crystallise SIPP early to avoid LTA?

gravlax

There was some interesting advice here that suggests crystallising your SIPP early to keep well within the LTA. Another approach added that crystallising when markets and the value of the SIPP has fallen, locks in a lower % LTA. Any subsequent gains growth on crystallised portion of the SIPP will not count towards the LTA, provided the gains are withdrawn before age 75.

This looks like a good approach, but is there a potential issue that being under pressure to withdraw crystallised gains could tip you from the 20% basic rate into the 40% higher tax rate? If you have unwrapped investments and/or any other income, could this early crystallisation and subsequent withdrawals result in more tax than the LTA 25% if that gets applied?

Albermarle

This looks like a good approach, but is there a potential issue that being under pressure to withdraw crystallised gains could tip you from the 20% basic rate into the 40% higher tax rate? If you have unwrapped investments and/or any other income, could this early crystallisation and subsequent withdrawals result in more tax than the LTA 25% if that gets applied?

The first thing to address, is what to do with the withdrawn 25% tax free cash, as it will be a substantial sum. Assuming you do not spend it all, you will probably want to invest it in similar funds as were in your pension. Although you can put some into S&S ISA's , this takes time due to the max £20K pa contribution limit. So this means investing in a non tax sheltered investment account, which means having to account for Capital Gains and Dividend Tax. This means some extra administration and probably payment of some extra tax, especially as CGT and dividend tax allowances have been substantially reduced in the recent financial statement.

Whether being 'forced ' to make withdrawals from the crystallised part tip you into 40% tax would depend a lot of course on your other income. Clearly paying more income tax reduces the impact of the LTA avoidance.

The 25% tax free now becomes part of your estate for IHT purposes. As another poster often rightly points out though, it is easier to avoid IHT than LTA, by the use of gifts, charity donations, spending a lot etc.

gravlax

What I'm wondering is whether the LTA excess tax is a worse penalty than income tax paid earlier. The LTA is tested at age 75, or possibly earlier but still usually around retirement age. Whereas crystallising earlier, other sources of income are likely to be higher, and taxable SIPP withdrawals will add to that and the overall tax paid.

There's no much written about avoiding the LTA, people like doctors in vital professions retiring early to avoid the tax penalty. But is the cost of crystallising early actually any better?

Plus crystallising early means taking out the 25% tax free, meaning all crystallised income later in retirement will be taxable. In retirement when the pension may be the main source of income, you could get more in hand by crystallising then and paying tax on only 75% of your pension income. 

Albermarle

Whereas crystallising earlier, other sources of income are likely to be higher, and taxable SIPP withdrawals will add to that and the overall tax paid.

You do not need to start taking taxable withdrawals straight away, you can wait until you stop working for example. All that matters is that the amount left in the pot at 75 is no more than it was when you crystallised it, ( assuming you have used 100% of the LTA and have no headroom left)

There's no much written about avoiding the LTA, people like doctors in vital professions retiring early to avoid the tax penalty. But is the cost of crystallising early actually any better

Doctors are a special case due to the way the NHS pension works. Crystallising early is more of a tactic to hopefully reduce your overall tax bill. The amount it does this is open to opinion, but it seems to work. 

gm0

If well under the LTA - quarterly/monthly UFPLS / small FAD slices taken in their entirety more likely to be optimal. Incremental crystallisation.  Allowed LTA may get indexed sometime.  No TFLS in estate with IHT risk as TFLS taken incrementally alongside income.Downside is growth of uncrystallised pot may become subject to an LTA penalty tax at age 75 BCE 5B
BCE5A won't apply as there are no crystallised wrapped funds with incremental UFPLS/FAD slices and taking all the income at the time each time.

But around/a bit above LTA it is possible to do as you suggest.  Taking TFLS fully for other uses and recycling to ISA S&S and also gifting to spouse and family members.  Reduce height of single tall taxable poppy.  Balance spouse assets.
Help dependents.  But the 75% marked for drawdown is now all in scope for BCE5A

So you then draw an income based loosely on nominal growth.   So the 5A crystallised growth test at age 75 is close to zero tax. 

Any pot above the standard or personal LTA value is of course hit - but only when crystallised for the levy. 
And you can keep the above LTA element of a DC pot uncrystallised until age 75 using partial transfers or FAD phasing leaving it untouched. Stick two fingers up at the chancellor(s) and make them wait for it. Only crystallise when needed.  Arguably it's a far out of the money option on this all getting trashed legislatively.  As well as a political comment on the nonsensical design of the whole thing which is radically horizontally unfair to different workforce slices and family arrangements at the same wealth level.

Method - from age 55 to 75 you have 50k x 20 years or 1m of sub higher rate band income tax capacity to take income - assuming no other income.  But only in the 50k chunks sub HRB each year.  Use or lose. Less 90k or so to allow for the arrival of SP at 67 (or perhaps little later if deferred).  Other income or a later retirement makes it more challenging.  If inflationary or market growth exceeds this then you pay HRB taxes on extra income, or some levy at age 75.  Monitor and update.

Volatility will mean that the returns element of the pension investments won't deliver its contribution to income some years.  And over deliver in others.,  However, the goal will be to keep the nominal value below the crystallisation value - keeping up with drawings despite lean and fat years and inflation. SORR buffers, asset mix etc. need to allow for this.  S&S ISA gets bigger, consumption, buffer goes up and down. Pension gets smaller (slowly as capital and returns are smoothly drawn) but remains below the "at crystallisation" bar for the 75% marked for drawdown for optimal tax treatment.

You lock in the LTA value now (which if it was indexed would be a bad thing but it hasn't been repeatedly).
And lock in other rules like TFLS being available to the full 25% of LTA

You will have your own view on whether the rules will change and if they will get more or less generous when they do.

After market sequence of return the biggest risk as DC drawdown pensioners we all face is argubaly regulatory.  Deliberate targeting and unintended consequences of other changes.

Albermarle

Maybe some pressure building on the issue.
Lift pension tax rules to stop early retirement surge, Rishi Sunak told (msn.com)

Pat38493

Albermarle said:

Maybe some pressure building on the issue.
Lift pension tax rules to stop early retirement surge, Rishi Sunak told (msn.com)

What kind of money is actually raised from LTA tax?  I would suspect not much because a lot of people who have enough wealth for it to be an issue will go out of their way to avoid it?

Albermarle

Pat38493 said:

Albermarle said:

Maybe some pressure building on the issue.
Lift pension tax rules to stop early retirement surge, Rishi Sunak told (msn.com)

What kind of money is actually raised from LTA tax?  I would suspect not much because a lot of people who have enough wealth for it to be an issue will go out of their way to avoid it?

I think it was not a big amount, but it is getting bigger every year. Maybe getting towards a Billion Pounds a year ??
You can not really avoid it, except for some tinkering around the edges, or of course by investing less via a pension. It is more of a limit on how much tax relief you can get on contributions than anything else. If they abolished it they would have to find another way of stopping relatively wealthy earners from filling their boots too much with 40% tax relief, which is very expensive for the Treasury.

NedS

Albermarle said:

Pat38493 said:

Albermarle said:

Maybe some pressure building on the issue.
Lift pension tax rules to stop early retirement surge, Rishi Sunak told (msn.com)

What kind of money is actually raised from LTA tax?  I would suspect not much because a lot of people who have enough wealth for it to be an issue will go out of their way to avoid it?

I think it was not a big amount, but it is getting bigger every year. Maybe getting towards a Billion Pounds a year ??
You can not really avoid it, except for some tinkering around the edges, or of course by investing less via a pension. It is more of a limit on how much tax relief you can get on contributions than anything else. If they abolished it they would have to find another way of stopping relatively wealthy earners from filling their boots too much with 40% tax relief, which is very expensive for the Treasury.

That would be the Annual Allowance, although I accept the LTA is probably much more limiting for the most wealthy / highest earners as it effectively caps and taxes growth.

EdSwippet

Pat38493 said:
What kind of money is actually raised from LTA tax?  I would suspect not much because a lot of people who have enough wealth for it to be an issue will go out of their way to avoid it?

From the linked article (emphasis is mine):

Baroness Altmann, a former pensions minister, said the threshold was an “ill-thought out” policy, costing more than it brings in for the Exchequer. She said it should be scrapped at the very least for critical workers, such as those in the health service, who cannot be easily replaced.

EdSwippet

Albermarle said:
I think it was not a big amount, but it is getting bigger every year. Maybe getting towards a Billion Pounds a year ??

Far short of that at the moment. £382m in 2020/21, apparently. But yes, growing.

You cannot look at this in isolation. You have to offset that comparative drop in the bucket of additional tax with the income tax lost when people -- like me! -- retire years earlier than they would have otherwise. Overall, it's entirely possible that it actually is a net loss to the Exchequer.