop of around 24% to be within the LTA. Normal market correction sort of level, expected routinely a few times a decade.

Ffacoffipawb probably doesn't need to hurry and probably has sufficient margin to continue contributing without great concern, though dropping to paying in only higher rate income would increase flexibility of timing when and how much to crystallise and is probably wise. Unless that costs child benefit, which might deliver sufficient extra value to make it OK to risk going over the allowance if timing turns out not to be favourable.

Ultimately it's up to ffacoffipawb but it seems more sensible not to opt for protection given the amounts involved here, unless there is an inflexible need for a higher than 50% of pension lump sum on a set date.

ffacoffipawb

jamesd wrote: »

Ultimately it's up to ffacoffipawb but it seems more sensible not to opt for protection given the amounts involved here, unless there is an inflexible need for a higher than 50% of pension lump sum on a set date.

Food for thought there, thanks jamesd.

EdSwippet

jamesd wrote: »

...Of the total £1,103,000 (1102539 rounded) pot in my spreadsheet, £240,000 is the DB part, leaving £863,000 of DC. Assume three more years of £40k a year and no growth on that for simplicity, that's another £120k by 5, total DC of £983,000.

I was with you up to this paragraph, but assuming zero growth over three years seems a stretch. Conventional projection suggest 22.5%, adding nearly £200k to the total you used.

jamesd wrote: »

Say Ffacoffipawb wants a lump sum and crystallises half of the pot, £491,500...

But would s/he do that? In annuitisation perhaps, but in drawdown taking a chunk this big would be... ill-advised.

Also, I don't see where you have factored in the PCLS, and in particular the deleterious effects of the reduction in LTA on that. I have looked, but maybe I have missed it.

jamesd

EdSwippet wrote: »

I was with you up to this paragraph, but assuming zero growth over three years seems a stretch. Conventional projection suggest 22.5%, adding nearly £200k to the total you used.

The 1102539 already included growth on both the initial DC pot and on the whole of the DB part even though that's probably only inflation-linked.

I assumed no growth on the £40,00 being added, not on the existing pot. I did that because it doesn't significantly affect the overall picture, adding less than £8,600 to the pot size.

If you do want to include those two effects go ahead but you'll find that the four years of 5% above inflation growth on the DC part's £240,000 valuation is £51,700 while the three years of growth on £40,000 added a year is around £8,600. That's around 4.1% of the lifetime allowance that I unnecessarily included in the valuations, inflating the pot value and drop sizes required to stay within the LTA.

What I did was just use £240,000 for the effect of the DB on lifetime allowance in that single post, even though my previous one had already included it and growth in it in the total pot size. I did that to avoid having to recalculate everything and because I knew that it was adding a safety margin. To be more strictly correct I should have reduced the 1102539 by the part that was growth on the DC's £240,00 instead of just ignoring it and writing that "£240,000 is the DB part".

It just didn't make enough of a difference to be worth the extra calculating and writing in what was already going to be a long post.

EdSwippet wrote: »

But would s/he do that? In annuitisation perhaps, but in drawdown taking a chunk this big would be... ill-advised.

I don't agree that it is ill-advised. I intend to take the maximum available tax free lump sum from my own pension as soon as I'm able to do it. This is to reduce legislative risk and increase diversification opportunities. I doubt that an annuity at age 55 is being considered here. More likely moves to other tax wrappers like VCT and ISA. Such moves would reduce the need for a lump sum and increase the timing flexibility. A requirement to pay off an interest only mortgage on a set date is one big possible concern but that could be deferred by advance planning now if it's a factor. Of course I'm assuming that the tax fee lump sum isn't just being taken and thrown away on nothing of value.

EdSwippet wrote: »

Also, I don't see where you have factored in the PCLS, and in particular the deleterious effects of the reduction in LTA on that. I have looked, but maybe I have missed it.

The value of the 25% tax free lump sum was included in all of the crystallisation calculations, since those use the amount before the lump sum is considered.

I don't know what deleterious effect of the LTA on the lump sum you're thinking of, unless its from people like ffacoffipawb stopping paying in and getting the relief and lump sum when they don't actually need to do that if they pay attention to timing and their actual likely needs.