LTA .. UFPLS vs Drawdown

EdSwippet

anselld wrote: »

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 I agree the growth must be withdrawn.

In that case, I think so. UFPLS consumes everything taxably, leaving nothing untaxed at the end. FAD could leave you £750k that is still tax-deferred. You would pay tax on accessing it, though. Or your heirs might, depending on your age at death.

ETA: In case it's not already clear, UFPLS is really just FAD cut into small chunks and where the drawdown element of each chunk is immediately taken as taxable income rather than deferred.

gm0

I have now built a quick and dirty spreadsheet and the penny has perhaps finally dropped on the scale of the uncrystallised nominal growth issue for large DC funds - thanks for your patience OP.

Using the original model portfolio in the thread: A fund which moves towards the limit - Fund = LTA = 1m - growth +4.5% real (after fees), +2.5 inflation. Optimistic but not completely wild - knock the real growth down and the inflation up a bit if you prefer. Ignores volatility - not path simulation just linear. Then draw 50k indexed 2.5% via UFPLS annually or a lower figure around 40k indexed 2.5% via FAD from the 750k (ignoring whether SA bands, LTA gets indexed properly) - (equalising the other 10k out of the TFLS investments)

UFPLS burns out the LTA limit age 71ish (I just approximated when you crystallise + draw an LTA worth not the actual calcs) and dumps a few years of pre-75 penalty tax and an excess fund tax on 400k or so at 75 - result 175k of taxes on top of income tax. LTA indexation would knock that back a little bit. Whereas FAD taking the crystallisation event pre the growth and putting the TFLS outside the LTA regimen but inside IHT removes those taxes. Indexing a draw at 2.5% of up to 40k from 750k via FAD you are at just under the magic penalty number at 75. Result 0 LTA taxes.

If this is correctly modeled - what on earth is the rationale for why this is so different ? (Not the *why* is there an LTA discussion) - but the difference between the two pensions freedom methods seems a bit odd Or I have just confused myself.

And it seems to get worse. If you are bothered by sequence of return risk in the first decade then you didn't necessarily want to draw as much as these numbers imply. 5%-5.3% is a fairly racy SWR but you wouldn't want to take 3.25% wait 10 years and get it wrong the other way either - you would be back into high earnings SA tax and still hitting the LTA penalties. So behaviour gets bent by penalty tax planning but it is manageable I guess.

I'll go and model my own potential portfolio and pre-55 growth assumptions now and start thinking about what that means i.e. finding a (phased) TFLS + FAD platform solution most likely and considering when best to move to it - just before 55 probably to keep low costs and "not a SIPP" protection for as long as possible.

zagfles

I'm not sure why you find this surprising - the LTA is tested at BCEs and assuming positive growth of the fund wrt LTA inflation, the earlier the BCEs are the less you're going to get hit by the LTA because it's tested earlier, when the fund is smaller wrt the LTA.

By fully crystallising early, you therefore get less hit by the LTA tax. The age 75 test on crystallised funds is an anomily in this but it can be completely or mostly avoided by drawing down growth.

cfw1994

zagfles wrote: »

I'm not sure why you find this surprising - the LTA is tested at BCEs and assuming positive growth of the fund wrt LTA inflation, the earlier the BCEs are the less you're going to get hit by the LTA because it's tested earlier, when the fund is smaller wrt the LTA.

By fully crystallising early, you therefore get less hit by the LTA tax. The age 75 test on crystallised funds is an anomily in this but it can be completely or mostly avoided by drawing down growth.

I think you have said this on a previous thread....but it sounds like if one is approaching the LTA at 55, “perceived wisdom” would suggest crystallising it all (taking the 25% TFLS) and managing to extract any significant growth from the “drawdown pot” to avoid the second test leaving monies owing at 75.

Gets a bit tricky when one had a couple of smaller “pots” with guarantees that won’t be touched until perhaps 60 or later.....any wisdom on how to manage that?!
In my case it will be them that tip me over the LTA edge....the DC pot at 55 will be decent but not at the LTA.

zagfles

cfw1994 wrote: »

I think you have said this on a previous thread....but it sounds like if one is approaching the LTA at 55, “perceived wisdom” would suggest crystallising it all (taking the 25% TFLS) and managing to extract any significant growth from the “drawdown pot” to avoid the second test leaving monies owing at 75.

Gets a bit tricky when one had a couple of smaller “pots” with guarantees that won’t be touched until perhaps 60 or later.....any wisdom on how to manage that?!
In my case it will be them that tip me over the LTA edge....the DC pot at 55 will be decent but not at the LTA.

Would depend on exact details, but as with DB benefits, it might be best to leave some DC (or "normal" DC without guarantees) uncrystallised so that takes the LTA hit, rather than DB or the guarantees. Would depend on how it's handled by the scheme, but you'd likely want to avoid getting reduced guarantee due to the LTA or having to pay the LTA tax from outside the pension wrapper.

ukdw

EdSwippet wrote: »

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.

I agree that I don't see a future chancellor completely eliminating the 25% tax free allowance, especially a party who depends heavily on pensioner votes, however I would be surprised if the ability to withdraw £250k+ remains. This limit has already been reduced down from £450k in the last few years without many votes changing and I wouldn't be surprised to see it further reduced down to say £100k or even lower in the coming years.

This would however have a negative effect on overall tax receipts as there would be less money flowing around - so I wouldn't be surprised to see 25% of the rest of the LTA still being available at a reduced tax rate instead to still act as incentive to crystallise a large chunk of pensions at the start.

EdSwippet

gm0 wrote: »

If this is correctly modeled - what on earth is the rationale for why this is so different ? (Not the *why* is there an LTA discussion) - but the difference between the two pensions freedom methods seems a bit odd Or I have just confused myself.

I think you're looking for a difference that isn't there. UFPLS is not something entirely distinct from FAD, but rather just a particular fixed configuration of FAD. You could salami-slice pension crystallisations using FAD and then immediately take the entire drawdown portion, and this would come to exactly the same thing.

As to why UFPLS exists at all, probably just a user 'convenience'. Crystallising a pension through FAD is time-consuming and heavy on paper to-and-fro, and with an uncertain lead time and timescale in general. In contrast, a periodic UFPLS can be set up relatively easily within provider systems that deliver regular (monthly, likely) payments.

As already mentioned by zagfles, the outcomes are so different because over the LTA, delaying the BCEs leads to larger LTA penalty due to above-inflation growth during the delay. While below the LTA though, UFPLS can be a benefit because it allows a larger 25% PCLS to be extracted over time, since growth during the delay to BCEs plumps that up. UFPLS is designed for people below the LTA, not above it.

Symmetry, basically. UFPLS is tax-efficient below the LTA and tax-inefficient above it because holding an uncrystallised pension is tax-efficient below the LTA and tax-inefficient above it.

No shame in finding this difficult to fathom, by the way. It took me ages to get it all to gel in my mind. And if you read a lot of the media around this, it seems like many professional finance writers also haven't got fully under the skin of the LTA subtleties either.

cfw1994

zagfles wrote: »

Would depend on exact details, but as with DB benefits, it might be best to leave some DC (or "normal" DC without guarantees) uncrystallised so that takes the LTA hit, rather than DB or the guarantees. Would depend on how it's handled by the scheme, but you'd likely want to avoid getting reduced guarantee due to the LTA or having to pay the LTA tax from outside the pension wrapper.

Good point: I probably need to contact those scheme administrators to really understand the impact.

EdSwippet wrote: »

No shame in finding this difficult to fathom, by the way. It took me ages to get it all to gel in my mind. And if you read a lot of the media around this, it seems like many professional finance writers also haven't got fully under the skin of the LTA subtleties either.

Yes indeed. I seem to be wavering between thinking I have it sussed to "oh, I hadn't thought about that - how does THAT work"!
Any suggestions on where to seek clarity? (ie, what helped you get to grips with it). I do wonder occasionally if it is worth spending money with an IFA just to get to grips with understanding options....

Thanks both!

zagfles

cfw1994 wrote: »

Good point: I probably need to contact those scheme administrators to really understand the impact.



Yes indeed. I seem to be wavering between thinking I have it sussed to "oh, I hadn't thought about that - how does THAT work"!
Any suggestions on where to seek clarity? (ie, what helped you get to grips with it). I do wonder occasionally if it is worth spending money with an IFA just to get to grips with understanding options....

Thanks both!

If you do make sure you find an IFA that actually understand the LTA and related issues - seen loads of examples here where it's obvious they don't.

cfw1994

zagfles wrote: »

If you do make sure you find an IFA that actually understand the LTA and related issues - seen loads of examples here where it's obvious they don't.

& that is precisely my concern!