Take 25% lump sum or not?

terin

I came across a suggestion I had not considered before - when starting to withdraw an income from a SIPP, instead of talking a 25% tax free lump sum, it was suggested taking 25% of each years withdrawals tax free, every year.

If the rate of withdrawal is realistic (say 3-4%) and the pension pot is planned to at least keep pace with inflation or grow above inflation, then the amounts being withdrawn annually can increase so the amount received tax free over the long-term could be worth more than the amount taken in one go at todays values.

Is this a valid approach? Or are the other considerations that mean taking the 25% in one go is generally the way to go?

dunstonh

when starting to withdraw an income from a SIPP, instead of talking a 25% tax free lump sum, it was suggested taking 25% of each years withdrawals tax free, every year.

It is called phased drawdown. Been around a long time but a niche option until recently.

Is this a valid approach?

If it fits the need and is the most suitable option, then yes.

kidmugsy

From time to time there's something in the papers about Treasury studies into restricting the lump sum. The last piece I read mentioned a proposed cap at £36k. It seems unlikely to me that the Great Pension Liberator would want to tarnish his reputation with such a law but he won't be Chancellor of the Exchequer forever.

jamesd

terin wrote: »

I came across a suggestion I had not considered before - when starting to withdraw an income from a SIPP, instead of talking a 25% tax free lump sum, it was suggested taking 25% of each years withdrawals tax free, every year.

If the rate of withdrawal is realistic (say 3-4%) and the pension pot is planned to at least keep pace with inflation or grow above inflation, then the amounts being withdrawn annually can increase so the amount received tax free over the long-term could be worth more than the amount taken in one go at todays values.

The logic of the argument is false. It doesn't make any more money or allow any more tax free money.

It starts with an assumption: that any money you take out is spent immediately. If you simply take out the 25% tax free lump sum and invest what you don't need inside a S&S ISA you end up with the same amount of tax free money growth over time only it's outside the pension instead of inside it. It's just smoke and mirrors.

Phased drawdown has been an income tax planning strategy for years. What it does is use the tax free lump sum portion each year to reduce the overall income tax burden. It's applicable mainly to cases where either there is a risk of changing into a higher income tax bracket or where there's so much tax free lump sum available that it's not practical to move it all into an ISA in reasonable time. For these situations it can be useful.

terin wrote: »

Or are the other considerations that mean taking the 25% in one go is generally the way to go?

There are at least three potentially major reasons for taking the whole tax free lump sum immediately:

1. Legislative risk. There is constant talk about capping, eliminating or otherwise messing with it. Once you've taken it you're safe from those things.
2. You can pick any amount of tax free lump sum up to 25%, even 0%. Once you crystallise a pension pot you can't take out any more tax free lump sum from it, even if you took out none originally. So when crystallising you should take out 25% of whatever you're crystallising.
3. Lifetime allowance. When you crystallise a pension the amount of lifetime allowance is calculated as a percentage of the lifetime allowance at the time you do it. It's reducing next year and there's talk from some political parties of reducing it further. You protect yourself from lifetime allowance charge by crystallising as early as possible so that growth in the pension pot doesn't cause you to go over it later. There's a second lifetime allowance check at age 75 that you avoid by taking money out of the pension.

You should always try to take enough out of the taxable portion of the pension to use your full income tax personal allowance, since that's a use it or lose it allowance.

If you want more tax saving when taking money out of a pension you can use VCTs for a suitably small portion of your total investing. VCT tax relief is 30% so VCT buys can offset significant amounts of taxable income. There are some with secured loans as their main investments that are quite low risk and provide quite nice income, 10-11.2% tax free from a couple, 7-8% for many.

For those with larger sums who like the idea of living in Portugal for several years, Portugal has a claimable 0% income tax rate on foreign income, including pension income and lump sums. So you can move to Portugal, take out the whole pension tax free and stay out of the UK for the next several years to avoid being caught by measures intended to prevent temporary use of this sort of approach. I suspect that many of us could stomach living in Portugal for a few years, or starting in Portugal and living anywhere but the UK for a few years.

westy22

jamesd wrote: »

There are some with secured loans as their main investments that are quite low risk and provide quite nice income, 1011.2% tax free from a couple, 7-8% for many.

1011.2% ? - I wish!

James, which VCTs do you use for low risk / nice income as I am interested in starting to use VCTs as I have maxed all my tax-free options such as SIPPs and ISAs and am still firmly in the 40% camp.

OP - sorry to hijack

jamesd

The Albion VCT expects to pay 10.02%. The Crown Place one expects to pay 11.16%. Albion VCT is 100% secured on property of various sorts. Crown Place partly so. Those rates are after allowing for the reduction in purchase price from the tax relief on the way in.

They are still micro company investments but the security is good and the income plus tax relief makes it pretty hard to actually suffer a net loss.

I put 1k in each of the Albion-managed set of linked VCTs except Albion VCT where I put 15k. I considered more in the higher dividend paying Crown Place and if I was doing it again would have had more in that one as well. The top up offer page gives interest rate assuming even investment in all six but you don't have to do that if you don't want to. There's a free phone number on page 55 of the prospectus that you can use to check which are still accepting new money before you complete the form.

Be sure that you read the Tax Efficient Review and Tax Shelter Report independent reviews before deciding if they are for you. They are lighter reading than the prospectus and set yo up nicely to appreciate that.

For my next purchase I'll buy something else for diversification, not because of any dislike for these. I'd happily buy more but diversification is important as well.

zagfles

As well as phased drawdown there's UFPLS (google it), where you basically take a lump sum out of the pension without crystallising it, and you get 25% of it tax free, the other 75% being taxed. Not sure if all SIPP providers offer it.

jamesd

Two more reasons:

4. If you take anything beyond the 25% tax free lump sum your pension money purchase annual allowance is reduced from £40k to £10k so using the tax free lump sum can beat taking any of the rest while still making pension contributions.

5. When recycling tax free lump sums into new pension contributions one of the rules to stay within is increasing the pension contribution total by no more than 30% compared to previous years during the two tax years before the lump sum, the year it's taken and the two following years. Bigger tax free lump sums make this easier.

Thrugelmir

terin wrote: »

the pension pot is planned to at least keep pace with inflation or grow above inflation, then the amounts being withdrawn annually can increase

If this is only your source of income in retirement are you prepared to take the risk?

kidmugsy

Thrugelmir wrote: »

If this is only your source of income in retirement are you prepared to take the risk?

I think he meant "planned" in the technical sense of 'prayed for'.

terin

Thank you all for these replies.

jamesd - thank you for the detailed analysis! I think I need a quick crash course in what crystallising means. I have googled and it's still not clear in the context of a SIPP.

I had thought that crystallising meant (in practical terms) making a withdrawal. I had also thought that once you take any money out of a pension, the pension - i,e, the SIPP - was crystallised. I had also though that once you take (any) money out of a pension a line was drawn and you could not make any further contributions into your pension (SIPP). But points 2,3,4 seems to suggest that not all of these statements are correct - although I'm not totally clear which are and which are not!

2,3,4 were:
2. You can pick any amount of tax free lump sum up to 25%, even 0%. Once you crystallise a pension pot you can't take out any more tax free lump sum from it, even if you took out none originally. So when crystallising you should take out 25% of whatever you're crystallising.
3. Lifetime allowance. When you crystallise a pension the amount of lifetime allowance is calculated as a percentage of the lifetime allowance at the time you do it. It's reducing next year and there's talk from some political parties of reducing it further. You protect yourself from lifetime allowance charge by crystallising as early as possible so that growth in the pension pot doesn't cause you to go over it later. There's a second lifetime allowance check at age 75 that you avoid by taking money out of the pension
4. If you take anything beyond the 25% tax free lump sum your pension money purchase annual allowance is reduced from £40k to £10k so using the tax free lump sum can beat taking any of the rest while still making pension contributions.

Is point 2 saying that you get once chance at taking out a tax free lump sum, and that lump sum must be taken the first time, and only the first time, you make any withdrawal (crystallise)? Which is why you said use it or lose it.
4. So if you take 25% or less from your SIPP, then you can still make further contributions into your SIPP up to £40K p.a.?

Thank you again!