Flexible drawdown while still working to maximise LTA

PKY

I’m 55 this year, a higher rate tax payer, and plan to work for another 11 years and would like to maximise my pension contributions going forward. For the last few years I've been making maximum annual pension contributions and I’m concerned about hitting the lifetime allowance (LTA) and have come up with a strategy which I would have thought would interest many people in a similar position. Is my plan logical, legitimate and worthwhile?

If I put my current £400K SIPP into flexible drawdown as soon as I turn 55 it will be tested against the current £1250k LTA and I will have used 32%. (Next tax year with the LTA dropping to £1million my fund would be 40% of the LTA.) I’m not going to withdraw any of the funds. I don’t even want to remove the tax free 25% if I don’t have to. I want to leave the fund invested in drawdown and continue making maximum annual pension contributions, currently £40K. Any growth in this drawdown fund will not be tested against the LTA for another 20 years at age 75.

If I continue working and making maximum SIPP contributions until I retire in another 11 years I would have made another £440K of contributions which with growth I would put into flexible drawdown on retirement age 66. This would be tested against the LTA (£1million) of which I would have 68% left so I could get another £680K into drawdown without incurring a Lifetime Allowance Charge LTAC.

Age 66 I would retire and put the rest of my SIPP into drawdown. With about 5% growth my drawdown fund could be worth £700K for the first crystallised chunk and £600K for the second chunk for a total of £1.3million but still pass below the LTA. I would take the tax free cash 25% and drawdown the growth of about £50K a year so that age 75 when the LTA is tested again it is below the limit and avoids the LTAC again.

Do I have to take the tax free lump sum when I put the first chunk into drawdown? If I do will I fall foul of HMRC pension contribution recycling rules? Can I continue making maximum pension contributions? Are there any downsides to this plan? The only negative I can see is higher rate tax relief being withdrawn making pension contribution less worthwhile and the additional charges incurred running a drawdown fund alongside an uncrystallised SIPP.

I welcome your comments.

peterg1965

I am no expert, but that sounds like a reasonable and sound plan to take advantage of, and lock in the benefit of the higher LTA this year. I am pretty sure once you crystallise you are not under any obligation to take 25% TFLS straight away. You may also benefit from the indexation of the LTA from 2018 should your second pot grow above expectation and there is probably little chance of breaching LTA, provided the Government do not move the goalposts again over the next 11 years.

I am in a similar position, by taking my DB pension this year (I am only 49) I have it measured against the £1.25m LTA, which gives me slightly more head room as I generate another pot via SIPP/DC to use the remaining portion of my LTA.

madeinireland_2

This is interesting for me as well but I think my situation is tricker with a large DB scheme and a smaller SIPP.

I want to take the SIPP next year and delay taking the DB till 60 but the value of both is likely to be above the LTA even if I lock the SIPP at the 1.25m level - so I will be forced to take the DB earlier to avoid breaching the LTA unless anyone has any clever ideas.

All I can think i can do is leave the DB deferred, opt out of any more contributions and go for protection at 1.25 before they change it at the end of this financial year.

Any other ideas ?

I didn't know you can crystallise without taking the lump sum but won't you start to get charges from your SIPP supplier and they are fairly large ? I am interested a bit in this because I don't want to fall foul of recycling as well.

jamesd

You must either take the 25% tax free lump sum or lose the chance. You can take anything from 0 to 25% but it is a once only decision and if you take 0% or 10% you can't later choose to get the 25% or 15% you didn't take initially.

You can crystallise only part of the pot and take the full 25% from each part as you crystallise it, but that's contrary to your get the lifetime allowance calculation done now objective, which is a sensible one.

Your plan to take nothing beyond the 25% is good because if you take a penny more you have your pension money purchase annual allowance reduced from £40k to £10k.

For your ongoing contributions you have two choices, both good in different ways:

1. You can crystallise regularly. This will limit how much growth has happened before crystallising, reducing the likely percentage of the LTA used.
2. You can wait for market downturns and crystallise then to try to reduce the LTA percentage. If you adopt method 1, a downturn would be a good time to bring forward a planned crystallisation to increase the benefit.

Waiting until 66 to crystallise the new contributions would almost certainly be a bad move because lots of compounded investment growth would become part of the pot value. That also increases your legislative risk and several political parties have indicated a desire to continue to reduce the LTA.

The lump sum recycling rule part that is most likely to apply to you is the one that says that you can be charged if you have increased your pension contributions by more than 30% [STRIKE]of the lump sum amount[/STRIKE] over the two tax years before you take the lump sum, the year you take it, and the following two years. If you have a record of high contributions already it could be easy to pass this test. [STRIKE]Taking a big lump sum increases the 30% amount and can help to pass this test.[/STRIKE]

You won't be able to use the no more than £7500 tax free lump sum in a rolling 12 month period rule for the big initial crystallisation because the amount is too big. It could be useful for later years, though since you'll be making high contributions the 30% rule is the one that will probably be the one that really matters to you.

Taking the lax free lump sum now is useful. You could, say, use it to fund VCT purchases to eliminate much or all of your remaining income tax liability. There's a wide range of risk levels in VCTs, from 100% asset backed (meaning secured on property) loan-based ones like the Albion Venture Capital Trust to highly speculative types. VCT tax relief is 30% of the initial purchase and has to be refunded if you sell within 5 years. Generalist VCTs like that one typically pay around 5% of the purchase price as tax free income, equivalent to 7-10% after allowing for the effect of the initial tax relief and the various levels of dividend being paid out by the various VCTs. Happens to be 10% for the Albion one.

If you don't sell these can provide a solid source of tax free ongoing income. Or you can sell and buy back later to get 30% tax relief again. Have to wait six months before rebuying one you just sold or you don't get the initial tax relief on the new purchase.

EdSwippet

I have been thinking along the same lines as PKY, being in a similar position. I'll throw out two things not mentioned in the above excellent commentaries.

Firstly, taking any PCLS earlier rather than later may be a good idea as a backstop against any limits, caps, or other fiddling with this by a future government (and yes Mr Balls, I'm particularly looking at you here).

Secondly, a lot of the benefits from arranging things like this rely on current rules, and these will change in ways that could unravel all this careful planning. All major parties have said they will curb pension tax relief for higher earners, with the only variation among them being the definitions of 'higher' and 'curb'. In future, if you earn more than some limit in a year, where 'earn' includes investment income, a pension could be toxic and worse than just not contributing at all.

When a government says they want to turn pensions into bank accounts, what they mean is they want to turn your pensions into their bank accounts.

kidmugsy

EdSwippet wrote: »

Firstly, taking any PCLS earlier rather than later may be a good idea as a backstop against any limits, caps, or other fiddling with this by a future government (and yes Mr Balls, I'm particularly looking at you here).

Hear, hear. Personally I'd make the move ASAP, before there's any anti-forestalling legislation.

EdSwippet wrote: »

Secondly, a lot of the benefits from arranging things like this rely on current rules, and these will change in ways that could unravel all this careful planning.

Yes. I think there's a public interest argument for limiting tax relief on pension contributions, and the obviously sensible way to do it is (i) don't have an LTA on accumulated assets (except perhaps for DB schemes) (ii) leave the level of tax relief alone (20%, 40%, 45%), but (iii) limit the annual allowance (at least for DC schemes), perhaps in an income-dependent way, or perhaps in an averaging-over-a-decade way, or perhaps replace it altogether by an LTA applied to contributions instead of accumulated assets.

So there's no chance of that combination being legislated for.

PKY

Thanks for all your useful comments. It seems everyone agrees that going into FAD (Flexible Access Drawdown) asap is a wise move to protect against unnecessary charges on fund growth, announced changes in LTA (Lifetime Allowance) and possible future pension rule tightening.

It seems I have to take the PCLS so I will view it as an opportunity to diversify and invest in some proportion, still to be decided of BTL, VCTs, cash and/or gold, instead of the high equity exposure of my SIPP investments.

I’m finding the pension recycling rules hard to understand. I have only been contributing to my pension for 10 years. I am self employed, my income varies by up to 300% year to year, and so do my pension contributions. In good years I have made large contributions using carry forward rules. 2013-14 was one of those good years

Specifically can someone explain the 30% rule. What years are A, B, C, D & E annual pension contributions being compared to? and am I right to assume this would be the annual contributions including carry forward amounts?

2013-14 A
2014-15 B
2015-16 C
2016-17 D
2017-18 E

madeinireland_2

I would like to do something now but sadly I think I have to wait till I'm 55 which is not until March next year. Even then like the OP I'm thinking I may have to delay so as to avoid recycling rules (I think) mainly as I don't fully understand them.

So can someone explain the 30% rule please in more detail ?

Two years ago I made a 50k SIPP contribution - last year I made a 24k contribution. The pension is worth about £100k after they were grossed up etc. so I intend taking 25k out on my birthday. This excludes my DB scheme where I have also made some contributions.
I have used the carry forward. Rule over the last couple of years and I plan to leave work at or around the time I take the TFLS out of my SIPP - but I may choose to stay on for a while and wait for a redundacy scheme?

So will I fall foul of the recycling rules or not ?

Thanks...

mania112

Ok there are 2 things you can 'recycle'; your tax free cash, and your taxed pension income.

Your taxed pension income can be re-contributed to a pension without any problem, you just have to satisfy the normal contribution rules (100% of earned income up to £40,000 or £10,000 pa if you have activated a Flexi-Access Drawdown account).

Recycling Tax Free Cash is a lot more complicated. There are a few more boxes to tick to satisfy HMRC, and there are actually two '30% rules' (and these rules only come into play if more than £7,500 has been taken as tax free cash).

1) Has the pension contribution increased by more than 30%. HMRC will check the contributions made over a 5 year period.

This is the year the tax free cash was paid - 2 years before - and 2 years after.

If the cumulative increase over these years exceeds 30%, this would be classed as significantly greater. To calculate the increase, each of these five tax years is measured individually against the expected contribution for that year and the percentage figures obtained added together.

Example - Contributions were £20,000 pa, in the year PCLS was paid contributions were increased

PCLS -2 £20,000 Contributed
PCLS -1 £20,000
PCLS Year £24,000
PCLS +1 £24,500
PCLS +2 £25,000

In each year individually the increase was less than 30% of the original £20,000 contributions, but cumulatively the increase was 67.5% and therefore falls foul of the rules.

2) No more than 30% of the tax free cash payment can be recycled.

It can therefore be suggested that if you are thinking of utilising Carry Forward you're almost certainly going to be falling foul of the rules (because that would probably mean you're increasing your contributions significantly from previous years).

mania112

PKY wrote: »

Specifically can someone explain the 30% rule. What years are A, B, C, D & E annual pension contributions being compared to? and am I right to assume this would be the annual contributions including carry forward amounts?

2013-14 A
2014-15 B
2015-16 C
2016-17 D
2017-18 E

So continuing from my previous post:

You will need to note what your contributions where in years A and B, and what they will be in C, D and E, including all carry forward. If A-E cumulatively sees and increase of +30%, you'll need to reconsider contributions in the future.

Also, if you enter Drawdown you will activate a reduced annual contribution limit of £10,000, and carry forward is no longer possible (except for pre-drawdown years, i.e, after 3 years in Drawdown your entitlement to Carry Forward will have ceased completely).

PKY

Thanks you mania112 for trying to explain the recycling rule but I am still do not clear how the contributions are compared.

How is the "expected contribution for that year" calculated? Is it the value of PCLS -2 or the average of (PCLS -2 ) + (PCLS -1)?

Your calculation takes £20K as the "expected contribution" and then calculates the payments in later years to have grown by 65% and so fall foul of the 30% rule. Is the calculation of the increase in contributions (PCLS - PCLS-2) + (PCLS+1 - PCLS-2) + (PCLS+2 - PCLS-2)?

These are my actual contributions. I want to crystallise my £400K SIPP this year and have no intention of recycling contributions. I just want to be sure of not falling foul of the 30% rule. How would the calculations work with these figures? With that large payment and carry forward figure for PCLS-2 am I in the clear?

2013-14 £140K
2014-15 £17K
2015-16 £53K
2016-17 £ ? would like to make £40K
2017-18 £ ? would like to make £40K

Also you say "if you enter Drawdown you will activate a reduced annual contribution limit of £10,000" but others on this forum lead me to believe that I could go into flexi access drawdown crystallising the fund taking the PCLS but if I do not withdraw any more money I can keep making full pension contributions, £40K earnings permitting.