Crystallisation - must you take the 25% cash?

artyboy

Hi all - another question if you don't mind. I've read that a valid strategy for mitigating LTA charges is to fully crystallise your DC pension as soon as it's accessible (and is around the LTA limit) - and then withdraw income at a level that keeps it below LTA when the 2nd test is applied at age 75.

Assuming that's correct, and my and Mrs Arty's pensions are at around that level when we are able to access them, the only downside I can see is that i understand you have to take 25% out as cash? 

Now we're not planning any big capital investments immediately after retirement - if anything we could end up  downsizing and releasing a lot of cash from that (have got no mortgage). So we'd prefer not to suddenly end up having about £500k in cash paid out from both our pensions, and critically, into our estate for IHT purposes.

So my question is twofold:

1) is it a hard and fast rule/law that crystallisation requires 25% to be paid away from the pension in cash?
2) if not, are there pension providers that allow for you to fully crystallise and keep all funds invested in the pension (to then be drawn down in a more measured way).

I know these are obviously first world problems, and from what I've read on here before, I also know the subject of IHT is quite polarising (I am against it, but then I would be!). I just want to understand what would be most effective in terms of minimising both LTA and IHT potential charges and appreciate any information or advice

cheers
Arty

Linton

When you take taxable money from drawdown it cannot be before you have taken the corresponding tax free money.  However you dont have to take all of your tax free money in one go.  There are 2 options that permit you to avoid 100% initial crustalisation:

1) Partial crystallisation.  So you could crystallise say £10K from a £100K pot by taking £2500 tax free.  You can then withdraw  the corresponding taxable £7500 as and when you wish.

2) UFPLS,  whereby every drawdown includes 25% tax free.  This is particularly useful when you are have no other income and you want to drawdown the maximum possible without paying tax.  So with a tax allowance of £12570 you can draw down £12570 X 4/3=£16760 without being liable for tax.

You will have to check with your platform as to whether/how they support these options.

EdSwippet

artyboy said:

1) is it a hard and fast rule/law that crystallisation requires 25% to be paid away from the pension in cash?

No. You can take anything between 0% and 25% on crystallising (a chunk of) your DC pension.

However -- and this is a big one -- if you do not take the 25% on crystallising, you cannot take it later on. By saying no to the maximum tax-free PCLS, you effectively convert what would have been tax-free income into income that will be taxed when you do take it.

As a general rule, crystallising but not taking the full 25% is a mistake. Paying tax on something that would have been tax-free is not usually a winning strategy.

artyboy said:

I just want to understand what would be most effective in terms of minimising both LTA and IHT potential charges and appreciate any information or advice

The maths here is that mitigating one tends to worsen problems with the other. More in the pension escapes IHT but leaves a larger LTA penalty; less in the pension reduces the LTA penalty but adds to the risk of IHT.

My own view is that IHT is the easier issue to confront. If you crystallise and take the 25% tax-free you can reinvest that in identical funds initially, and then spend it, or give it to relatives, or give it to charity, all over time, and defuse IHT that way. Conversely, if you don't crystallise but leave everything in the pension then you will face an LTA penalty at some point, age 75 if not before. A potential and reducible IHT problem versus a certain and likely increasing LTA one, then.

Linton

MallyGirl said:

something incorrect - removed so that it doesn't confuse future readers

No, that is not right.  Yo can take parts of the 25% at different times.  What you cant do, and I dont think the platforms would let you anyway, is to take taxable money and later claim the 25% tax free.

MallyGirl

What I said was incorrect so I have removed it to avoid confusion. Apologies.

I have looked and my platform (ii) says:
You don't have to take the full 25% in one go. Some people take their tax-free cash in several smaller lump sums.

As Linton says though - you would need to understand how any remaining tax free amount and a desire to take some of the 75% would interplay.

artyboy

Oh wow, thanks for all the replies!

Linton - yes I was aware of those 2 options, but as you say, neither of them actually result in full crystallisation from the word go. So if I'm already at LTA at age 57, if I don't fully crystallise then (and take income to keep it below LTA till I'm at least 75), any future growth in the uncrystallised part of the pension will start to attract LTA penalties. And that was what I though immediate full crystallisation could help avoid - if that makes sense?

EdSwippet - ok so I could fully crystallise, stay invested, and just gradually liquidate and draw down the 25% tax free as income to start with? That sounds like exactly the approach I'm looking for. Is that a common approach that pension platforms support or  is there a provider that is 'best' for this?

Mallygirl - thanks, and yes noted re tax treatment - we'd be looking at achieving a steady net income so clearly would need to make a smaller gross withdrawal of the tax free 25% than we would of the later taxable 75%...

All very helpful!

Albermarle

If you crystallise and take the cash and want to keep it/not gift it or spend it immediately . Then you have to save it at low interest rates, or reinvest it. You and your wife can add £20K per tax year to a S&S ISA ( as I am sure you know) but the rest will have to be invested unwrapped. So you will have to monitor your investments for capital gains and dividend tax liability, which means time spent on admin. and you will almost certainly generate some actual tax liability as well. There are also  some possibilities to reduce tax by investing in risky start up companies and Venture Capital Trusts, if you are so inclined.

I agree with Ed Swippet, in that although some tweaking is possible for someone in your position, the choice is largely 40% LTA, or 40% IHT, but the IHT issue is easier to control, although you will probably have more admin/active management  of the non pension  finances needed, as described above.

I know these are obviously first world problems

Of course another valid alternative is not to lose any sleep over this 'luxury problem', and just pay the tax with a smile !

( and I know Ed Swippet will not agree with me on this point  )

Linton

I dont see how you can take the TFLS but leave it in your pension.  Crystallisation in practice means taking the TFLS which must take it out of the pension wrapper.   Wealth can only be removed from a pension as cash.

What you do with it then is another matter.  You can obviously invest it in a non-tax-sheltered account and with care avoid CGT, drip feed into an S&S ISA and/or cashing in to pay your on-going expenses.  Or you could do something more esoteric as Albemarle suggests.

EdSwippet

artyboy said:

EdSwippet - ok so I could fully crystallise, stay invested, and just gradually liquidate and draw down the 25% tax free as income to start with? That sounds like exactly the approach I'm looking for. Is that a common approach that pension platforms support or  is there a provider that is 'best' for this?

This is what I did ... although of course you are not me, so will want to analyse your own circumstances thoroughly before acting.

One key realisation is that although it would take more than a decade to funnel £250k into ISAs, even investing this tax-free lump sum in an unwrapped trading account is usually more tax efficient than leaving it in a pension above the LTA. Dividend tax is currently 8.75%/33.75% (basic/higher rate), and capital gains tax 10%/20%. Compare to the 40%/55% you would pay on income from these same investments if left in a DC pension that is above the LTA.

That's not to say that tax rates on unwrapped investment won't change (rise). Nor, of course, that the LTA rates won't change, or the LTA be reduced (yet again), or pension access ages change (again), or flexi-drawdown be removed as a way of accessing pensions, or the PCLS be cut or capped, or any number of other potential political risks. And while there is a breakeven point where letting gains roll up tax-deferred in a pension overcomes the eventual higher rate, it will likely come too late in life to be useful, perhaps around age 95.

Given these factors, anyway, for me at least the arguments fell in favour of crystallising my entire pension(s) at the LTA, and managing investing the PCLS outside and in broadly equivalent funds.

artyboy

I'm possibly being thick - and I do have a habit of tying myself in knots over financial stuff - but i seem to be getting different answers to the same question - this is what it boils down to:

If I have a £1m pension and I fully crystallise it at age 57, do I have to immediately take the £250k tax free cash outside of the pension wrapper (and therefore into my 'estate' for IHT purposes)? Or can I leave it within the pension/outside my estate, and withdraw it more gradually as needed?

EdSwippet

artyboy said:

If I have a £1m pension and I fully crystallise it at age 57, do I have to immediately take the £250k tax free cash outside of the pension wrapper (and therefore into my 'estate' for IHT purposes)?

Effectively, yes. Because ...

artyboy said:

Or can I leave it within the pension/outside my estate, and withdraw it more gradually as needed?

No.