LTA - trying to understand net result of (additional) tax hit

jamesd

MrBobbins said:

I was rather surprised to see that the LTA therefore seems to have the effect of losing 25% of the gross value (£10K here) off the net!

Now nervously awaiting the "you've completely misunderstood how this works" reply!

You've correctly understood it. The income LTA charge is 25% of the gross and this also becomes 25% of the net if the income tax rate is the same.

This is also why the potential taxes from using unwrapped investments and unwrapped allowances for a while aren't likely to be too harmful, since the total cumulative bill is unlikely to reach the 25% of the initial excess capital. Of course, that's often looking into the future because you don't know what growth will actually be and hence what the bills in each case would be.

Personally, as someone unlikely to exceed the LTA, I largely avoid the ongoing income tax problem with a combination of VCT and ISA investing. VCT gets relief from the tax cost of withdrawing and ties up the VCT part in a tax wrapper for at least five years while the ISA uses much of the rest:

£50270 + £3600 out in basic rate band = £53870 of basic rate band to use
- £2880 in net pension contributions that produces the £3600 extra out basic rate band leaves £50990
- £12570 personal allowance leaves £38420
- £25000 VCT buying before relief (38420 * 0.2 / 0.3 = 25613 but you can normally only buy in 1k increments) leaves £613 taxable in effect. Leaves £13420
- £13420 and another £6580 needed from PCLS to cover the ISA 20k allowance
- the unwrapped money also has to pay for the living expenses, though probably topped up by some VCT dividends

That leaves the very gradual moving of £6580 a year into the ISA from the tax free lump sum and further reduction by the income actually being used. Might be a bit more VCT buying if there are any taxed gains on the unwrapped investments.

zagfles

jamesd said:

MrBobbins said:

I was rather surprised to see that the LTA therefore seems to have the effect of losing 25% of the gross value (£10K here) off the net!

Now nervously awaiting the "you've completely misunderstood how this works" reply!

You've correctly understood it. The income LTA charge is 25% of the gross and this also becomes 25% of the net if the income tax rate is the same.

This is also why the potential taxes from using unwrapped investments and unwrapped allowances for a while aren't likely to be too harmful, since the total cumulative bill is unlikely to reach the 25% of the initial excess capital. Of course, that's often looking into the future because you don't know what growth will actually be and hence what the bills in each case would be.

Personally, I largely avoid the ongoing income tax problem with a combination of VCT and ISA investing. VCT gets relief from the tax cost of withdrawing and ties up the VCT part in a tax wrapper for at least five years while the ISA uses much of the rest:

£50270 + £3600 out in basic rate band = £53870 of basic rate band to use
- £2880 in net pension contributions that produces the £3600 extra out basic rate band leaves £50990
- £12570 personal allowance leaves £38420
- £25000 VCT buying before relief (38420 * 0.2 / 0.3 = 25613 but you can normally only buy in 1k increments) leaves £613 taxable in effect. Leaves £13420
- £13420 and another £6580 needed from PCLS to cover the ISA 20k allowance
- the unwrapped money also has to pay for the living expenses, though probably topped up by some VCT dividends

That leaves the very gradual moving of £6580 a year into the ISA from the tax free lump sum and further reduction by the income actually being used. Might be a bit more VCT buying if there are any taxed gains on the unwrapped investments.

What's the point of paying £3600 gross into a pension and taking it out again if you're over the LTA? If you're below the LTA and won't exceed it it's sensible, as you get £900 more tax free, saving you £180 in tax assuming BR tax in retirement, but if you're above the LTA, it will cost you £900 in extra LTA tax!! Or £720 after BR tax.

Albermarle

zagfles said:

jamesd said:

MrBobbins said:

I was rather surprised to see that the LTA therefore seems to have the effect of losing 25% of the gross value (£10K here) off the net!

Now nervously awaiting the "you've completely misunderstood how this works" reply!

You've correctly understood it. The income LTA charge is 25% of the gross and this also becomes 25% of the net if the income tax rate is the same.

This is also why the potential taxes from using unwrapped investments and unwrapped allowances for a while aren't likely to be too harmful, since the total cumulative bill is unlikely to reach the 25% of the initial excess capital. Of course, that's often looking into the future because you don't know what growth will actually be and hence what the bills in each case would be.

Personally, I largely avoid the ongoing income tax problem with a combination of VCT and ISA investing. VCT gets relief from the tax cost of withdrawing and ties up the VCT part in a tax wrapper for at least five years while the ISA uses much of the rest:

£50270 + £3600 out in basic rate band = £53870 of basic rate band to use
- £2880 in net pension contributions that produces the £3600 extra out basic rate band leaves £50990
- £12570 personal allowance leaves £38420
- £25000 VCT buying before relief (38420 * 0.2 / 0.3 = 25613 but you can normally only buy in 1k increments) leaves £613 taxable in effect. Leaves £13420
- £13420 and another £6580 needed from PCLS to cover the ISA 20k allowance
- the unwrapped money also has to pay for the living expenses, though probably topped up by some VCT dividends

That leaves the very gradual moving of £6580 a year into the ISA from the tax free lump sum and further reduction by the income actually being used. Might be a bit more VCT buying if there are any taxed gains on the unwrapped investments.

What's the point of paying £3600 gross into a pension and taking it out again if you're over the LTA? If you're below the LTA and won't exceed it it's sensible, as you get £900 more tax free, saving you £180 in tax assuming BR tax in retirement, but if you're above the LTA, it will cost you £900 in extra LTA tax!! Or £720 after BR tax.

I think Jamesd is hoping to avoid actually breaching the LTA.

Albermarle

Perhaps "vexatious" covers things rather better than "spiteful"?

Lets go with that !

jamesd

zagfles said:

What's the point of paying £3600 gross into a pension and taking it out again if you're over the LTA? If you're below the LTA and won't exceed it it's sensible, as you get £900 more tax free, saving you £180 in tax assuming BR tax in retirement, but if you're above the LTA, it will cost you £900 in extra LTA tax!! Or £720 after BR tax.

It looks likely that both I and the person responded to can avoid exceeding the LTA without withdrawing taxable money in the higher tax rate band. So the usual benefit of ongoing pension contributions applies.

If already over the LTA and going to stay that way regardless of market moves then it's not worth doing unless it's part of inheritance planning, when it might sometimes be useful.

zagfles

Albermarle said:

zagfles said:

jamesd said:

MrBobbins said:

I was rather surprised to see that the LTA therefore seems to have the effect of losing 25% of the gross value (£10K here) off the net!

Now nervously awaiting the "you've completely misunderstood how this works" reply!

You've correctly understood it. The income LTA charge is 25% of the gross and this also becomes 25% of the net if the income tax rate is the same.

This is also why the potential taxes from using unwrapped investments and unwrapped allowances for a while aren't likely to be too harmful, since the total cumulative bill is unlikely to reach the 25% of the initial excess capital. Of course, that's often looking into the future because you don't know what growth will actually be and hence what the bills in each case would be.

Personally, I largely avoid the ongoing income tax problem with a combination of VCT and ISA investing. VCT gets relief from the tax cost of withdrawing and ties up the VCT part in a tax wrapper for at least five years while the ISA uses much of the rest:

£50270 + £3600 out in basic rate band = £53870 of basic rate band to use
- £2880 in net pension contributions that produces the £3600 extra out basic rate band leaves £50990
- £12570 personal allowance leaves £38420
- £25000 VCT buying before relief (38420 * 0.2 / 0.3 = 25613 but you can normally only buy in 1k increments) leaves £613 taxable in effect. Leaves £13420
- £13420 and another £6580 needed from PCLS to cover the ISA 20k allowance
- the unwrapped money also has to pay for the living expenses, though probably topped up by some VCT dividends

That leaves the very gradual moving of £6580 a year into the ISA from the tax free lump sum and further reduction by the income actually being used. Might be a bit more VCT buying if there are any taxed gains on the unwrapped investments.

What's the point of paying £3600 gross into a pension and taking it out again if you're over the LTA? If you're below the LTA and won't exceed it it's sensible, as you get £900 more tax free, saving you £180 in tax assuming BR tax in retirement, but if you're above the LTA, it will cost you £900 in extra LTA tax!! Or £720 after BR tax.

I think Jamesd is hoping to avoid actually breaching the LTA.

Well perhaps he can edit his post to make that clear, in a thread discussing the tax hit of the LTA!! It's clearly a daft thing to do if you will or even might exceed the LTA.

zagfles

jamesd said:

zagfles said:

What's the point of paying £3600 gross into a pension and taking it out again if you're over the LTA? If you're below the LTA and won't exceed it it's sensible, as you get £900 more tax free, saving you £180 in tax assuming BR tax in retirement, but if you're above the LTA, it will cost you £900 in extra LTA tax!! Or £720 after BR tax.

It looks likely that both I and the person responded to can avoid exceeding the LTA without withdrawing taxable money in the higher tax rate band. So the usual benefit of ongoing pension contributions applies.

If already over the LTA and going to stay that way regardless of market moves then it's not worth doing unless it's part of inheritance planning, when it might sometimes be useful.

The downside if the LTA is ever breached is worse than the upside if it isn't, so unless you're fairly sure you won't ever breach the LTA it's not a good plan.

And how can it help with inheritance planning? I can't see any circumstances where it'd make it better for inheritance planning. The only thing it does is move pension from crystallised to uncrystallised. Both are treated the same for inheritance, except that uncrystallised is subject to an LTA test on death under 75. So neutral if LTA isn't breached, negative if it is.  

jamesd

zagfles said:

Well perhaps he can edit his post to make that clear, in a thread discussing the tax hit of the LTA!! It's clearly a daft thing to do if you will or even might exceed the LTA.

zagfles said:

The downside if the LTA is ever breached is worse than the upside if it isn't, so unless you're fairly sure you won't ever breach the LTA it's not a good plan.

And how can it help with inheritance planning? I can't see any circumstances where it'd make it better for inheritance planning. The only thing it does is move pension from crystallised to uncrystallised. Both are treated the same for inheritance, except that uncrystallised is subject to an LTA test on death under 75. So neutral if LTA isn't breached, negative if it is.  

This is mainly about MrBobbins and as usual in discussions of an individual the comments are mostly about their question. For them, as for me, going over the LTA seems unlikely.

It's not daft if you just might exceed the LTA, though, that depends how likely it is and whether it'd take uncommonly good investment results to go over, say. In which case it'd be sad if there's an LTA charge to pay but good that it's because things went better than expected. But doing it once exceeding the LTA is certain or even very likely requires more thought.

Pensions are normally outside the estate and accessible at any age once inherited. That benefit can also can be inherited, retaining the outside the estate status potentially for many generations, but without repeated LTA charge bills. That can look quite attractive to some people compared to the general treatment of trusts. If crystallising to avoid the LTA there's an initial negative effect on potential inheritance tax bill because 25% just got removed from the trust to the estate. I'm not particularly keen on this approach, preferring lifetime giving, but that's just my preference and it's an approach that's more likely to be of interest to those with assets far above the LTA, who might even want to make pension contributions that don't receive tax relief.

zagfles

jamesd said:

zagfles said:

Well perhaps he can edit his post to make that clear, in a thread discussing the tax hit of the LTA!! It's clearly a daft thing to do if you will or even might exceed the LTA.

zagfles said:

The downside if the LTA is ever breached is worse than the upside if it isn't, so unless you're fairly sure you won't ever breach the LTA it's not a good plan.

And how can it help with inheritance planning? I can't see any circumstances where it'd make it better for inheritance planning. The only thing it does is move pension from crystallised to uncrystallised. Both are treated the same for inheritance, except that uncrystallised is subject to an LTA test on death under 75. So neutral if LTA isn't breached, negative if it is.  

This is mainly about MrBobbins and as usual in discussions of an individual the comments are mostly about their question. For them, as for me, going over the LTA seems unlikely.

OP was talking about delaying breaching the LTA, not avoiding breaching it. So maybe when you describe your schemes in the context of a thread about what happens if the LTA is exceeded you should make clear that it's only sensible for those who don't breach the LTA!

It's not daft if you just might exceed the LTA, though, that depends how likely it is and whether it'd take uncommonly good investment results to go over, say. In which case it'd be sad if there's an LTA charge to pay but good that it's because things went better than expected. But doing it once exceeding the LTA is certain or even very likely requires more thought.

It doesn't require more thought. It's obvious that if "exceeding the LTA is certain or even very likely", then recycling £3600 into and out of a pension is a daft thing to do.

Pensions are normally outside the estate and accessible at any age once inherited. That benefit can also can be inherited, retaining the outside the estate status potentially for many generations, but without repeated LTA charge bills. That can look quite attractive to some people compared to the general treatment of trusts. If crystallising to avoid the LTA there's an initial negative effect on potential inheritance tax bill because 25% just got removed from the trust to the estate. I'm not particularly keen on this approach, preferring lifetime giving, but that's just my preference and it's an approach that's more likely to be of interest to those with assets far above the LTA, who might even want to make pension contributions that don't receive tax relief.

We're talking about your idea to drawdown an extra £3600 above the basic rate band and pay £3600 gross back into the pension. That makes zero difference to your net income, it makes zero difference to the total size of your pension pot, all it does is move £3600 from your crystallised pot to your uncrystallised pot. That is clearly bad if you exceed the LTA and good if you don't, but I can't see any upside in any circumstances for inheritance. Crystallised and uncrystallised are treated the same except that uncrystallised has an LTA test on death under 75. So how can it ever be beneficial for inhertitance as you claimed?

jamesd

zagfles said:

We're talking about your idea to drawdown an extra £3600 above the basic rate band and pay £3600 gross back into the pension. That makes zero difference to your net income, it makes zero difference to the total size of your pension pot, all it does is move £3600 from your crystallised pot to your uncrystallised pot.

We're discussing what I, as a person not expecting to exceed the LTA, do, and what might be useful in that situation, because that's what I was describing. In that case there is at least the usual 6.25% a year gain from making pension contributions with basic rate relief and taking them out again with basic rate tax and a 25% tax free lump sum.

With no tax free lump sum over the lifetime allowance and the lifetime allowance charge there would need to be a fairly strong trust motivation to do it in that situation because the anticipated result is negative, if we ignore inheritance tax effects. I don't see a reason in that case to do the paying in of 2880 to withdraw what would with no tax free lump sum be 2880 on the way out at basic rate, with LTA charge on top.