Tax free lump sum from pension

SomeMadeUpName

As I understand it as soon as you qualify to withdraw from a DC pot you can take 25% tax free then leave the rest in the pot to draw over time (but it is all then taxable income as it's drawn), OR, you can draw regular payments over time with 75% of each payment being taxable and 25% tax free.

So my question is:  Why would anyone not draw the whole 25% upfront?  It's then out of the wrapper, and your money to do what you want with and invest how you like.  I guess as subsequent investment gains once out of the DC pension are taxable then a better way top ask it is why not draw the 25% as quickly as you can within the restriction of annual ISA limits (ie draw it out as swiftly as you can whilst stuffing it into ISA) might only take 1-5 years for most folks pots.

The only possible reason I can see for leaving it in the pension is to keep it away from your estate (and possible IHT) if under 75 years old.

Am I missing something?

HappyHarry

What is wrong with leaving it in the pension wrapper?  In the pension wrapper it grows tax-free, and in a SIPP you can invest it pretty much in what you want to. Whilst in the SIPP it is exempt from Inheritance Tax for ever.
This then leaves the ISA allowance free for other monies.

I don't see the advantage of taking the tax-free cash and then investing it inside an ISA. The only thing you are doing is making the monies eligible for IHT.

Nick9967

Because as I understand it if you leave it all and start drawdown (i.e. don't take 25% at the beggining) you're only crystalizing what you're drawing (25% of each draw is tax free) and the remaining un-crystalized pot remains invested and grows (or not as the case may be) then you draw again , same effect etc etc ,
the amount you end up taking tax free over the draw down period will actually likely be more than if you take the tax free all at the beggining:
Someone on this forum explained this to me sometime ago and put me right on my calculations which were miles off!
example is below

Year	UnCrystallised	Crystallised	Tax Free	Taxable	UnCrystallised	Crystallised
1	300,000.00	0	18,000.00	54,000.00	239,400.00	56,700.00
2	239,400.00	56,700.00	18,000.00	54,000.00	175,770.00	116,235.00
3	175,770.00	116,235.00	18,000.00	54,000.00	108,958.50	178,746.75
4	108,958.50	178,746.75	18,000.00	54,000.00	38,806.43	244,384.09
5	38,806.43	244,384.09	9,701.61	29,104.82	0	287,163.35
6	0	287,163.35	0	0	0	301,521.52
TOTAL			81,701.61

dunstonh

As I understand it as soon as you qualify to withdraw from a DC pot you can take 25% tax free then leave the rest in the pot to draw over time (but it is all then taxable income as it's drawn), OR, you can draw regular payments over time with 75% of each payment being taxable and 25% tax free.

They are two of the options but they are not exclusive and would be unusual for a 55 year old.

So my question is:  Why would anyone not draw the whole 25% upfront? 

Wrong question.  The question should be why would you want to draw the whole 25% upfront?  Its typically the least efficient option.

It's then out of the wrapper, and your money to do what you want with and invest how you like. 

Pensions, ISAs and unwrapped pretty much share the same investment options apart from a small number of highly niche areas.   So, how is the wrapper preventing you from investing how you like?

The only possible reason I can see for leaving it in the pension is to keep it away from your estate (and possible IHT) if under 75 years old.

Pensions are outside of the estate in 99% of cases irrespective of age.
You are looking at the pension wrapper back to front.    You may well find it is better to be using it rather than the ISA which you appear to prefer.

SomeMadeUpName

Thanks @dunstonh , @Nick9967 & @HappyHarry

I'll try to explain my thinking more clearly over a few response posts, but first, do I have a basic misunderstanding of the process, something @Nick9967 said makes me wonder:

I'm not entirely sure what the full meaning of crystalize is in regard to pensions.  If you had say £100k in a DC pot and you are past the age you can draw.  If you drew the £25k tax free then does the remaining £75k get treated differently in some way?  Is it not still in the pension, invested in whatever you choose?  I know it has undergone some sort of 'change' (or maybe ring fencing is a better way to look at it) as it is a pot that is now fully taxable if withdrawn, but it is still actively invested is it not?  And any growth it achieves how is that treated?  If it say grows to £80k over a few years (no other withdrawals since that initial £25k) is the £5k of growth all taxable at withdrawal (as it is fruit of the taxable tree as it were) or is it 75% taxable and 25% tax free on withdrawal?

Thx for the info

SomeMadeUpName

Nick9967 said:

Because as I understand it if you leave it all and start drawdown (i.e. don't take 25% at the beggining) you're only crystalizing what you're drawing (25% of each draw is tax free) and the remaining un-crystalized pot remains invested and grows (or not as the case may be) then you draw again , same effect etc etc ,
the amount you end up taking tax free over the draw down period will actually likely be more than if you take the tax free all at the beggining:
Someone on this forum explained this to me sometime ago and put me right on my calculations which were miles off!
example is below

Year	UnCrystallised	Crystallised	Tax Free	Taxable	UnCrystallised	Crystallised
1	300,000.00	0	18,000.00	54,000.00	239,400.00	56,700.00
2	239,400.00	56,700.00	18,000.00	54,000.00	175,770.00	116,235.00
3	175,770.00	116,235.00	18,000.00	54,000.00	108,958.50	178,746.75
4	108,958.50	178,746.75	18,000.00	54,000.00	38,806.43	244,384.09
5	38,806.43	244,384.09	9,701.61	29,104.82	0	287,163.35
6	0	287,163.35	0	0	0	301,521.52
TOTAL			81,701.61

But (subject to my question in the post above) if you pull the money out and invest is in S&S ISA then it will grow at the same rate outside the pension but still tax free.  So your aggregate gains over time are similar and the amount of them tax free is similar.  So no advantage leaving it in the pension. 

Marcon

SomeMadeUpName said:

If you drew the £25k tax free then does the remaining £75k get treated differently in some way?  Is it not still in the pension, invested in whatever you choose? 

If you draw the £25K, the remaining £75K remains invested within the pension as you choose. It grows in a tax-efficient environment while in the pension scheme. Anything you withdraw is taxable - there is no further tax free cash however well your pension savings do.

Notepad_Phil

SomeMadeUpName said:

I'm not entirely sure what the full meaning of crystalize is in regard to pensions.  If you had say £100k in a DC pot and you are past the age you can draw.  If you drew the £25k tax free then does the remaining £75k get treated differently in some way?  Is it not still in the pension, invested in whatever you choose?  I know it has undergone some sort of 'change' (or maybe ring fencing is a better way to look at it) as it is a pot that is now fully taxable if withdrawn, but it is still actively invested is it not?  And any growth it achieves how is that treated?  If it say grows to £80k over a few years (no other withdrawals since that initial £25k) is the £5k of growth all taxable at withdrawal (as it is fruit of the taxable tree as it were) or is it 75% taxable and 25% tax free on withdrawal?

The crystallised funds remain 100% crystallised regardless of fund growth i.e. in your case the £5k of growth is fully taxable when withdrawn as it came from the crystallised part of the pension. They will however remain tax-efficient whilst in the pension.

They can be invested however you like (within the boundaries of what your pension will allow you to invest in). I'm not aware of any pension that would have any differences on where you could invest crystallised funds compared to the non-crystallised funds.

SomeMadeUpName

HappyHarry said:

What is wrong with leaving it in the pension wrapper?  In the pension wrapper it grows tax-free, and in a SIPP you can invest it pretty much in what you want to. Whilst in the SIPP it is exempt from Inheritance Tax for ever.
This then leaves the ISA allowance free for other monies.

I don't see the advantage of taking the tax-free cash and then investing it inside an ISA. The only thing you are doing is making the monies eligible for IHT.

But, many couples estates are worth well less than £1m (including PPR) especially in the north of the UK with the lower house prices, so if you get the tax free money out of the pension then it becomes part of a tax free estate, whereas if you leave it in the pension once you are 75 isn't the recipient after death taxed on it?*
So really it's down to your age and size of your estate.

*actually just Googled and seen they can do a staged drawdown themselves so not too bad really.  Even so if in a sub £1m estate it's post tax money, in a pension pot it's pre tax money.

Marcon

SomeMadeUpName said:

HappyHarry said:

What is wrong with leaving it in the pension wrapper?  In the pension wrapper it grows tax-free, and in a SIPP you can invest it pretty much in what you want to. Whilst in the SIPP it is exempt from Inheritance Tax for ever.
This then leaves the ISA allowance free for other monies.

I don't see the advantage of taking the tax-free cash and then investing it inside an ISA. The only thing you are doing is making the monies eligible for IHT.

But, many couples estates are worth well less than £1m (including PPR) especially in the north of the UK with the lower house prices, so if you get the tax free money out of the pension then it becomes part of a tax free estate, whereas if you leave it in the pension once you are 75 isn't the recipient after death taxed on it?*
So really it's down to your age and size of your estate.

But not IHT - it would be income tax.

SomeMadeUpName

Marcon said:

SomeMadeUpName said:

HappyHarry said:

What is wrong with leaving it in the pension wrapper?  In the pension wrapper it grows tax-free, and in a SIPP you can invest it pretty much in what you want to. Whilst in the SIPP it is exempt from Inheritance Tax for ever.
This then leaves the ISA allowance free for other monies.

I don't see the advantage of taking the tax-free cash and then investing it inside an ISA. The only thing you are doing is making the monies eligible for IHT.

But, many couples estates are worth well less than £1m (including PPR) especially in the north of the UK with the lower house prices, so if you get the tax free money out of the pension then it becomes part of a tax free estate, whereas if you leave it in the pension once you are 75 isn't the recipient after death taxed on it?*
So really it's down to your age and size of your estate.

But not IHT - it would be income tax.

Agreed.  In the scenario above though (over 75, total estate less than the relevant IHT limit) better to have the money out and passed totally tax free (as estate), than in (the pension) and so subject to income tax on withdrawal by the beneficiary.

I do acknowledge though that I am now dancing on the head of a pin, and for many folk there is a balance to be struck on whether to leave much of the 25% in for steady draw down.

I think maybe my view point is forged from my own life experience, where ready access to decent lumps of cash has often been a necessary feature.  Digging into these things though, asking these questions, getting alternate perspectives, is how I hope to make the right decisions when the time comes.  So now I have added to my planning that the trigger for pulling all of the 25% out of our (rather meagre)** pension pots will be nearing/passing 75 years old if (as is likely) total remaining estate at that time is sub £1m (or relevant figure at the time).

Thx all 
@Marcon, @Notepad_Phil, @dunstonh, @Nick9967, @HappyHarry

**not crying the poor tale here, it's just we're late to the 'pension party' and as such much of our asset base is (and will remain) outside a pension wrapper.  DC pots are sub £100k at present, but I hope/expect to have that upto £300k (plus growth) by the time we're 75 (assuming we make it).  It's all still a plan in the making though, so thx again for everyone's input, plus as we all know, no plan survives first contact with the enemy, so we'll have to see.