Which platform for separate crystallised and uncrystallised pots?

Pat38493

TheTelltaleChart said:

Pat38493 said:

I posted a thread about this a while back with a worked example showing that if you get a better growth on your high growth pot, you are better off having it in a crytallised pot because in the notional split pot, the percentage of your pot which is non crystallised is a fixed number (until you take money out) - therefore when you made a large gain on your high growth assets, the benefit of that gain is spread out over your crystallised and non crystallised pension, and consequently your tax free cash available is less than it would have been if the uncrystallised money and equities are in a dedicated account.

On the other hand, if equites plunged by 40%, your available TFC available amount doesn't go down by 40% if the split is notional even if you theoretically have your uncrystallised money in 100% equities.

Sorry, but this is just wrong. What matters is not how much tax free cash you get, but your net return after all taxes. Looking at the latter, there is no difference between having higher return from the crystallised or from the non-crystallised pot.

E.g. suppose you will pay 20% tax on all taxable withdrawals (i.e. everything except the tax free cash).

Suppose you have a £170k crystallised pot and a £160k uncrystallised pot. I picked those numbers because these 2 pots have the same net value, viz. £136k each (because you will pay £34k tax at 20% on the crystallised pot; and from the uncrystallised pot, you'll take £40k tax free and pay £24k tax at 20% on the remaining £120k).

You can either:

1) invest the crystallised pot in higher return assets, uncrystallised in lower return.

To keep it simple, suppose the higher return assets double in value, and the lower return assets just retain their value.

The crystallised pot is now worth £340k before tax, the uncrystallised is still £160k. The net values of the pots are now: crystallised £272k (after paying £68k tax at 20%), uncrystallised £136k (unchanged). Total net value is £408k.

or:

2) invest the crystallised pot in lower return assets, uncrystallised in higher return.

Again, suppose the higher return assets double in value.

The crystallised pot in still worth £170k before tax, the uncrystallised is up to £320k. The net values of the pots are now: crystallised £136k (unchanged), uncrystallised £272k (after taking £80k tax free, you pay £48k tax at 20% on the remaining £240k). Total net value is £408k.

So there is indeed more tax free cash in option 2) than in option 1), but that's irrelevant, because your net return after all taxes in identical in both cases.

This is the original discussion
https://forums.moneysavingexpert.com/discussion/6578314/considering-partial-transfer-of-uncrystalised-employer-pension-to-interactive-investor/p1

Your example is comparing which type of assets you invest in which pot.  I am discussing whether the split between the 2 pots is real or notional.

You need to run an example 3 where the split between the pots is based on a constant % number rather than an amount in pounds - this is how Interactive Investor calculates the values.  You have 48.484848% uncrystallised.  Then apply the growth figures and recalculate the 48.484848% across the entire pension.  

You end up with more money in an non taxable situation (if the growth of the uncrystallised is a lot higher) when the pots are tracked separately.  

Another way to see this is that per definition, uncrystallised pensions are worth more to you than crystallised ones in total.  Interactive Investor are effectievely applying your average growth rate across both parts.

As I said in my first comment though - the real world difference to most people is likely to be minimal.

Pat38493

TheTelltaleChart said:

Pat38493 said:

Your example is comparing which type of assets you invest in which pot.  I am discussing whether the split between the 2 pots is real or notional.

You need to run an example 3 where the split between the pots is based on a constant % number rather than an amount in pounds - this is how Interactive Investor calculates the values.  You have 48.484848% uncrystallised.  Then apply the growth figures and recalculate the 48.484848% across the entire pension.

OK, let's try that:

3) £330k pot, of which 52.52525252% is crystallised, 48.48484848% is uncrystallised.

We invest 50% of the mixed pot in high return assets, 50% in low return assets; i.e. £165k in each.

The high return assets double in value (to £330k), the low return assets just retain their value. Total pot is now £495k.

At those constant percentages, we now have £255k crystallised and £240k uncrystallised.

The £255k crystallised pot is worth £204k net (after paying £51k tax at 20%). The £240k uncrystallised pot is worth £204k net (after taking £60k tax free, and paying £36k tax at 20% on the remaining £180k). Total net value is £408k.

That's exactly the same net value in 3) as in 1) and in 2). Three identical results.

Pat38493 said:

This is the original discussion
https://forums.moneysavingexpert.com/discussion/6578314/considering-partial-transfer-of-uncrystalised-employer-pension-to-interactive-investor/p1

Thanks. Hopefully this is the relevant calculation:

Let’s take an example.

Aegon pension 100% equities started at 100K and grows by 20%
II pension in drawdown £100K invested is in cash and earns zero interest (to hopefully make the maths easy).

TFC available grows from 25K to £30K.

On the other hand, if I had merged the Aegon pension into II,  the total amount is the same - £220K, but my TFC available only went up to £27500 (50% of £220K x 25%).

The difference here is because you're not investing in the same way in the real and nominal split cases. £100k crystallised and £100k uncrystallised are not worth the same amount. The uncrystallised pot is worth more, because less tax will be payable on it.

In the nominal split case, you're investing 50% in each of the higher and lower return assets. In the real split case, you're investing more than 50% in the higher return assets, because the uncrystallised pot is bigger (allowing for tax) than the crystallised pot. You've only got a higher return by taking more risk.

How much bigger the uncrystallised pot is than the crystallised pot depends on your tax rate. E.g. if you pay tax at 20%, then a £100k crystallised pot has a net value of £80k, but an uncrystallised £100k pot has a net value of £85k, so you have 51.51515151% uncrystallised, and in the real split case you are investing 51.51515151% (not 50%) in higher return assets.

Other tax rates will give different figures, but the effect is similar.

But I didn't change the risk - I made no adjustment to the investment mix.  I took no action other than transferring the pots from separate ones into an notional split provider.

In both cases, at the start of the sequence of events, I had the same risk level in the same type of taxability situation.

Let's look at it different and step by step.

I have a Hargreaves Lansdown pension pot of £160K in Vanguard global all cap, and an Aviva drawdown pot of 170K in money market fund.

I opened an Interactive Investor account and launched in specie transfers to transfer the pots into II.

Luckily they all arrived the same day.  I now have on the II interface:
160K Vanguard Global all cap
170K in Money market.
Total 330K 48.48% uncrystallised.
Nothing has changed so far.

After applying the growth, according to II you experienced overall growth of 48.4848% (coincidentally because of the exact numbers you chose but it would not be the same in real scenarios), but this growth is applied equally to the crystallised and uncrystallised portions.

However according to you, at the point I do the transfer, I must now sell 5K of Vangurd and invest it in Money market?  II will certainly not do this automatically.  Therefore we appear to be in agreement that given the exact same non notional starting pots the risk profile of what is happening changed slightly because a notional split now exists instead of a specifically tracked quantitative value per pot.

I suspect it is also not helping to force scenarios that give equal net results as this can be dangerous and give misleading conclusions that might not be the same if the numbers were more random.

Also - from what I can gather, according to your logic and conclusions, the comment by Triumph13 in the prior linked thread that you can avoid this by taking the TFC immediately and putting it in an ISA, is also incorrect because according to your conclusions, you must then change the investments in the ISA to force the same assumed net final result?

Edit - forcing the investment mix to achieve the same net result in the II account is a one trick pony.  What happens if your results in your examples 2 and 3 is the end of year 1.  Now try calculating year 2, where the low growth items still maintained the same nominal value and the high growth ones doubled again?  I think you will now find that the results diverge unless you are going to tell me I now have to adjust the invesment mix again at the end of year one differently in each of the two cases.

Pat38493

Telltale - the flaw in your method is that in order to proceed with your method in real life, you need to explain how you will calculate the adjustment from £170K/£160K to £165K/165K in your scenario 3 in a real world scenario with unknown future returns.

We have to keep in mind that the merge of providers happens first.  The returns of 100% and 0% are your assumed returns - in real life we don't know at this moment what the returns will be.

At the point where you change the provider from a real split to notional, the net value of your investments in a notional provider is identical no matter what asset mix you pick, so you cannot use the current split to calculate this proposed one off £5K adjustment.

As far as I can tell, the only way to calculate this adjustment is to have perfect knowledge of future investment returns.  In this case, it would be mad to reduce your equity exposure - you would simply increase it to 100% in all cases as you now have zero risk.

What happens if your assumed returns of 100% on equities and zero on cash, doesn't materialise and the actual return on equities is minus 50%?

Any changes to the risk that are created by moving the pot from real to notional are not under my control - they are triggered by the methodology that II uses to track the split which is what I have been saying all along.

I don't have an issue with this - I have a bulk of my pensions with II at the moment and these factors can work either for or against you and the effect will be pretty small unless your pots are huge.

Of course all assuming that crystallised pots have a more beneficial tax treatment in your particular case in all scenarios.

Triumph13

So the net upshot of TheTelltaleChart's excellent analysis is actually the opposite of the original idea in the thread! That's because the one circumstance where you would win by having separate pots is if you are in danger of hitting the lifetime limit for tax free cash.  This would increase the effective tax rate on the uncrystallised pot.  So you should actually put the growth assets in the crystallised portion.  LOL. 

Pat38493

Triumph13 said:

So the net upshot of TheTelltaleChart's excellent analysis is actually the opposite of the original idea in the thread! That's because the one circumstance where you would win by having separate pots is if you are in danger of hitting the lifetime limit for tax free cash.  This would increase the effective tax rate on the uncrystallised pot.  So you should actually put the growth assets in the crystallised portion.  LOL. 

My original statement
All other things equal, the priority order for keeping your highest growth assets
1) ISA
2) Uncrystallized pension
3) Crystallized pension
4) GIA

Telltale said this was "plain wrong".

I still stand by my original statement since Telltale did not disprove it in any meaningful way - changing the opening allocations after creating a notional split is moving the goalposts.  My original comment was based on the allocations being the same in either situation.  My comment was about what happens in the future, if you move your pot from a split provider to a notional split provider, or vice versa, without changing your asset allocations.

You win by having separate pots with the same allocation mix, if you get a good sequence of returns.  In worst case scenarios, you are worse off.

Creating a notional split disconnects the taxability status of the pots from the overall investment mix going forward.

I don's disagree with Telltale's analysis proving that the taxability status of different items gives a different net value, but I never claimed anything different.

I also accept that there may be some cases for individuals where the order needs to be changed for various reasons.

I even don't disagree that this is largely meaningless in the long run because you will be (hopefully) regularly rebalancing anyway, but that doesn't mean my theoretcial statement was wrong.

RockPools

I'm hoping for an idiots guide at the end of all this 

michaels

TheTelltaleChart said:

You want proof?

For any asset class which forms part of a portfolio, let's call the initial gross value of that asset class in each account (i.e. in ISA, crystallised pension, etc):

g1, g2, g3, ...

Let's call the tax application ratio, i.e. what each account needs to be multiplied by to give its net value (e.g. 1 for an ISA, 0.8 for a crystallised pot if your tax rate is 20%, etc):

t1, t2, t3, ...

Therefore the initial net value held in this asset class is:

N0 = (g1 * t1) + (g2 * t2) + (g3 * t3) + ...

At any later date (x), let's call the return on this asset class since the initial date, expressed as a ratio (e.g. 1 for no change, 2 for doubling, 0.58 for a 42% loss, etc):

R

If there is no change in the portfolio's allocations to this asset class, between the initial date and date x, then the gross values held in it in each account are therefore now:

(g1 * R), ( g2 * R), (g3 * R), ...

[Note: using the same value of R in all accounts works for all ISA and pension acounts, but not for GIAs, where R may be reduced due to taxes on income/gains.]

Therefore the net value held in this asset class at date x is:

Nx = (g1 * R * t1) + (g2 * R * t2) + (g3 * R * t3) + ...

[Note: that the tax application ratios for each account is unchanged, despite the account growing or shrinking in size, is not always true. There are important exceptions, such as getting part of your taxable pension withdrawals taxed at different rates, or hitting the lifetime TFLS limit.]

That equation can be rearranged as:

Nx = R * ((g1 * t1) + (g2 * t2) + (g3 * t3) ...)

And then as:

Nx = R * N0

That is to say: the net value of your holdings in this asset class, at any future date, depends only on the net value of your holdings in it at the start date and on the returns in the asset class between the 2 dates.

But, since the net value of the whole portfolio is, at any date, simply the sum of the net values of all the assets classes held on that date, we can also say:

The net value of the portfolio at any future date depends solely on the amount of net value assigned to each asset class at the start date and the performance of each asset class during the subsequent period.

In other words (apart from the important exceptions noted above): if you get a different net result by assigning asset classes differently among accounts 1)-3), it can only be because you also assigned different initial net values to the asset classes. If you had assigned the same initial net values, you would have gotten the same net result. QED.

I thought we were discussing what would happen where r1<>r2 rather than r1=r2=R?

Pat38493

We can simplify this down to things that have been stated by others on these boards many times:

1) All other things equal, you should try to keep your highest growth assets in wrappers with the lowest marginal tax rate.  

2) If you have a pot of £100K in drawdown in cash, and pot of £100K in equities in an uncrystallised pension, and you leave it there for x amount of time, you will have a high statistical probabiilty of ending up with more money at the very end than the person who put the equities in the drawdown pot and the cash in the uncrystallised.  This is because more often than not, equities grows more than cash.  The marginal tax rate of the uncrystallised pot on withdrawal is lower.

3) If you move the above pot into a provider like II that has a notional split, you can no longer guarantee at all times on every day, that the amount of equities you have will correspond to the amount uncrystallised, because it's now a fixed % and the equities will grow at a different %.  Yes of course you can continually adjust it to get the outcome you think you should have, but the bottom line is that notional split pots behave differently to separate pots regarding ongoing future growth.

4) Point 3 will probably have negligable impact on your long term wealth if you are regularly rebalancing, but it might be more of a difference if you are lazy and never rebalanced your portfolio regularly.

Telltale is basing everything on trying to achieve the desired net (future) value of the overall pension assets at any given point in time, which is all well and good in theory, but in reality we don't rebalance our pension every second or every day.  I also suspect there is something missing from the equations once the split becomes notional because the assets which form t1, t2, t3 will be changing daily (or even continually if the fund is in ETFs).

Triumph13

Let's try a really simple example to prove TheTelltaleChart's point.

Assume that you are going to be a basic rate taxpayer in retirement, and your asset allocation calls for you to have £85k after tax value of equities and you have a choice of two places to hold it - ISA or uncrystallised pension.  You achieve that by either having £85k of equities in the ISA or by having £85k / 85% = £100k in the pension.  If equities then double in value you would end up with either £170k in the ISA, or £200k gross = £170k after tax in the pension.

Exactly the same logic applies to any asset class and to any number of wrappers.  It only makes a difference where you put what if the amount you hold in a particular wrapper is enough to risk making a change in the tax rate applied to withdrawals from that wrapper.

Pat38493

Regarding point 3 - if I transfer a pot from a real split to notional split whilst keeping the exact same allocation by gross value, surely the net value of the pot hasn't changed on the day of the transfer.  In fact, I could change the theoretical allocation to any asset allocation whatsoever, and the net value would not change (e.g. if it was a Sunday and markets were closed, the net value of the pot is driven by the notional split and nothing else)?

Let's say the notional split if 50/50 and the pot value is £1m.  The net value is fixed on that day at that moment in time - you can theorize any change to asset allocation that you like but the net value is determined only by the gross value and the fixed notional split % value, nothing else?

My point is that I am no longer in moment to moment control of how the assets are allocated to each wrapper as there is no tracking of this anymore.

Therefore I am still struggling to see in Telltale's earlier example, how would I be able to know to make an adjustment of (exactly) £5K on the day that I move the pot into a notional split?  I might know that an adjustment will be  needed, but how do I calculate the 5K number?  The notional split at the time of transfer is calculated exactly based on the real split that was moved in, so the numbers should be identical.  Even if I calculate the target gross allocations based on net results, if the split did not change yet and the target net allocation is the same, surely I will get the same answer?

Regarding the other points, I guess I have to admit I am wrong if your objective is to achieve a fixed net asset allocation after theoretical tax is deducted.  However this is not how I have really looked at it up to now.  In fact, I have paid hundreds of points for an retirement planning course from an IFA, and watched many videos from IFAs on Youtube, and none of them ever pointed out that you have to decide your asset allocation based on the calculated net value of your pots, and then recaluclate the asset allocation back up to the wrapper you want the asset to be in.  In fact the video had a worked example in detail and this adjustment was not included as far as I remember.

As it happens, I am calculating my asset allocations using a cash flow ladder which was populated from data from a cash flow planning software, so probably these factors are already taken into account in another way, since the expected tax is already included in the annual tax flow.

I am getting better results when putting the same gross allocations in lower marginal tax wrappers.

Further, even when accepting your POV, as soon as you start to take into account that having the equities in higher marginal tax wrappers will be statistically more likely to put you into a higher tax bracket at some future point, my point one actually becomes "yes" but not for the reason I was stating.