Avoiding the LTA?

Thrugelmir

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.

 I know there is an annual CGT allowance but I would probably exceed it one way or another. 
 

Will you need to realise over £12,300 of gains in a tax year to supplement your income from all other sources? 

jamesd

gravlax said:

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?

If the markets have already dropped and the value after drop is 500k I'd be inclined to crystallise it all. The reasons for this relate to loss of inflation increases for the LTA and possible growth:

1. Average UK equity market growth has been around 5% plus inflation, so if we use 7%, in 20 years a pot value is multiplied by 3.9 if nothing is withdrawn.
2. Safe withdrawal (spending)  rates vary with guidelines chosen but are unlikely to exceed 5.5% of the pot so growth can be expected.
3. Markets often recover quickly from big drops, like the covid crash, but not always. Being positioned for rapid recovery case is a decent thing.
4. 500k now could be a reduction in a 40% drop from 833k and if so that'd be a big drop well worth fully exploiting in a lot of cases.

This situation is far more doubtful and there's likely to be a lot of headroom to allow gradual crystallising, depending on future pension contribution plans and how big the drop has been.

jamesd

gravlax said:

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!

Remember that a significant part of the potential picture can be the pension tax relief on future contributions and the avoiding of LTA charge.

Say you've taken 160k of tax free lump sum and no ISA is available.

I'd be looking in part at VCT use since that has nice tax benefits, like effectively eliminating your income tax bill if buying enough very small company funds is appropriate for you. Since VCTs are tax exempt on income and growth as well that can quite rapidly shift a lot of money out of the taxable pot.

Ignoring VCTs you might see on average 7% including inflation growth on average, so £11.2k a year. CGT allowance is currently £12,300 a year so there's the potential over time to carry out sell transactions producing a gain of up to £12,300 and buys of something similar to avoid accumulating any material CGT bill. Using trackers you might switch from brand A global equity tracker to brand B global equity tracker with enough sold to use the £12,300 of allowance. For larger pots or more growth you might accumulate some gain but it's likely that at some point the sales will happen when there's available ISA allowance and will remove money from the unwrapped pot over time.

Dividends get taxed from mostly share funds and interest from mostly bond funds but there are allowances for those two as well.

If the last two paragraphs do leave some gain, there's always limited VCT buying as an option to mitigate the tax cost.

When using unwrapped investments, best to use income units rather than accumulation units because that makes it easier to track the tax numbers for distributions (dividends or interest) and capital gains.

gravlax

jamesd, I'm not sure I'd do VCTs although I will look into it. I think you may have to be UK tax resident, not sure. But I may move and retire outside the UK so staying flexible.

I think the barrier I am facing is accepting selling (to crystallise the whole pot) when the market is down! It goes against every instinct having held through all previous market falls. In a situation where you may be within a couple of years of starting to drawdown rather than contribute, seeing your pot fall from say £800,000 to £500,000 and then selling 25% to taking out £125,000 tax-free, rather than waiting until your pot has recovered to £800,000. An £800k tax-sheltered pot paying out 25% tax-free income, versus a £500,000 pot because you sell when it's down. It's a real leap of faith! I'm still trying to work out the numbers to see how you come out ahead.

ex-pat_scot

gravlax said:

jamesd, I think the barrier I am facing is accepting selling (to crystallise the whole pot) when the market is down! It goes against every instinct having held through all previous market falls. In a situation where you may be within a couple of years of starting to drawdown rather than contribute, seeing your pot fall from say £800,000 to £500,000 and then selling 25% to taking out £125,000 tax-free, rather than waiting until your pot has recovered to £800,000. An £800k tax-sheltered pot paying out 25% tax-free income, versus a £500,000 pot because you sell when it's down. It's a real leap of faith! I'm still trying to work out the numbers to see how you come out ahead.

But in your scenario - why not take the £125,000 and invest?
You have £20,000 pa ISA limit, plus your spouse (if you have one).
That means that in 3 years or 5 you can wrap the PCLS into tax free ISA.
In the meantime, presuming a 6 year timespan, then you can invest the non ISA stuff in an investment account, selling off any gains up to the CGT threshold of £12,300. 
Frankly, you'd have to have spectacular growth to be paying any CGT in this scenario, and you can choose to crystallise up to the CGT threshold each year until everything is wrapped into the ISA.

Albermarle

Growth of £500K to £800K is 60%.

If you take 25% tax free from 800K = £200K .

If instead you crystallised at £500K , you would get £125 K tax free which you would invest in something similar to the SIPP investments . So it would also grow 60% and become £200K .
So financially you would be in the same position but less LTA % used .

Downsides are some admin with a general investment account . Possibly paying some low amounts of CGT and dividend tax.
VCT 's as suggested are more for the experienced investor .

Also crystallising at any time moves money out of IHT protection , but that would have the same effect whether you crystallise £500K or £800K .

Another option is to stop worrying about it, and accept some LTA tax might have to be paid .

HCIMbtw

do you have to take 25% lump sum when you crystalise, or can this be deferred? 

Albermarle

HCIMbtw said:

do you have to take 25% lump sum when you crystalise, or can this be deferred? 

You have to take it, as it is part of the crystallisation process.

zagfles

Albermarle said:

HCIMbtw said:

do you have to take 25% lump sum when you crystalise, or can this be deferred? 

You have to take it, as it is part of the crystallisation process.

Technically you don't have to take it, but it's a once only option at the point of crystallisation, and for a DC pension it would nearly always be sensible to take it. With DB it's quite often better not to take the tax free cash if it comes at the cost of a bad commutation rate

MK62

gravlax said:

jamesd, I'm not sure I'd do VCTs although I will look into it. I think you may have to be UK tax resident, not sure. But I may move and retire outside the UK so staying flexible.

I think the barrier I am facing is accepting selling (to crystallise the whole pot) when the market is down! It goes against every instinct having held through all previous market falls. In a situation where you may be within a couple of years of starting to drawdown rather than contribute, seeing your pot fall from say £800,000 to £500,000 and then selling 25% to taking out £125,000 tax-free, rather than waiting until your pot has recovered to £800,000. An £800k tax-sheltered pot paying out 25% tax-free income, versus a £500,000 pot because you sell when it's down. It's a real leap of faith! I'm still trying to work out the numbers to see how you come out ahead.

In reality you aren't really selling though.....well, technically you are, but then you'd be buying back the same assets but now outside the pension. You would be out of the market for at least a few days though (which could work either way, for or against). If you run the numbers, as Albermarle said, you'd be pretty much in the same position, financially, apart from the effect, if any, of the period out of the market.....but this period is unavoidable no matter when you crystallise, if your intention is to reinvest the PCLS.
Plus...it's easier to get £125k into ISAs than £200k.....unless you are expecting increases in the ISA allowance, but personally I wouldn't hold my breath....