When to crystallise pension funds in relation to the Lifetime Allowance

Jim9999

I have a question in relation to the Lifetime Allowance (LTA) and the timing of the crystallisation of pension funds.

I am 60 and have pension funds that are just exceeding the LTA - most of this is in Defined Contribution funds. Assuming that these funds will continue to grow, then so will my tax liability under the LTA up until the age of 75 Does it therefore make sense to crystallise ALL my DC funds up to the LTA limit as soon as possible, taking the 25% tax free lump sum and putting the remainder into drawdown - and then take off any growth from the funds in drawdown up until the age of 75? This means that any growth in the funds can be taken at my 20% tax rate rather than leaving the funds uncrystallised and paying 25% plus marginal tax rate on any continuing growth in the funds.

This strategy would provide a large sum of tax free money which I don't really need at this time.
Therefore, should I adopt an alternative approach to phase the crystallisation of the funds year on year thereby producing smaller but regular amounts of tax free money, whilst the remainder is moved into drawdown. Assuming that the funds grow, this would probably result in a higher overall LTA tax liability at 75 though, as the growth in the uncrystallised funds would be subject to LTA tax.

Your thoughts are welcome!

dunstonh

Remember that pensions are not the only tax wrapper. There is S&S ISAs and unwrapped holdings that you can place the 25% back in.

kidmugsy

dunstonh wrote: »

Remember that pensions are not the only tax wrapper.

Indeed, people of 60 often have tax wrappers called wife, children, even grandchildren.

EdSwippet

Jim9999 wrote: »

Does it therefore make sense to crystallise ALL my DC funds up to the LTA limit as soon as possible, taking the 25% tax free lump sum and putting the remainder into drawdown - and then take off any growth from the funds in drawdown up until the age of 75?

You might get a range of answers on this -- including perhaps some that argue that if you wait you might catch a downturn that will reduce or eliminate the LTA from your life entirely -- but for my money, doing what you plan here seems like the path of least risk. It is certainly what I plan to do. The main point of note is that tax even outside any wrapper will generally be lower than 25% plus marginal tax on money left inside the pension and drawn out later.

The LTA will (should!) rise with inflation, but you should expect your investments to grow faster than that, so the longer you wait, the more the LTA penalty you accrue. I take it that you either have one of the protections, or if not, are no longer eligible for Fixed Protection 2016?

Alibert

I am in a similar situation and I think your analysis is correct. You should def crystallise an amount equal to your LTA . (possibly wait until April a six months wait to get an extra annual increase in the LTA)

Amounts over the LTA I am not sure about , perhaps hang on in the hope the LTA is abolished one day.

I am irritated that the govt tax policy is driving me to come out of my low cost company scheme into a more expensive SIPP , and to take tax free cash I would really rather keep back until I retire

Jim9999

Thanks for your responses - very helpful - I have a follow-up question in relation to EdSwippets reply

The LTA will increase with CPI each year - so if you have say 15 years until your final benefit crystallisation event at 75, the LTA could have risen to over £1.3 million (say assuming CPI increase of 2% year on year). This could have a big impact on whether to decide to crystallise all funds now and take out the growth to avoid exceeding the current £1.03M LTA threshold, or leave the funds alone for a few more years to hopefully grow on the assumption that the LTA at 75 will have risen significantly.....

Thoughts?.....is the Government likely to change its mind in linking the LTA to CPI!! And I wonder what would happen when the LTA rises above the 2016 Fixed Protection of £1.25M.....!!

kidmugsy

Jim9999 wrote: »

The LTA will increase with CPI each year - so if you have say 15 years until your final benefit crystallisation event at 75, the LTA could have risen to over £1.3 million (say assuming CPI increase of 2% year on year). This could have a big impact on whether to decide to crystallise all funds now and take out the growth to avoid exceeding the current £1.03M LTA threshold, or leave the funds alone for a few more years to hopefully grow on the assumption that the LTA at 75 will have risen significantly.....

If you take funds out and then invest them in the same things within an ISA, or even unwrapped, they'll grow just as much. But they won't impinge on your LTA.

Jim9999 wrote: »

.....is the Government likely to change its mind in linking the LTA to CPI!! And I wonder what would happen when the LTA rises above the 2016 Fixed Protection of £1.25M.....!!

Probably everything will depend on Mr Trotsky-lite and his cronies. If they let the LTA grow at all it would probably just replace the £1.25M when it overtakes it.

collideorscape

I've been experimenting a bit with a spreadsheet. For the sake of argument, I assumed that tax thresholds, the lifetime allowance and the growth of funds all go up at the same rate, which I have assumed is 2%. I don't think my arguments are very much affected unless you can get much better guaranteed growth rates than this. (If you can, please can you let us all know!) I have also assumed no massive change in government policy, so keep voting for the sensible party, if you can find one. I also discount all amounts to today's date, using the same 2% rate, just to keep everything fair.

I compared three strategies:

1. Draw everything you can now as cash, at least to bring yourself down to the lifetime allowance. It's a painful one-off hit, but thereafter there is no extra tax (unless growth rates are greater than CPI -- see above).

2. Leave everything alone, and pay the tax later on, when you actually need the money or when you hit 75.

3. Assuming you are not paying any other significant amounts of income tax, draw down what income you can up to the top of the 20% tax band. You pay the extra 25% until your excess pension runs out, at which point you can do what you like.

For example, if you start off with 1.5M, after about ten years you'll have reduced it to the allowance so we can compare how much you donated to HMRC using each of these strategies. 1 and 2 are exactly equal, donating 258.5k. Strategy 3 donates about 180k. You get similar sorts of results with starting sums less than 1.5M -- I've not tried more than 1.5.

Thus, I think that strategy 3 is your best bet, so long as you are not earning much and you can afford to live on that amount of drawdown per year.

I am not an accountant, so my figures might be up the spout, of course. Caveat, caveat, caveat....

AnotherJoe

collideorscape wrote: »

I've been experimenting a bit with a spreadsheet. For the sake of argument, I assumed that tax thresholds, the lifetime allowance and the growth of funds all go up at the same rate, which I have assumed is 2%. I don't think my arguments are very much affected unless you can get much better guaranteed growth rates than this. (If you can, please can you let us all know!) I have also assumed no massive change in government policy, so keep voting for the sensible party, if you can find one. .

If your investments only grow at 2% that essentially implies no growth at all once you factor in inflation, if your 2% is above inflation, that's still a very poor return since you should be able to get 3%+ just from dividends, and you can get 2.5% in a savings account, essentially zero risk, so you should be getting much higher in investments to balance the extra risk.

Is that "guaranteed" ? No, but if you insist on guaranteed then you are are guaranteed to get pathetic returns and have no business discussing investment

collideorscape

If you make the assumption that your pension pot grows faster than CPI, and the option of drawing down the excess as income within the 20% tax band is not open to you, then I agree that the best thing is to crystallise early. If your pot actually grows slower than CPI, then you would end up giving the tax man more than you need to by crystallising early. Hopefully, this is a less likely scenario.