SIPP not getting any tax free

gravlax

If you don't have a good reason for taking the cash, is there a case for crystallising your SIPP early and taking nothing out tax free and no  withdrawals so it can all remain invested to grow without any LTA test before age 75? 

Say you crystallise £500k SIPP and choose to take 0% tax free, no taxable income, and leave all £500k invested. You have foregone the 25% tax free £125,000 but the £125,000 remains invested in a SIPP which can grow tax free. 

Over 11 years assuming average 7% growth £500,000 becomes over £1m and can soon exceed the LTA, but as it’s all crystallised will escape the LTA test until age 75. You've not taken any taxable income you can also keep making new contributions.

Over just 10 years assuming 7% growth the £125,000 portion invested rather than taken out tax free becomes £245,000. If the £245,000 is later withdraw at 20% tax rate the net income is £192,000, at 40% tax £144,000, both more than the £125,000 forgone 10 years earlier. OK it’s not an inflation adjusted comparison but taking the tax free £125,000 out and leaving £375,000 to grow tax free doesn't look clearly better than having £500,000 snowballing tax free. 

Is there any reason this is really a very bad idea?

Dazed_and_C0nfused

Can you crystallise it without taking anything out??

Notepad_Phil

If I knew I was not going to be around before I got to 75 AND I had enough other income to keep me going AND I wanted to pass the full amount on as an inheritance AND I knew that inflation was going to come back under control AND I knew that average growth rates wouldn't bring me into an LTA issue AND I knew that LTA rates would definitely 100% start rising by inflation again AND I was already filling up S&S ISAs with other income and would continue to do so AND probably a few other things that would come to mind if I really thought about it, then yes I might think about doing such a thing.

And you don't seem to have considered what you could do with the £125,000 tax-free lump sum. Personally I wouldn't take it all out in one go but would at least take out tax-free lump sums to fill up a S&S ISA every year, plus the same for any partner - so potentially £40k each year. That way the growth remains tax-free and you don't have to pay any income tax on that portion at all.

QrizB

gravlax said:

Is there any reason this is really a very bad idea?

Yes.

Say you crystallise £500k SIPP and choose to take 0% tax free, no taxable income, and leave all £500k invested. You have foregone the 25% tax free £125,000 but the £125,000 remains invested in a SIPP which can grow tax free.

Or you could take the £125k tax-free and invest it in an SS ISA and a GIA* in exactly the same funds you would've chosen inside your SIPP, get all the same growth but then not need to pay tax when you withdraw it.

(* There will potentially be tax to pay on gains in the GIA, but with careful use of your allowances you will be able to avoid some/most/all of it.)

dunstonh

Can you crystallise it without taking anything out??

Theoretically yes.   However, in reality, you would take the 25% and use ISAs/GIAs (with bed & ISA).

Over 11 years assuming average 7% growth £500,000 becomes over £1m and can soon exceed the LTA, but as it’s all crystallised will escape the LTA test until age 75. You've not taken any taxable income you can also keep making new contributions.

Plenty of time to wait.

zagfles

Dazed_and_C0nfused said:

Can you crystallise it without taking anything out??

Yes. The tax free cash is an option, not a requirement. You could theoretically crystallise without taking any tax free cash. With DB pensions it's often sensible as some DB schemes have appalling commutation rates. But for DC it's almost certainly a bad idea not to take the max tax free cash. If you did ever try to I'd hope the SIPP provider will double check you understand what you're doing!

gravlax

The reasons against seem to rely on putting the cash into an ISA as it's the only other place it can grow tax-wrapped.

I should have said that ISAs are already covered from income. Without that the reasons against look less clear which is why I wondered about the sense of taking 25% out of the tax wrapped SIPP when you want to crystallise it before any income is needed.

zagfles

gravlax said:

The reasons against seem to rely on putting the cash into an ISA as it's the only other place it can grow tax-wrapped.

I should have said that ISAs are already covered from income. Without that the reasons against look less clear which is why I wondered about the sense of taking 25% out of the tax wrapped SIPP when you want to crystallise it before any income is needed.

Even if you leave it unwrapped, the tax on unwrapped growth is almost certainly far less than paying income tax on pension withdrawal. Exact amount will depend how the 7% growth is split between dividends and capital gains, but say dividends 2% and capital gain 5%, dividends will start at £2500, of which £2000 is tax free (dividend allowance) and the £500 is taxed at 8.75% for a BR taxpayer so that's £44 a year. It'll rise a bit with growth but will be well under £1000 over 10 years.

Capital gains could be avoided completely by selling less than £30k per year (reducing slightly in future years with further growth), as your gain is 5% per year compunded ie 63% so selling £30k after 10 years the capital gain is within the £12300 allowance.

So, unwrapped you pay under £1000 tax. Withdrawing from the pension you pay £49,000 tax.

gravlax

zagfles I wish it was as easy as that with the tax maths comparison. But I already take up my dividend and CGT allowances from other taxable investments. So if I take money out the SIPP wherever I invest it the gains will be fully taxed.

That's why I am uncertain about the idea of taking money out the SIPP where it can compound tax free for as long as possible. But by crystallising it early it locks in the current value below the LTA so it can keep growing even beyond the LTA limit but without any LTA tests until age 75. 

EdSwippet

gravlax said:

I wish it was as easy as that with the tax maths comparison. But I already take up my dividend and CGT allowances from other taxable investments. So if I take money out the SIPP wherever I invest it the gains will be fully taxed.

You can model this with a spreadsheet. There is definitely a breakeven point, where the benefit of leaving money to grow tax-sheltered inside a pension overcomes the effect of having to pay tax on withdrawing, compared to withdrawing it tax-free but then paying some tax annually on dividends and gains where reinvested but not in an ISA.

What you will probably find though, depending of course on the assumptions you use for growth, dividends, future tax rates, and so on, is that this breakeven point is very remote. When I did this for my own case, even using pessimistic tax and growth assumptions (such as tax of 20% of gains annually; I'm a tracker investor, not a hyperactive trader, so that won't happen in practice), breakeven did not arrive for some 35-40 years. Not a useful timescale, then.

zagfles

EdSwippet said:

gravlax said:

I wish it was as easy as that with the tax maths comparison. But I already take up my dividend and CGT allowances from other taxable investments. So if I take money out the SIPP wherever I invest it the gains will be fully taxed.

You can model this with a spreadsheet. There is definitely a breakeven point, where the benefit of leaving money to grow tax-sheltered inside a pension overcomes the effect of having to pay tax on withdrawing, compared to withdrawing it tax-free but then paying some tax annually on dividends and gains where reinvested but not in an ISA.

What you will probably find though, depending of course on the assumptions you use for growth, dividends, future tax rates, and so on, is that this breakeven point is very remote. When I did this for my own case, even using pessimistic tax and growth assumptions (such as tax of 20% of gains annually; I'm a tracker investor, not a hyperactive trader, so that won't happen in practice), breakeven did not arrive for some 35-40 years. Not a useful timescale, then.

By which time, in the OP's example, there'll be LTA tax to pay on the growth.