LTA Protection

coyrls

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.

I don't want to derail this discussion but isn't there another test of growth against the LTA at 75? I don't really understand how this growth test is applied.

gadgetmind

Thanks to everyone for useful stuff in this thread. My DC pension is also likely to go over the new LTA by 2018 and the suggestion of phased crystallisation is tempting, but ...

1) I'd rather grab the PCLS as soon as I can.
2) If the government back-pedal on the new freedoms, I won't be able to take enough income from crystallised segments to use my 20% tax band.

kidmugsy

EdSwippet wrote: »

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

Now you're making me wonder whether I've misunderstood. Help, someone!

jamesd

kidmugsy wrote: »

Now you're making me wonder whether I've misunderstood. Help, someone!

He misunderstood the rules in at least two ways that can make a big difference to what's best.

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.

As kidmugsy wrote, you have to crystallise the money to get to the 25% tax free lump sum but you don't have to actually withdraw any of the 75%. Indeed, today, you can't, because the GAD limit for capped drawdown restricts it. The GAD limit goes away with flexi-access drawdown but you still get to choose how much of the 75% to take and do that whenever you like.

EdSwippet wrote: »

I'm in a similar situation, but not identical -- no DB element at all in my case.

That makes your case a bit easier if the amounts are the same, since the LTA you have to reserve for DB increases the drop required to stay under the LTA with the rest.

EdSwippet wrote: »

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.

I've reordered this and the next paragraph for clarity.

First thing to know is that the 25% tax free lump sum is not necessarily 25% of the whole pot or 25% of the part being crystallised. It is capped at 25% of the lifetime allowance at the time of crystallisation. So if your pot is over the LTA the 25% will be capped. It's not so much reduced as being impossible to take in the first place.

Now you know that the 25% tax free lump sum is capped, the next bits will make more sense. Key thing to remember: none of the lump sum that is taken above the LTA can be a 25% tax free lump sum, it's all taxable lump sum. Not the part within the LTA, that 25% of 1.25 or 1 million is still tax free lump sum and can be fully taken.

The Lifetime Allowance Charge depends on how the money is being taken. If it's taken as a taxable lump sum it is first subject to a 55% tax charge that the pension provider will deduct, instead of normal income tax. if it's placed into a drawdown pot or used to buy an annuity there's a 25% one-0time charge that the pension provider will deduct. Then any income you take is added to your normal taxable income just like any other pension income payment.

So in one way you're right that the reduced LTA reduces the tax free lump sum amount. But we're positing a temporary market drop that temporarily reduces the maximum tax free lump sum below the 25% of LTA cap anyway, so this doesn't actually matter unless that drop just doesn't happen. Of course it'd matter if there was an urgent need for the money and it would matter for a person who is 55 before the drop, if they just want to take out 25% tax free lump sum from the 1.25 million LTA instead of 25% from 1 million and without waiting.

EdSwippet wrote: »

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?

Yes, it's where the LTA is 1.25 million. With a 1 million LTA the excess benefit value is 1248k - 1000k = 248k. That 248k is what the lifetime allowance charge will be paid on. Any part of it taken as a lump sum has a 55% tax charge, any part taken for income has a 25% tax charge. So some permutations include:

1. £250k tax free lump sum plus 248k less 55% LTA charge, net total lump sum 250k + 111.6k = 361.6k net lump sum and the £750k drawdown/annuity pot.

2. £250k tax free lump sum, the whole 248k taken as income so subject to 25% LTA charge. Net lump sum £250k, drawdown/annuity pot of £750k + 248k less 25% LTA charge = £936k drawdown pot.

3. £250k tax free lump sum, 25% of 248k taken as lump sum subject to 55% LTA charge, net lump sum £277.9k. Drawdown/annuity pot of £750k + 75% of 248k less 25% LTA charge = £889.5k drawdown/annuity pot.

3 at £277.9k/£889.5k compares to the £312k/£936k with £1.25 million LTA, assuming no waiting for a market drop is done.

What I'd really suggest is taking some initially to use some of the LTA so that the market drop needed to get the rest out without going over the LTA is 20% or less.

Note that I haven't reviewed this for possible changes on 6 April, it's all using the charging levels as they are today and the announced LTA change. None come to mind but I haven't paid as much attention to this as some other things so I might have missed a significant change to the rules/charge levels.

Whew! In some ways pensions can be quite simple. This isn't one of those ways.

jamesd

coyrls wrote: »

I don't want to derail this discussion but isn't there another test of growth against the LTA at 75? I don't really understand how this growth test is applied.

Value in the pot at 75 minus value in the pot at initial crystallisation. Take out income and growth to avoid being affected by this.

EdSwippet

jamesd wrote: »

...So in one way you're right that the reduced LTA reduces the tax free lump sum amount. ... Of course it'd matter if there was an urgent need for the money and it would matter for a person who is 55 before the drop, if they just want to take out 25% tax free lump sum from the 1.25 million LTA instead of 25% from 1 million and without waiting.

Right. That one, modulo my clumsy explanations and muddled use of terminology. Thank you for the full explanations.

Upthread you stated that "... 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.".

Isn't one effect of the LTA allowance reduction a very rapid reduction in PCLS cap? Anyone in their 50s and with a £312k outstanding mortgage they plan to repay in a few years using their PCLS will now have to either remortgage (no fun at age 54), take FP if offered, or find 55% of £312k-£250k = £34k elsewhere. All these options are unpleasant.

jamesd

Yes, it's potentially a rapid reduction in cap but not to the degree of say the £50,000 sort of cap that I've seen some politicians mentioning, most notably in the Labour Party, who don't seem to realise that £50,000 of 25% tax free lump sum corresponds to a lifetime inflation-linked annuity level from the 75% of £4,500 a year or so. Beyond that pensions wouldn't offer an advantage for basic rate tax payers so we could expect - and would suggest - that they cease all personal pension contributions beyond those that get employer matching, so they don't go over their virtual cap on gains to compensate for the reduced pension flexibility.

As with many other things pension-related, it's the area of long term financial planning and rapidly imposed caps and restrictions tend to be inherently unfair to those who made long term plans. Short-termism by politicians is particularly unhelpful.

kidmugsy

The more I think about this the more I conclude that the problem isn't that the LTA is £1M, the problem is that an LTA exists at all. For DC pensions it should simply be scrapped.

For DB pensions it may make sense, but in that case the annual allowance should be scrapped.

This way contributors to both sorts of pension would gain a useful degree of simplicity and certainty for their planning.

I think I'll put this in my manifesto for the election.

gadgetmind

I really can't understand why the politicians keep attacking DC pensions. Taking on 100% of market risk yourself is bad enough without all the stupid caps and restrictions.

Orwell

Because they can without affecting their precious public sector. Ever notice how higher rate tax is now unfair because it affects some teachers etc? MPs spend their lives surrounded by civil servants.