Lump-sum allowance and pension growth

FatherAbraham

I'm trying to help someone, whose DC pension fund is around £900k, which gives a potential crystallisation lump-sum of £225k, to understand the consequences of fund growth.

Since the Lump-Sum Allowance is £268,275, which is the lump sum available from a fund size of £1,073,100, it seems that growth of only about 19.25% will hit the cap, and begin to reduce the relative percentage of tax-free lump sum. Two years of annual investment growth at 9.2% is not unfeasible.

Is there a sound case for crystallising enough to take £20k tax free to put into an investment ISA, and perhaps another £50k tax-free to put into Premium Bonds (or low-coupon, short-term gilts), leaving £198,275 of lump-sum allowance remaining, and an uncrystallized pot of £620k (that's £900k - £280k)?

Now the residual lump-sum allowance of £198,275 is almost 28% above the uncrystallised funds potential lump sum of £170,000 (25% of £620k), creating breathing room for longer tax-free growth within the pension wrapper before the lump-sum allowance is used up.

It seems clear that money probably can't be transferred into an ISA at £20k a year fast enough to never have funds in a GIA, but this moderated transfer does seem to avoid taxation or investment difficulties which could be posed by taking the entire lump sum in one go.

Albermarle

To my mind that is a good plan to try and keep below the frozen lump sum limit.

Early gifting to family ( or charity) can be another outlet for the tax free cash ( or spend some of it !)

mrklaw

you have 268k of lump sum allowance. if you have 225k already, you have 43k left. No matter if you take some tax free cash and move into an ISA now, you still ahve 43k of PCLS allowance left. so effectively 172k of overall uncrystallised growth (which creates 43k tfc).

I suppose by removing some TFC you’re reducing the uncrystallised pot so it’ll take longer to generate that 43k but I don’t know if thats more efficient or not. It does make sense to move tfc out of a sipp if you’re going to crash into the limit though. if invested in the same thing it’ll grow unimpeded past the 268k figure. And if you want to shelter it (sensible) you need to start pretty early

Triumph13

IF they are very likely to hit the lifetime limit AND if they expect to be in the same tax band after retirement as they are now, then currently it looks like a good deal to get the money out and into a GIA.

All growth above the lifetime limit in the pension is effectively taxed at the income tax rate they will have in retirement. Growth in a GIA will be taxed at some mix of CGT rates and dividend rates, both with small annual allowances if they aren't already using them.

Whether the CGT and dividend rates continue to be lower than income tax rates after the next budget is, of course, anyone's guess.

DRS1

The other thing is inflation - with the LSA likely fixed at £268275, each year that goes by inflation will erode the value of that amount. So better to draw it sooner than later.

FatherAbraham

This whole thing is interesting, because it's made me realise that UFPLS really is a bad idea for those who want fine control.

Pension-fund operation can be optimized for both tax-free withdrawals and for taxable income, and only Flexi-access drawdown gives the necessary independence of those two distinct goals.

mrklaw

https://forums.moneysavingexpert.com/discussion/comment/82123491#Comment_82123491

all withdrawals above the PCLS limit would be taxed such. If you don’t anticipate drawing more than 1.068m and the rest might be bequeathed, then the tax on that is less of an issue? nitpicky I know

Triumph13

https://forums.moneysavingexpert.com/discussion/comment/82123685#Comment_82123685

In which case the comparison becomes your tax on capital gains and dividends vs your heirs income tax rate - unless you are obliging enough to die before 75 😉

Qyburn

https://forums.moneysavingexpert.com/discussion/comment/82123636#Comment_82123636

Pension-fund operation can be optimized for both tax-free withdrawals and for taxable income, and only Flexi-access drawdown gives the necessary independence of those two distinct goals

Is there a way to truly separate then? I mean have the option of taxable withdrawals while there's still some tax-free available.

FatherAbraham

https://forums.moneysavingexpert.com/discussion/comment/82123888#Comment_82123888

No, because it's crystallisation which established the tax-free amount, and once done, that's fixed.

Crystallisation must precede any taxable withdrawal, to create the tax-free lump sum. Once done, that lump sum can't be increased, so it's crazy not to get it out, even if one has to pay taxes on further growth in a GIA.

mrklaw

UFPLS - pays you the tax free and taxable immediately

FAD - pays you the tax free immediately.

from a TFC angle both are equivalent. although UFPLS may make it harder if you’re not intending to spend it all - you’ll get more cash out so harder to shelter quickly.

Mathematically - if you can take all the tax free cash in one go - wouldn’t it be better to leave it in the pension until the last moment as it’ll compound quicker? or is it the same.

if you have 100k in a pension, all uncrystallised - 25k is tax free. If it doubles in size over time to 200k now you have 50k tax free.

if you’d taken the 25k out you’d have no more uncrystallised so no more tax free growth. but assuming the same investments, the 25k tax free on its own in an ISA for example owuld still have doubled to 50k. so is it neutral in terms of where you put the tax free cash? and if so (and you are able to confidently predict hitting the ‘lifetime allowance’ that isn’t called that but is the easiest way to explain it IMO) - should you be actively crystallising at the earliest opportunity?