LTA .. UFPLS vs Drawdown

anselld

Hi,

I am trying to fully understand the LTA implications of UFPLS vs Drawdown, specifically the second test at age 75.

As far as I can see UFPLS is a BCE6 event which obviously consumes some LTA.

Whereas crystallising into drawdown is a BCE1. The difference being that the amount crystallised can remain in the pot at age 75 without further LTA charge so long as growth was withdrawn.

Surely this means UFPLS is at a big disadvantage as far as the second LTA test is concerned. Is that correct?

gm0

Not based on my reading of prior queries on the forum and google. I would also like to understand the difference and materiality of it.

Ignoring all the emergency tax code and admin differences as noise and focusing on the LTA charge and test at 75 per your post.

Take a £1m fund i.e at LTA more or less at 55

FAD - TFLS @ 25% out + 3x crystallised instantly =1000k - all done. LTA used. 250k out no tax - off to consumption, ISA recycling, cash buffer, debt, unwrapped investments conventional or down the property, transfer to family (PET), non-pension investments - P2P or VCT route.
The 750k stays now in the crystallised state and is now drawn in stages via the FAD mechanism (this all at marginal rate for SelfAssessment before 75.

An even run over 20 years is 37500 - basic rate with no other income until state pension cuts in. Can take less from designated for drawdown fund leaving more in crystallised fund at 75 obviously - If can stay below LTA for the nominal fund value for undrawn funds vs LTA at 75 then no extra LTA charge. If more is sat there due to inflation and superb returns or little drawn to keep these funds outside estate then 55%/25% extra LTA tax with SA on lump/income. Continue post 75 until depletion or death.

With UFPLS - no TFLS. Same payments 55-75 x 20 of 12,500 tax free and 37500 taxable under SA (or both less scaled down as chosen each year). Slight difference in that LTA will be indexed a bit and nibbled at slowly payment by payment. If you die early the mix of uncrystallised to crystallised benefits will be a difference (less crystallised for UFPLS but the residue unspent + growth of the 250k TFLS in the FAD case being inside the estate for IHT vs outside the estate in the pension with UFPLS. I am not convinced the crystallisation difference now makes as much difference as it did earlier on when "not crystallised" was valuable in the inheritance treatment of pension benefits. I believe this is now more about how old you are when you die. Some expert may come along and correct this understanding.

There is a line in some of the docs about needing some LTA left after 75 to take benefits certain ways. If you are limited on mechanisms this could matter - if it is true. Once the 25% TFLS has been taken step by step to the LTA limit tested each time then the UFPLS payment becomes all taxable like FAD.

This ignores political risk - that this all changes - bird in the hand etc.

In conclusion - I believe this means that if you are exactly at the LTA (as in my example) at 55 and you take sufficient income then it makes no meaningful difference to the outcome. It just depends on whether you want to take the TFLS cash to deploy it differently unrestricted by pension rules at the cost of the IHT difference or not. Or you may be forced by a schemes limitations (if you wish to keep it for unrelated reasons) to use one method over the other.

This ignores phased FAD (doing the fund in multiple steps tfls, designation to draw) but I am not sure this makes a difference to the "compare" of pot size to limit at 75 per the original question. You are still over the limit - or you aren't. A nice problem to have assuming its investments not inflation !

EdSwippet

gm0 wrote: »

With UFPLS - no TFLS. Same payments 55-75 x 20 of 12,500 tax free and 37500 taxable under SA (or both less scaled down as chosen each year). Slight difference in that LTA will be indexed a bit and nibbled at slowly payment by payment.

This straight-line assumption for annual payments doesn't account for above-inflation growth in the pension investments, something you would very much hope and expect to achieve.

Factoring that in argues for jumping the LTA hurdle right at the £1mm balance to get it out of the way soonest. Otherwise, any above-inflation growth in the pension will occur above the LTA and so in the 25% penalty zone.

Usual counterarguments apply, such as where the need to avoid IHT dominates.

gm0

Ed - this is what I had also assumed to be the simplest and most practical route for DIY if you are running up towards the limit in the long bull market and projecting ahead to hit it. If you are old enough to act before the next round of political changes moves the goalposts in some complex manner yet again.

Thus - if it is offered at retirement date PCLS/TFLS + FAD ensuring that the balance is kept low enough to pass the 75 test without extra tax. The "Worst" case scenario being so much growth to draw that your SA tax goes up. The TFLS lump creates issues with unwrapped funds placed somewhere (CGT) and ISA recycling >5 years depending upon consumption and other factors. This being one reason I believe why the IFAs often suggest "phasing" the FAD method in a series of chunks rather than "all at once at the start/55" leaving investments inside until there is need to draw or opportunity to recycle to ISA - monitoring the 75 test and not letting the tax tail wag the dog more than is sensible. Again this phasing option is scheme or platform dependent as to what is supported by IT and procedurally. Mine doesn't do FAD at all. Clearly you can transfer to a SIPP platform which will do the method you want but that has consequences. IFA+Platform fee or DIY platform fee. v.s. Employer scheme existing non-fund costs (if any). And of course SIPP protection limit vs pension scheme protection regimen differences. So it *may* be better to use multiple UPFLS if that's all you have provided to you and you are happy with your limited investment options and the likely old school employer scheme outsourced admin.
Most won't be happy with that and will want access to a modern platform - but some will be based on specific tradeoffs.

Can't tell what will happen to the rules in the future of course - so UPFLS phasing would also be a "bet" on rule stability of roughly the magnitude of 1/2 the 25% fund x basic rate tax (scenario being a TFLS limitation imposed on uncrystallised funds a few years ahead) - alternative being - take any transfer costs and crystallise the lot with TFLS/FAD before the rules have a chance to change)

EdSwippet

gm0 wrote: »

This being one reason I believe why the IFAs often suggest "phasing" the FAD method in a series of chunks rather than "all at once at the start/55" leaving investments inside until there is need to draw or opportunity to recycle to ISA - monitoring the 75 test and not letting the tax tail wag the dog more than is sensible. ...

Yup, that's spot-on. Your initial example was somebody age 55 with a pension right at the LTA, so here specifically the best act is crystallise it all now.

For someone over 55 and closing in on the LTA, crystallising in chunks and perhaps deferring taking taxable income makes good sense. This is my situation exactly. Four weeks ago 5% growth in my pensions would see me hit the LTA. I crystallised one third of my SIPP, so now it will take 7.5% growth in the remainder to consume the unused LTA. When that hits 4% I will crystallise one half of the remainder, for 8% growth headroom. Maybe another iteration or two after that. I expect two to four years to reach the final crystallisation. My SIPP is mostly gilt and bonds, with most of my stock allocation outside.

Ideally I would have started phasing sooner. However, I'm not far over age 55, and it's a balance to get the best out of the current rules. Up to the LTA, the 25% PCLS makes a pension a tax benefit. Above the LTA, a pension is a tax ball-and-chain. Slowly and steadily gliding up to the LTA and crystallising in chunks as you go (if over age 55) is optimal. Against this you have to weigh the considerable political risk of an adverse rule change, and that argues for getting to the LTA as fast as possible and then getting out while you still can.

As for rule changes ... likely, but the 25% PCLS is the one thing about pensions that everybody understands, so it would be a brave or foolhardy chancellor that would change this. And I would expect any change to come with either a phase-in period that would give me chance to act now and take the rest while I can, or -- more likely -- yet another protection regime to avoid egregious retroactive effects.

gm0

To summarise mechanics then:

1 Choose investment strategy + desired portifolio mix for life in drawdown - viewed across ISA + Pension pot

2 Choose an approach to sizing drawdown and indexation of the chosen SWR amount (per GK rules, simple fixed + indexation, prime harvesting. CAPE rules etc etc - pick a poison.

Add the tax planning requirement of take enough to stay below the penalty zone where that makes sense on SA taxation at the time. Consider how rebalancing will work in practice for the chosen strategy - within the pension and considered across assets inside and outside (SIPP + ISAs) given the "barrier" between the two.

3 If around the LTA at retirement take the TFLS as soon as possible and disperse and ISA recycle according to need. (Key assumption IHT planning makes this an acceptable approach)

Clearly if below but on course to hit LTA use the glidepath of phasing based on returns as described as this has the benefits discussed.

A lot of people will have an equities heavy posture in the pension if not previously auto profiled into bonds by their funds - so to buy the equities "outside" the pension i.e. in ISA) and hold most of the cash+bonds inside will require the TFLS cash extracted from the pension reinforcing a "get it done while you can" approach subject to the phasing (if supported) to avoid having a lot of unwrapped cash "waiting" to be ISA invested. Some of this can clearly be the consumption "buffer cash" if your strategy involves a cash/FI bucket - arguably more cash fund deposit options outside pensions anyway.

5 Select the extraction mechanics last based on what is supported, minimise tax admin + cashflow pain where possible. Likely to be phased or single TFLS/FAD default. A series of UFPLS to higher rate band lower income limit as a secondary option - if that's all you have.

I might build a "what if spreadsheet" for the two scenarios on a model £1m (using long term equity returns 5.9 + inflation (as working in nominal for the tests) and a range round it to see how well or badly this approach is likely to work to visualise the slopes on extra 25% penalty taxes paid vs age for when growth catches the limit and returns. Clearly a crystal ball needed re inflation and LTA indexation.

I am interested in this particular little corner of arcana because funds may grow enough to come into this zone. Scheme (with better protection than a SIPP) and subsidised for platform - doesn't support FAD so need to understand what features I need in order to transfer to the right place as I dislike hopping around and want to compare "what can I do at what cost and protection level here vs there"

I don't sense this has come up a lot in IFA recommendation to take under management and switch out of occupational as either a) the increased investment and access options provide the justification anyway b) most existing older schemes didn't support anything when hit with the legislation other than transfer out for pensions freedoms - so the received wisdom has become strongly embedded based on that.

I wonder if IFA contributors are starting to see DC cases like this where this decision on protection+cost and drawdown methods + investment choice is becoming more relevant to the transfer recommendation as pensions freedom features are added in the outsourced scheme operations market.

anselld

Thanks for all the replies. I am more in the crash landing than the glide path to LTA so I am keen to make a decision.

Fortunately I have the option to take FAD. My advisor its against it though as he feels it is unwise to take funds out of the tax free wrapper and possible IHT exposure when they are not immediately needed. However his alternative seems to be to suck up the 25% LTA charge when the time comes.

I am still interested in the UFPLS question in my original post though. Fair enough if that is the only available option but am I interpreting the BCE rules correctly ie FAD creates a pot of circa £750k which is immune to the second LTA test but UFPLS does not?

gm0

My understanding does not quite concur - FAD - 750k designated - but *still* need to draw the excess growth on it before 75 (I have picked up this idea somewhere but could be wrong). If it is "immune" for all growth that would be lovely. But my understanding was/is that nominal fund value still matters at the age test - and that this is frankly the "gotcha" moment - crystallised or not. Hence the view in the above thread that *how* you got to a fully crystallised to LTA (and sequence of during the process provided you don't go over) is less material than the simpler "how much money is left" at 75

An advisor I know was similarly adamant about the pension and IHT estate planning point - leave it all inside, don't crystallise, spend everything else first. Clearly he was short on my longevity. IMHO a huge assumption that a middle class wealth transmission privilege and IHT in general gets left unmolested for 20 years+. But a sceptical mindset doesn't mean it's wrong advice based on the rules today if you are over the IHT thresholds via property value vs mortgage, savings for care costs etc. etc. Which are all very nice problems to have.

EdSwippet

gm0 wrote: »

My understanding does not quite concur - FAD - 750k designated - but *still* need to draw the excess growth on it before 75 (I have picked up this idea somewhere but could be wrong).

That's my understanding too. From this paper:

BCE 5A

Where member reaches 75 having designated sums or assets held for the purposes of a money purchase arrangement for payment of drawdown pension.

The total amount representing the individual's drawdown pension fund plus amount representing the individual’s flexi-access drawdown fund, less the total amount crystallised previously under BCE 1 (i.e. this BCE accounts for any growth received within the drawdown fund).

So BCE 1 at any time before age 75 creates a drawdown fund that is again subject to a spiteful lifetime allowance test at age 75 under BCE 5A. The trick to avoiding lifetime allowance penalties here is to draw down all the nominal gain before age 75. UFPLS doesn't suffer the same problem, but only because under UFPLS (BCE 6) the drawdown element is immediately paid out taxably, so there is no untaxed residue to test against the lifetime allowance later.

Personally, I have no direct descendants, so for me using a pension as an inheritance tax bypass is of far less interest than optimising the amount of spendable money I can extract out of it while alive. There are cases where sucking up the 25% penalty anyway can make sense, but I don't see that I am one of them. I don't know if that puts me in a minority or a majority.

anselld

Thanks. Yes, when I said "immune" I meant only the £750k immune not the growth. I agree the growth must be withdrawn.

zagfles

EdSwippet wrote: »

That's my understanding too. From this paper:

So BCE 1 at any time before age 75 creates a drawdown fund that is again subject to a spiteful lifetime allowance test at age 75 under BCE 5A. The trick to avoiding lifetime allowance penalties here is to draw down all the nominal gain before age 75. UFPLS doesn't suffer the same problem, but only because under UFPLS (BCE 6) the drawdown element is immediately paid out taxably, so there is no untaxed residue to test against the lifetime allowance later.

No, but if you're at the LTA it has the worse problem of growth above inflation/LTA inflation being taxed at 25% extra.

Personally, I have no direct descendants, so for me using a pension as an inheritance tax bypass is of far less interest than optimising the amount of spendable money I can extract out of it while alive. There are cases where sucking up the 25% penalty anyway can make sense, but I don't see that I am one of them. I don't know if that puts me in a minority or a majority.

Yes I think IHT would be the main reason not to crystallise all when at the LTA.