Avoiding the LTA?

gravlax

Some advice suggests the benefit of crystallising a SIPP early in order to maximize the potential future value of the SIPP, so it can exceed the LTA in value without triggering the LTA excess tax. One strategy involves taking advantage of a market drop.

As an example. A SIPP is worth £800,000. The market falls and the SIPP value is £640,000. At this point it is fully crystallised, taking 25% tax-free, £160,000 leaving £480,000 in the SIPP. The £160,000 is invested outside the SIPP so that total investments remain £640,000. When the market eventually recovers back to where it was (total investments £800,000) this would make £600,000 in the SIPP and £200,000 outside. The £100,000 increase within the SIPP (and any further increase) is not counted against the LTA.

But isn’t the problem that you miss out on tax-free income? You have taken £160,000 tax free and fully crystallised your SIPP. Had you crystallised it when the value was higher, and the SIPP was £800,000, you could extract £200,000 tax-free. The £100,000 growth inside the SIPP may not count towards the LTA, but if you want to withdraw it, won’t you be paying income tax at your marginal rate – in which case it’s no better than any other taxable investment gains?

Is that right?

Also, by crystallising when the SIPP is substantially less than the LTA, are you not missing out on even more potential future tax-free income? If instead of crystallising the SIPP, why not continue to contribute to the SIPP, until it is close to the LTA, e.g. £1m, then you could extract up to £250,000 tax-free.

Apart from inheritance planning, what advantage if any is there in increasing the value of a SIPP beyond the LTA? Even if tactical crystallising ensures you never pay the LTA excess tax charges, you still pay income tax at your marginal rate on any withdrawals – in which case the SIPP has no tax advantage. Isn’t it better to just allow the SIPP to reach as close to the LTA and then crystallise it?

zagfles

I don't think anyone, even jamesd, have suggested crystallising a SIPP well below the LTA in a dip. The suggestion is if the SIPP is above the LTA (or is together with other pensions), where if there is a dip, you could crystallise in the dip so reducing or even eliminating the LTA charge. Which is fine in theory but in practice I think the strategy of waiting for a dip is flawed for several reasons as I've written about here before. But for a SIPP below the LTA then waiting till it gets to the LTA (if it ever does) then crystallising (if you can) to avoid LTA charges is likely a good idea in most circumstances. You would need to take care to avoid the age 75 BCE on growth.

Albermarle

The £100,000 increase within the SIPP (and any further increase) is not counted against the LTA

It is £120K increase ( £480K to £600K ) This increase can be counted against LTA . When you reach 75, any amount above the £480K in the SIPP is counted . Easy solution is to make sure you spend or give away enough to make sure there is only £480K left.

But isn’t the problem that you miss out on tax-free income? 

Yes but saved more in LTA 

Also, by crystallising when the SIPP is substantially less than the LTA, are you not missing out on even more potential future tax-free income? If instead of crystallising the SIPP, why not continue to contribute to the SIPP, until it is close to the LTA, e.g. £1m, then you could extract up to £250,000 tax-free.

One solution is to part crystallise. This also means it is easier to get the tax free cash into S&S ISA's as there is less of it.

On the last point you are probably concentrating on the tax aspect too much . It is always going to be better to have a bigger pot than a smaller one . 50% of something is better than 100% of nothing .

NoMore

Albermarle said:

On the last point you are probably concentrating on the tax aspect too much . It is always going to be better to have a bigger pot than a smaller one . 50% of something is better than 100% of nothing .

This is such a good point, I see so many queries on this and the basis seems to be that the LTA must be avoided at all costs! As you rightly point out, its not necessarily a problem to breach it and with generous employer contributions it may even be worth it.

MarkCarnage

As noted, many miss the point that unless the tax rate was 100% you would still be better off above it than below it. I exaggerate of course as that would lead to perverse incentives and misallocation of capital.

Also worth noting that the practicalities of trying to crystallise in a market dip, particularly a fairly short lived one, are quite challenging. Every time I crystallise another chunk of my SIPP, I have to go through all the same !!!!!! covering !!!!!!, sorry compliance, some of which can't be done online apparently, and at best it takes a couple of weeks, usually longer by the time forms come to me and are returned. Even the SIPP provider staff, who are usually very good, didn't seem to know how the whole process worked the last time I did it. 

I did challenge them about this and was told it's a compliance requirement, and who dare challenge the mighty compliance department, certainly not the customer. 

gravlax

Albermarle said:

The £100,000 increase within the SIPP (and any further increase) is not counted against the LTA

It is £120K increase ( £480K to £600K ) This increase can be counted against LTA . When you reach 75, any amount above the £480K in the SIPP is counted . Easy solution is to make sure you spend or give away enough to make sure there is only £480K left.

But isn’t the problem that you miss out on tax-free income? 

Yes but saved more in LTA 

Also, by crystallising when the SIPP is substantially less than the LTA, are you not missing out on even more potential future tax-free income? If instead of crystallising the SIPP, why not continue to contribute to the SIPP, until it is close to the LTA, e.g. £1m, then you could extract up to £250,000 tax-free.

One solution is to part crystallise. This also means it is easier to get the tax free cash into S&S ISA's as there is less of it.

On the last point you are probably concentrating on the tax aspect too much . It is always going to be better to have a bigger pot than a smaller one . 50% of something is better than 100% of nothing .

"Easy solution is to make sure you spend or give away enough to make sure there is only £480K left."

Yes, but when you take out the £120,000 that has gained since you crystallised the SIPP, you still pay your marginal rate of income tax on it. 

I cannot see the benefit of crystallising earlier rather than leaving everything untouched until you are close to the LTA. 

Scenario 1: 
£600,000 SIPP
Crystallise it to lock in 100% against the LTA by taking out 25% £150,000 tax free
Now the remaining £350,000 SIPP can grow without another LTA test until age 75. The £150,000 taken out is also invested (not in an ISA, assume the ISA is already funded from other income).
The total investments grows to £1,000,000 - 75% was in the SIPP and 25% outside.
You can now have a £1m of investments to withdraw, but will pay income tax at your marginal rate on all of it. While your total tax-free benefit from the SIPP was £150,000 and is now all used.

Scenario 2:
£600,000 SIPP
Let it grow until it is worth £1m.
Crystallise it to lock in 100% against the LTA by taking out 25% £250,000 tax free
Now the remaining £750,000 SIPP can grow without another LTA test until age 75.
You can now have £1m in investments to withdraw, but will pay income tax at your marginal rate on all SIPP income but your total tax-free benefit was £250,000.
Also the SIPP remaining at £750,000 can continue to grow without another LTA test until age 75.

Scenario 3:
£600,000 SIPP
Let it grow until it is worth £1m.
Repeatedly withdraw the excess over £1m at any point it gets close to the LTA, (i.e. periodic withdrawals of approx. £70,000) of which 25% (£23,333) is tax free each time. 
You maintain a SIPP of around £1m from which can continue to draw income of which only 25% is tax-free.

Why would there be an advantage to doing something like option 1 over 2 or 3?

NoMore

For scenario 3, your using up some of your LTA on each withdrawal, after 14 withdrawals, you will have used up about 98% of your LTA, with still a million in your pot uncrystallised, if you have managed to maintain the growth like you envisage. So on 15th withdrawal, no more tax free cash and your now having to pay LTA excess charge and on every withdrawal hence, plus the LTA charge at 75, which would be pretty close after 15 years of withdrawals, if not already happened.

Albermarle

You can now have a £1m of investments to withdraw, but will pay income tax at your marginal rate on all of it.

Why would you pay income tax on withdrawing the £250K that was now outside the SIPP ? 

gravlax

NoMore said:

For scenario 3, your using up some of your LTA on each withdrawal, after 14 withdrawals, you will have used up about 98% of your LTA, with still a million in your pot uncrystallised, if you have managed to maintain the growth like you envisage. So on 15th withdrawal, no more tax free cash and your now having to pay LTA excess charge and on every withdrawal hence, plus the LTA charge at 75, which would be pretty close after 15 years of withdrawals, if not already happened.

Albermarle said:

You can now have a £1m of investments to withdraw, but will pay income tax at your marginal rate on all of it.

Why would you pay income tax on withdrawing the £250K that was now outside the SIPP ? 

But after 14 withdrawals (14 x £70,000) you have extracted £980,000 of which £245,000 was tax-free. That's still well ahead of option 1 where you limited yourself to £150,000 tax free income, ever.

"Why would you pay income tax on withdrawing the £250K that was now outside the SIPP ?"
I meant once it's taken out the SIPP you would pay tax on all the growth/capital gains when you draw it as income. The £250,000 was extracted from the SIPP not because it was needed, but to crystallise, so the money has to go into an unwrapped investment. 

I cannot see any argument that shows crystallising early such as Option 1 is better than leaving the SIPP to get bigger as in Option 2 or 3.

Albermarle

Why would you pay income tax on withdrawing the £250K that was now outside the SIPP ?"
I meant once it's taken out the SIPP you would pay tax on all the growth/capital gains when you draw it as income. The £250,000 was extracted from the SIPP not because it was needed, but to crystallise, so the money has to go into an unwrapped investment. 

You confused me by calling it income tax which it is not .

There are CGT and Dividend tax allowances which would lessen the impact . Plus you could put £20K in a S& S ISA each year. If you had a partner £40K . Probably the total amount of tax payable over a few years would be significantly less than income tax - probably in % single figures.

On the other hand you have removed the growth on the tax free cash from LTA .

I agree though that it is not clear which option is the obvious winner . Better wait for one of the LTA experts to comment .

NoMore

But nobody has made that argument, you posited it yourself and then zagfles quickly dismissed it as no one has made that suggestion and explained what was actually being suggested in other threads.