Avoiding the LTA?

MallyGirl

Scenario 4:
£600,000 SIPP
Crystallise it to lock in 100% against the LTA by taking out 25% £150,000 tax free. You still have approx 40% of LTA left at this point
Now the remaining £450,000 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).
£150k can be spread about (more easily by a couple) - ISAs if not full, Premium Bonds. More easy to manage than £250k!

Keep contributing to the pension until you are getting close to using the remaining 40% of LTA at which point you feel you have enough squirreled away to retire.
Crystallise the rest and then start withdrawing up to the Basic rate tax threshold (circa £50k) which should avoid the second test at 75.

Albermarle

MallyGirl said:

Scenario 4:
£600,000 SIPP
Crystallise it to lock in 100% against the LTA by taking out 25% £150,000 tax free. You still have approx 40% of LTA left at this point
Now the remaining £350,000 £450K 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).
£150k can be spread about (more easily by a couple) - ISAs if not full, Premium Bonds. More easy to manage than £250k!

Keep contributing to the pension until you are getting close to using the remaining 40% of LTA at which point you feel you have enough squirreled away to retire.
Crystallise the rest and then start withdrawing up to the Basic rate tax threshold (circa £50k) which should avoid the second test at 75.

Small correction as there was a mistake in the original post 

Chickereeeee

A small benefit of crystallising earlier is that, if you have some LTA left it will increase with inflation (or whatever government chooses to do when the freeze is removed.) So if inflation kicks off, or LTA is otherwise increased substantially, you will see the benefit at 75. If you have used all LTA, you won't.

A small benefit of crystallising on a market high is that, if you have other unsheltered investments and use the cash to buy more, you might see some capital loss to offset cgt.

(I said they were small benefits!)

jamesd

gravlax said:

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. 

Yes, it's potentially of value when there is a material risk or certainty of exceeding the LTA, as it would be for an 800k pot in most cases for retirement between 55 and state pension age. But with 800k I think it's likely to be better to crystallise at least most of it immediately because that guarantees over 200k of allowance for future use.

However, as has been discussed quite a few times, notably between zagfles and myself, there is a significant element of uncertainty involved, and while it's possible to know that many markets are in a situation where a substantial fall is more likely than not in a few years, nothing at all prevents markets from ignoring that and having say a ten year long bull run. Good times for the approach are when markets are high, bad times to delay are soon after a crash but before recovery, when crystallising would be better. In between there's just no way to know and some crystallising is likely to be best.

With an 800k value I think it'd be best to rapidly crystallise at least half of it and quite likely more over time with regular withdrawing of tax free lump sums so that at a minimum you lock in at least part of the unused allowance. At 800k, depending on future pension contribution plans, I might well suggest immediate crystallisation of the lot to guarantee that the whole unused portion is available for the future. Does depend on future contribution plans, though. If you say more about age and plans that'd help but expect it to be most likely that I'll suggest crystallising all 800k immediately.

gravlax said:

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.

At this point the growth to 600k is not counted against the LTA. However, at age 75 there is a further lifetime allowance calculation on the growth in value of a flexi-access drawdown pot since crystallisation.

With 480k at crystallisation growing to 600k that would mean that 120k of allowance would be needed at 75. Future growth similarly increases the amount. This is normally easy to avoid, since all you have to do is withdraw the money so that the value doesn't end up above 480k on your 75th birthday.

gravlax said:

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?

You're right that there's less income tax exempt (tax free lump sum) available to withdraw from the pension but the implication s wrong, because you've already extracted it all without income tax when you crystallised. That initial extraction and its growth wont' be subject to the pension income tax on withdrawing anyway. SO not, at a big picture level you haven't lost out on income free of income tax, you've just taken it out early and had it start to grow outside the pension inside. That 160k tax free also grows, to 200k, just as it would have if left uncrystallised inside the pension.

When outside the pension there are other potential taxes, notably capital gains tax, and potentially dividend and interest tax. You can reduce CGT by periodic selling to use your annual CGT allowance and avoid creating a large future accumulated bill.

Prime tool outside the pension is maximising the use of the 20k ISA allowance to shift the external pot back into a different environment where it continues to grow free of income tax and CGT.

gravlax said:

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?

No. Before the market drop it was 600k of taxable money in the pension and after the post-drop growth it's still 600k taxable inside the pension. What you've done is avoid the immediate potential use of 120k of LTA, without at all changing the amounts or split between free of income tax withdrawing and taxable drawing (subject to the age 75 LTA test on growth and the potential taxes outside the pension or ISA, though)

gravlax said:

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.

Nothing about crystallising prevents you from making more pension contributions in teh future and by doing it you increse the likely LTA headroom and facilitate higher future contributions. Since your question here implies missing some facts about how pensions work these days, here are a few key points:

1. You can have an unlimited number of pensions
2. You can pay into an unlimited number of pensions
3. Whether you've taken money from a pension makes no difference to whether you can pay into the other pensions and except in some work cases, doesn't prevent you from continuing to pay into that one itself. I am now paying into one that I crystallised a couple of years back...
4. You can open an unlimited number of pensions even after taking money out of some of them.
5. Until crystallising you can split off bits of a pension to switch into other pensions
6. You can crystallise only part of a pension (but some firms don't allow this and the remedy then is usually to switch the money to another one.

Some of the foregoing doesn't apply to defined benefit pensions like final or average salary but that's not what we're discussing at the moment.

So, back to the question. No, you've increased the potential for tax free income as a result of future contributions because instead of using 800k of LTA you've used 640k of LTA. That's left you with an extra 160k for future contributions and growth. Instead of just 200k and change you can pay in 360k and change (change being the bit over a million).

gravlax said:

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?

There can be advantage if taxes outside the pension on crystallised amounts would be excessive compared to the potential LTA charge saving. That usually doesn't apply but it can for people with lots of other income, notably when it takes their income tax rate above 40%, but not always even in that case. The disadvantage cases are relatively niche, just do exist.

No, it's not advantageous to leave it in the SIPP and pay the LTA charge when you can avoid that by having the lower tax free initial amount grow back to the higher tax free amount outside the SIPP, but not subject to potential LTA charge on that outside the SIPP growth.

Almost always, getting it out from the LTA is going to save the person with the pension more than the potential future income and other tax costs, with high other income the main potential exception.

For inheritance tax planning, after the age 75 LTA check on growth there's no further LTA checking done so money can be left to grow inside the pension if desired.

jamesd

gravlax said:

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.

400k plus change above one million of LTA available to use for contributions, assuming you withdraw enough to avoid the LTA charge on crystallised pot growth. 250k tax free outside the pension (after growth outside, ignoring CGT, dividend and interest taxes).

gravlax said:

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.

Nil LTA to use for contributions and the amount outside the pension is the same as 1, except for the possible effect of CGT, dividend and interest taxes. Still 250k tax free (but without the potential outside pension taxes).

gravlax said:

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.

Nil LTA to use for continued contributions. Identical tax free portion as 1 and 2 (ignoring the effect of outside pension taxes like CGT, dividend and interest).

gravlax said:

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

The far higher potential to make extra pension contributions which benefit from the generous pension tax relief system, likely more than outweighing the potential for some CGT, dividend or interest tax on the withdrawn tax free lump sum money.

But you've constrained your scenarios by sticking to cases where there's no LTA exceeding happening and in that case no planning to reduce potential LTA charge is required, since there's no charge anyway. The benefit shows up in increased contribution capability with associated tax benefit and reduced potential total taxation on the bit above the LTA.

At 600k there's a fair bit less pressure to crystallise than at 800k but there's still expected benefit, though doing so more gradually can be done to exploit the extra headroom within the LTA, unless it's planned for contributions to use that.

Having money outside the pension also has other uses, like VCT investing to exploit the five year repeating tax refund on those investments - 30% of your investment back provided you don't sell within five years, with tax exempt dividends and growth. It's an approach I'm using to effectively pay close to no income tax (after refund) from my pension withdrawing.

gravlax

Thanks jamesd.
A lot to consider there.
The tactic of crystallising earlier than close to the LTA e.g. at around £600k or £800k to lock in a percentage of the LTA taken up and leave headroom for growth.
Would this tactic still be recommended in a situation where the markets have dropped, say your SIPP is now £500,000 and you plan to start drawdown within say 1-2 years, and not making any further contributions into the SIPP. In a situation like this if you don't need any LTA headroom for more contributions, would it be better to wait to see if markets and your SIPP value recovers? Of course it could fall further, but does the benefit of crystallising earlier than necessary still remain when you have lots of LTA headroom and are not making contributions?

I'm still struggling with the idea that if you want to maximize the amount invested and minimize overall tax rate per £1 of income, that you make a net gain by crystallising early. As I said I assume the annual ISA allowance gets filled anyway from other income so I am not yet convinced that by removing a large lump sum from SIPP wrapper, and reinvesting it unwrapped where you pay CGT on any gains before you can extract income, which is then 100% taxable at your marginal rate, you make a net gain versus letting the SIPP approach the LTA, and then crystallising and start drawing an income where everything taken out is 25% tax free. I'm sure you're right but somehow it's hard to see!

MallyGirl

Yes you pay CGT but only on gains over £12k - your investments would have to be doing really well with the sort of money we are talking about here to be generating £12k gain

Albermarle

MallyGirl said:

Yes you pay CGT but only on gains over £12k - your investments would have to be doing really well with the sort of money we are talking about here to be generating £12k gain

Also if you have to pay some , it is not at marginal income tax rate , it is less.
Plus after  three or fours years enough could be transferred to ISA's to make paying any CGT tax at all even more unlikely.

gravlax

Albermarle said:

MallyGirl said:

Yes you pay CGT but only on gains over £12k - your investments would have to be doing really well with the sort of money we are talking about here to be generating £12k gain

Also if you have to pay some , it is not at marginal income tax rate , it is less.
Plus after  three or fours years enough could be transferred to ISA's to make paying any CGT tax at all even more unlikely.

But it seems there is a reliance on using an ISA to maintain the advantage of GCT exempt growth available in the SIPP. I'm trying to understand how you come out ahead when your ISA allowance cannot be used for reinvesting the sums taken out the SIPP and it has to be reinvested somewhere that any growth is subject to GCT. I know there is an annual CGT allowance but I would probably exceed it one way or another. As I said before my ISA contributions are covered from other income, so even if the SIPP cash is put in an ISA, it just means other cash that normally goes to the ISA has to go in a taxable account.

So in that context was not sure if it is still advised and you still come out ahead by crystallising early, in the scenario I was asking about above which I assume you were replying to.
 

Albermarle

gravlax said:

Albermarle said:

MallyGirl said:

Yes you pay CGT but only on gains over £12k - your investments would have to be doing really well with the sort of money we are talking about here to be generating £12k gain

Also if you have to pay some , it is not at marginal income tax rate , it is less.
Plus after  three or fours years enough could be transferred to ISA's to make paying any CGT tax at all even more unlikely.

But it seems there is a reliance on using an ISA to maintain the advantage of GCT exempt growth available in the SIPP. I'm trying to understand how you come out ahead when your ISA allowance cannot be used for reinvesting the sums taken out the SIPP and it has to be reinvested somewhere that any growth is subject to GCT. I know there is an annual CGT allowance but I would probably exceed it one way or another. As I said before my ISA contributions are covered from other income, so even if the SIPP cash is put in an ISA, it just means other cash that normally goes to the ISA has to go in a taxable account.

So in that context was not sure if it is still advised and you still come out ahead by crystallising early, in the scenario I was asking about above which I assume you were replying to.
 

It is a perfectly fair question .
So far I have avoided unwrapped investments , as there is more admin involved , so feels a bit like work !
However more experienced ( and maybe less lazy ) posters have said in previous threads, that by careful management , the CGT and dividend tax can be minimised on even large sums .
For sure should  be a lot less % than normal income tax rates ., if managed correctly .