OK not to take lump sum?

gravlax

Thinking ahead a few years about whether to take 25% tax free lump sum when starting to drawdown pension, and don't like the idea!

I have no need for the lump sum, no debts, both of us fill ISAs from other income. So taking out around £250k tax free it would sit alongside another £250k in an unsheltered investments account.

If the SIPP is £1m we would use a withdrawal rate of 3% p.a, so £30,000. Of that £7,500 (25%) would be tax free, the rest taxed at marginal rate, so either 20% if all other income is less than about £20,000 or 40% if total income exceeds the basic rate band.

Income taxes in future can go higher, (if they go lower, great) so having an ongoing source of income that is only ever taxed at 3/4 of whatever my marginal rate may be is a comforting idea. It feels better than using up tax free amounts at the start.

Is this reasonable, or muddled thinking?

NoMore

Usually yes don't take lump sum if you don't need it, but with a £1m pension pot, the LTA comes into play and taking the lump sum might not be a bad idea, however I will leave it t more informed posters about dealing with LTA issues.

Pat38493

Yes - normally I have seen the advice to be - only take cash out of the fund when you actually need it.  However, if your pot is really $1m and you are only just retiring now (age?) you will very likely exceed the LTA on the invested funds at some point - it might be a good idea to take out the tax free cash in order to reduce the amount that you will eventually end up with in excess of the LTA.  This won't stop you from exceeding the LTA but it might mitigate it.

If you are already maxed out on your ISA an other investment allowances outside of your pension it might still make sense to leave it in the pension pot - I guess you would have to post more details to discuss further.

The argument against this is - what if the LTA goes up in a few years from now - the consensus on this forums seems to be that it won't - if anything it will be reduced.

I guess going above the LTA is not the worst problem in the world to have but it probably merits some planning around it.

gravlax

But if the SIPP gets close to the LTA, do I need to take tax free lump sums to avoid it? Can't I just temporarily/as needed increase the normal rate of withdrawal and take any extra withdrawals at 3/4 taxable to keep the whole SIPP below the LTA? 

Linton

In theory I believe you dont have to take the tax free lump sum from a SIPP but I dont think that SIPP providers will support this because it is a strange thing to want to do.  Normally taking the tax free lump sum registers the 75% as being "crystallised" where it is eligible to be drawn down.

You do not need to take your whole lump sum in one go.  There are 2 ways not to...

1) partial drawdown: say you had £500K in a SIPP.  You could take say £25K as a tax free lump sum at which point £75K wuld be categorised as as crystallised with the remaining £400K carrying on as before to be crystallised (or partiallty crystalised) at a later date.  The £25K could be put in an S&S ISA in the same investments as in the SIPP if that is what you wanted.

2) UFPLS: every drawdown includes 25% tax free.

I think you will find that few providers support both methods.  Partial drawdoiwn is most common with SIPPs.

Pat38493

gravlax said:

But if the SIPP gets close to the LTA, do I need to take tax free lump sums to avoid it? Can't I just temporarily/as needed increase the normal rate of withdrawal and take any extra withdrawals at 3/4 taxable to keep the whole SIPP below the LTA? 

This isn't how the LTA work exactly.  If you really have or will have £1m already in the account, it's pretty much inevitable that your fund will exceed the LTA unless you are invested in cash or some kind of low return items.  However this won't necessarily have any impact on you (at least not until you are 75).  Especially if you only take out £30K - in a good year you could easily exceed the LTA just in that year.

The provider has to keep track of the amount of money in your SIPP which is crystallized vs un-crystalized, and keep track of how much % of the LTA you have currently used.

If you take your (e.g.) £250K tax free cash, you will effectively crystalize the whole £1m.  This means you have used 93% of your LTA at that point and your provider will keep track of that.  

Since the £750K will be already crystalized, you can then draw down on that amount of capital with no LTA impact as it's already crystalized.

However, any growth or further contribution in your fund in the future will be subject to another LTA test either when you crystalize it, or when you reach 75 years old if I remember correctly.  So if for example it grows by another £200k over the next decade and you then crystalize that 200K, you will have some LTA to pay (which you can either ask to be taken directly from the fund, or pay  yourself I think).

The remaining balance in your SIPP, both crystalized and uncrystalized will continue to increase based on your investment mix. 

So no you don't have to take the whole tax free cash, but if you take out smaller withdrawals than your 25% each year, the remaining SIPP balance will keep growing faster because there is more in it.

To put it another way - the LTA is not calculated based on the ongoing SIPP balance, but the amount that you have crystallised in total (stated as a % at the time of withdrawal).  Therefore keeping the total SIPP balance below the LTA won't necessarily prevent you from being subject to LTA tax.

Albermarle

To put it another way - the LTA is not calculated based on the ongoing SIPP balance, but the amount that you have drawn out crystallised in total (stated as a % at the time of withdrawal). If you choose not to crystallise all of it, the remainder will be effectively crystallised for you at 75 or when you die.

OP - As the post above explains well ( just needed one correction as above ) you have misunderstood how LTA works .You need to read through these posts, and research uncrystallised and crystallised pensions. Specifically for LTA, Benefit crystallisation events ( BCE's) etc

You also have to take into account that, if you are likely to be liable for IHT when you die, anything still in the pension is not included in the IHT calculation.

Although not usually quite so black and white, it can be a case of 40% IHT or 40% LTA.

gravlax

OK thanks all. I will look at the points about crystallising and the LTA. But apart from the fact I'd hoped the SIPP would provide an annual income at 3/4 my marginal rate of tax - I can't see what to do with large amounts in excess of our modest needs for income if we are filling ISAs from other income and have no debts. What to do once it's taken out? 

Pat38493

gravlax said:

OK thanks all. I will look at the points about crystallising and the LTA. But apart from the fact I'd hoped the SIPP would provide an annual income at 3/4 my marginal rate of tax - I can't see what to do with large amounts in excess of our modest needs for income if we are filling ISAs from other income and have no debts. What to do once it's taken out? 

There are various allowances for savings, capital gains etc beyond just ISA allowances - the first x amount is zero tax and then there is an allowance beyond that I think.  I haven't looked at it in detail recently but I think you can invest a reasonable amount in unsheltered assets and funds without paying any tax.  I think there is a starting rate for savings, then an allowance and then your capital gains tax allowance so if you use the right investments outside the pension you will be able to make a safe return on £250K for a few years without paying any tax and even then the CGT is 10% I guess if you are not earning.

You can also use that money as a cash float for hard times (or treats if there are no hard times).

The tipping point where this would work out better than just leaving it in the pension is a bit of a complicated question and probably requires deeper analysis or IFA advice.  You can also take the view that if you only need to crystallise less than the LTA during your lifetime, you don't really care about excess as it will never directly hit your cash flow during your life.  The excess will get reduced by your LTA check at age 75 and then it will go to your heirs free of IHT I guess.  This way it becomes a problem for your heirs not you!

My guess is that in your situation, only taking out small amounts in PCLS withdrawals each year is not going to be the most tax efficient long term due to LTA concerns but I am not an IFA, but like I say the tax impact might end up on your next of kin rather than you.  If you've got that much in your pot maybe you should consider taking some one off advice about it.

Again this is all my understanding but there are others who usually correct me if I'm saying anything wrong!

Linton

gravlax said:

OK thanks all. I will look at the points about crystallising and the LTA. But apart from the fact I'd hoped the SIPP would provide an annual income at 3/4 my marginal rate of tax - I can't see what to do with large amounts in excess of our modest needs for income if we are filling ISAs from other income and have no debts. What to do once it's taken out? 

What do you want the excess money for?  If you are going to spend it in your lifetime then it may just as well be sat in an ISA as a pension.  If the excess money is only going to be used as an inheritance you can minimise tax by simply keeping it in the SIPP (LTA issues excepted)

Pat38493

Albermarle said:

To put it another way - the LTA is not calculated based on the ongoing SIPP balance, but the amount that you have drawn out crystallised in total (stated as a % at the time of withdrawal). If you choose not to crystallise all of it, the remainder will be effectively crystallised for you at 75 or when you die.

OP - As the post above explains well ( just needed one correction as above ) you have misunderstood how LTA works .You need to read through these posts, and research uncrystallised and crystallised pensions. Specifically for LTA, Benefit crystallisation events ( BCE's) etc

You also have to take into account that, if you are likely to be liable for IHT when you die, anything still in the pension is not included in the IHT calculation.

Although not usually quite so black and white, it can be a case of 40% IHT or 40% LTA.

So can you remind me - if there is uncrystallised funds in your pension at 75, are those taxed at 55% or 25%?  I guess you are saying it's 25% but you will end up at 40% when you pay income tax if you draw it out? (but I thought there was no tax free cash on funds in excess of LTA so wouldn't it then become 45% if you are on 20% marginal?).