LTA Protection

EdSwippet

jamesd wrote: »

...I don't know what deleterious effect of the LTA on the lump sum you're thinking of...

Not just LTA, but reduction in LTA. A pot of £950k now is quite likely to grow to £1.25m through investment returns alone over five years from age 50 to age 55. Take no action to mitigate the LTA reduction and you effectively lose £63k in tax. Compare with taking fixed protection on the LTA (if possible) at 1.25m, where the LTA tax loss on the same withdrawals at the same dates would be zero.

Clearly either I'm missing something in your explanations, or we're talking past each other. I can't really see the logic in relying on a downturn to make a strategy work. Might turn up, but might not.

To mangle Keynes, the market could stay rational longer than you can wait for irrationality to provide LTA-penalty-free access to your cash. Fixed protection on the LTA seems to add a highly usable amount of headroom for folk with pension pots pushing up against the limits.

jamesd

Ah, I see what you mean about the PCLS reduction. That doesn't really matter that much since once it's outside the pension it can just be reinvested and will grow back once the recovery happens, whenever that happens to be.

The logic of relying on downturns is that they are sadly predictable in approximate frequency even if not specific timing, so we can be pretty sure that one will happen in time to take care of the issue here. Not a guarantee, but investing isn't guaranteed either. Those who invest should be well used to dealing with such uncertainties.

I do agree that the market could stay irrational longer than helpful in this case but I'm not really sure that ffacoffipawb or any of us should be sad if there is no market correction for the next ten or twenty years. What is lost on the lifetime allowance may be celebrated as unexpectedly large gains.

The protection offered by protecting hte LTA is real but it needs to be weighed against the chance of exceeding it and not being able to get the money out during a downturn within a desirable timespan. I think that the probability of that combination is not high in this case.

kidmugsy

EdSwippet wrote: »

why over a 20 year span, rather than the four year span the OP gave to retirement?

Because the latest age at which LTA is calculated is 75 not 55. He doesn't need to crystallise all his pension at 55, especially if he starts his final salary pensions then. As jamesd said, to take advantage of the fact that markets are erratic he can phase his drawdown.

The error in your thinking is repeatedly supposing that stock markets give steady returns. They don't. That gives this pension investor every chance of escaping from the LTA as long as he is patient, and canny, and seizes the day when it arrives.

EdSwippet

jamesd wrote: »

Ah, I see what you mean about the PCLS reduction. That doesn't really matter that much since once it's outside the pension it can just be reinvested and will grow back once the recovery happens, whenever that happens to be.

Here you seem to be assuming that the PCLS is taken after the (also assumed) downturn. I'm suggesting it's taken before. It makes good sense to take as early as possible -- as you say, reduce political risk.

With FP, LTA remains at £1.25m. Drawing £312k from a £1.25m pot uses 25% of protected LTA and attracts no tax (PCLS).

Without FP, LTA drops to £1m. Drawing £312k from a £1.25m pot uses 31.25% of LTA, and exceeds PCLS leading to a tax charge. The remaining pot needs to drop from £938k to £688k to be within the remaining 68.75% LTA. That's a 26% drop -- could (likely will) happen in stocks, but to reduce a balanced 50/50 stock/bond portfolio by this would take more like a 50% drop in stocks, and they don't come often.

One could take a smaller initial withdrawal of £250k without FP, avoid the PCLS tax charge, and then instead wait for the 50% drop in stocks to make up for not having taken FP, but it might be a long wait.

jamesd wrote: »

The protection offered by protecting the LTA is real but it needs to be weighed against the chance of exceeding it and not being able to get the money out during a downturn within a desirable timespan. I think that the probability of that combination is not high in this case.

Okay, but personally I'm not convinced. Lord knows my wife will tell you that I'm not a natural optimist, but even I find the idea of optimizing on the assumption of downturns disconcerting. In retirement my portfolio will be balanced, and a 26% 'routine correction' in stocks will not be enough to drag my pension pot back under the reduced LTA.

Neither of us knows what the OP will hold in their pension, and whether this 26% downturn, itself by no means certain, will be enough to counter the certainty of a loss of 1/5 of the LTA.

Thanks for taking the time to discuss this, anyway.

kidmugsy

EdSwippet wrote: »

Here you seem to be assuming that the PCLS is taken after the (also assumed) downturn. I'm suggesting it's taken before. It makes good sense to take as early as possible -- as you say, reduce political risk.

That's a good point: that deferring taking the PCLS leaves you at risk of facing a limit on its size. Such a limit on its size may well be imposed before the OP is 55. It's easy to imagine Mr Balls introducing a pension reform that abolishes the 20%/40% tax relief, and replaces it by 30%; reduces the annual allowance to £30k (that's already his policy); and limits the PCLS to (say) £40k or perhaps to 20% of the pot, justifying the latter with allusions to the new 30% tax rebate.

The OP's best policy, in my guess, is (i) stop making his problem worse by over-contributing, and (ii) wait and watch. In other words (ii) keep calm, and (i) don't carry on.

jamesd

EdSwippet wrote: »

Here you seem to be assuming that the PCLS is taken after the (also assumed) downturn. I'm suggesting it's taken before. It makes good sense to take as early as possible -- as you say, reduce political risk.

There's a risk and it's one of the many factors for the pension holder to consider. What I described was various mixtures of some before and some after the drop.

Given the large complexities for people's long term planning that would be involved we can at least hope that PCLS caps won't be imposed very rapidly. It would be quite unpleasant for someone who took out a 25 year mortgage to suddenly find after 20 years that they can't repay it as planned because the lump sum is capped. It's also what delivers the 6.25% gain that is the main benefit to basic rate tax payers, so a cap on it would amount to a cut in the incentive for basic rate tax payers to use pensions. We don't really need things discouraging basic rate tax payers from using pensions.

EdSwippet wrote: »

With FP, LTA remains at £1.25m. Drawing £312k from a £1.25m pot uses 25% of protected LTA and attracts no tax (PCLS).

That's impossible. The PCLS is a maximum of 25% of the pension pot size being crystallised so the lawful choices are either:

1. crystallise £312k using 312/1250 x 100 = 24.96% of the lifetime allowance and take 25% of it as a tax free lump sum worth £78k.
2. crystallise £1248k using 1248 / 1250 x 100 = 99.84% of the lifetime allowance and take 25% of it as a tax free lump sum worth £312k.

You don't get to take the 25% without crystallising the remaining 75%.

EdSwippet wrote: »

Without FP, LTA drops to £1m. Drawing £312k from a £1.25m pot uses 31.25% of LTA, and exceeds PCLS leading to a tax charge. The remaining pot needs to drop from £938k to £688k to be within the remaining 68.75% LTA. That's a 26% drop -- could (likely will) happen in stocks, but to reduce a balanced 50/50 stock/bond portfolio by this would take more like a 50% drop in stocks, and they don't come often.

One could take a smaller initial withdrawal of £250k without FP, avoid the PCLS tax charge, and then instead wait for the 50% drop in stocks to make up for not having taken FP, but it might be a long wait.

It's not worth responding to that much because you're describing PCLS options that are illegal. You do need to take account of the DB pot by reserving the LTA percentage it needs. If you don't, you won't be planning for large enough drops for the rest and will end up with artificially low drop requirements.

EdSwippet wrote: »

Thanks for taking the time to discuss this, anyway.

Such discussions are interesting. I don't recall any discussion here in recent years that has gone into this much detail of how stock market volatility makes the LTA less of a barrier than it could otherwise be.

EdSwippet

kidmugsy wrote: »

...The error in your thinking is repeatedly supposing that stock markets give steady returns. They don't. That gives this pension investor every chance of escaping from the LTA as long as he is patient, and canny, and seizes the day when it arrives.

The problem I have with your approach is that seizing the day may require taking large pension withdrawals under flexible drawdown at highly irregular intervals, and this is inefficient for ordinary income tax.

For example, the standard annual SWR of 4% on £1.25m is below the 40% band. By contrast, waiting a decade for a downturn and then taking 40% of balance in one go may avoid the LTA penalty but exposure to 40%, 45% and 60% income tax brackets destroys much, if not all, of the benefit.

EdSwippet

jamesd wrote: »

...
It's not worth responding to that much because you're describing PCLS options that are illegal. You do need to take account of the DB pot by reserving the LTA percentage it needs. If you don't, you won't be planning for large enough drops for the rest and will end up with artificially low drop requirements.

Yeah, bad terminology and starting to confuse the OP's case with my own. I'm in a similar situation, but not identical -- no DB element at all in my case.

Given your option 2:

2. crystallise £1248k using 1248 / 1250 x 100 = 99.84% of the lifetime allowance and take 25% of it as a tax free lump sum worth £312k.

This the outcome where the LTA is £1.25m, right? How do the figures look if you reduce the LTA to £1m but leave everything else the same? Does the tax free lump sum reduce because of a tax charge due to lower LTA? That's the possible distinction I've been trying -- clearly ineffectually -- to get at.

kidmugsy

EdSwippet wrote: »

The problem I have with your approach is that seizing the day may require taking large pension withdrawals under flexible drawdown at highly irregular intervals, and this is inefficient for ordinary income tax.

I don't understand your point. The only withdrawal you need take on crystallisation is the PCLS component. You can leave the rest of the crystallised pot behind, or draw some as taxable income, as the fancy takes you. It no longer affects the LTA calculation.

EdSwippet

kidmugsy wrote: »

I don't understand your point. The only withdrawal you need take on crystallisation is the PCLS component. You can leave the rest of the crystallised pot behind, or draw some as taxable income, as the fancy takes you. It no longer affects the LTA calculation.

Okay, then I have misunderstood. Never mind. Thanks.