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  • FIRST POST
    • caveman8006
    • By caveman8006 18th Jun 19, 3:40 PM
    • 74Posts
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    caveman8006
    Taking taxable income only from SIPP to maximise IHT protection
    • #1
    • 18th Jun 19, 3:40 PM
    Taking taxable income only from SIPP to maximise IHT protection 18th Jun 19 at 3:40 PM
    Say, for simplicity, that the LTA allowance is 1m with no indexation and you have exactly "landed" at that at age 60 via a combination of a 25k pa DB and a 500k SIPP. Also, you have a large ISA pot which, together with your DB pension and the investment returns from your SIPP (let's assume 25k pa), will be sufficient to cover your income needs for the rest of your lifetime. So, to maximise the IHT protection of your SIPP wrapper, you only wish to draw the investment returns from your SIPP as taxable income to avoid an eventual LTA charge at 75. What is the best way to manage the SIPP?


    I have been told by AJ Bell/You Invest that they allow you to "crystalize" the SIPP into a "tax-free pot" and a "drawdown pot", but leave both invested and take income as required from either pot. So, in this case, would it be possible to crystalize the SIPP into 125k with a tax-free income and 375k with a taxable income and then draw 25k pa of taxable income from the latter each year and not be liable to an excess LTA tax at age 75? Indeed, if necessary, you could also take out up to 125k from the first pot in an emergence tax-free at any time, but if it was not needed, then the full 500k could be passed on, IHT free to children on death.
Page 1
    • EdSwippet
    • By EdSwippet 18th Jun 19, 5:36 PM
    • 987 Posts
    • 1,000 Thanks
    EdSwippet
    • #2
    • 18th Jun 19, 5:36 PM
    • #2
    • 18th Jun 19, 5:36 PM
    I have been told by AJ Bell/You Invest that they allow you to "crystalize" the SIPP into a "tax-free pot" and a "drawdown pot", but leave both invested and take income as required from either pot. So, in this case, would it be possible to crystalize the SIPP into 125k with a tax-free income and 375k with a taxable income ...
    Originally posted by caveman8006
    I think you have the wrong end of some stick or other here. When Youinvest say you can do this, what I believe they mean is that they will split your holdings 75/25, move 75% into a drawdown pot and the remaining 25% as your PCLS into an unwrapped trading account. After crystallising a pension, the PCLS element has no special tax status. It is part of your estate for IHT, and you will have to pay tax annually on any dividends or interest it earns, and any capital gains on asset sales.

    ... and then draw 25k pa of taxable income from the latter each year and not be liable to an excess LTA tax at age 75?
    Originally posted by caveman8006
    You would need to taxably draw all the nominal gains in the drawdown part before age 75 to avoid an LTA penalty. 25k is 6.7% of 375k, so provided average growth does not exceed this you should escape. I generally use numbers of 3% for inflation and 4% for growth, so you're close to my guess (though of course, a guess is precisely what that is).

    Indeed, if necessary, you could also take out up to 125k from the first pot in an emergence tax-free at any time, but if it was not needed, then the full 500k could be passed on, IHT free to children on death.
    Originally posted by caveman8006
    Your numbers seem to be missing growth. Assuming no growth though, not 125k of it, since this (as noted above) is part of your estate for IHT once taken as a PCLS. Only the drawdown part is protected from IHT.
    • caveman8006
    • By caveman8006 18th Jun 19, 7:22 PM
    • 74 Posts
    • 13 Thanks
    caveman8006
    • #3
    • 18th Jun 19, 7:22 PM
    • #3
    • 18th Jun 19, 7:22 PM
    Thanks - I agree that AJ Bell probably did not understand my question, and were probably describing parallel "unwrapped" and "drawdown" accounts, rather than the hoped-for "100% iht-protected" solution.
    However, that still leaves open the best strategy for maximising iht protection without triggering LTA tax.


    By taking the full 125k income tax free at the outset , only 375k is ever protected from iht. Assuming a conservative 5%pa investment return, that 375k drawdown pot will generate 18,750pa of investment returns that will need to be taken out as taxable income until 75 after which further returns can be left to grow without any LTA charge.


    Alternatively, the potential LTA charge could be avoided by annual UFPLS withdrawals of 25,000 of which 18,750 would again be taxable and 6,250 would not. After 10 year of this the LTA would be used up, so for the last 5 years until 75, the full 25k of returns would have to be taken out as taxable income. After 75, the iht-protected pot could be allowed to grow. This seems to be a more efficient strategy, albeit with the slight complication that some top-rate income tax my have to be paid in the last 5 years if a full state pension is being received.


    Thoughts?
    • EdSwippet
    • By EdSwippet 18th Jun 19, 7:39 PM
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    • #4
    • 18th Jun 19, 7:39 PM
    • #4
    • 18th Jun 19, 7:39 PM
    Alternatively, the potential LTA charge could be avoided by annual UFPLS withdrawals of 25,000 of which 18,750 would again be taxable and 6,250 would not. After 10 year of this the LTA would be used up, so for the last 5 years until 75, the full 25k of returns would have to be taken out as taxable income.
    Originally posted by caveman8006
    Once the LTA is used up, you can no longer use UFPLS and all future withdrawals from uncrystallised elements are liable to the LTA penalty. On a 25k crystallisation, you would lose 6,250 to LTA penalty, and then face income tax at your marginal rate on the remaining 18,750.

    Put differently, below the LTA you get 25% tax free, but above it the government takes all of that 25% for itself instead, then income tax on the remainder in both cases.
    Last edited by EdSwippet; 18-06-2019 at 7:42 PM.
    • caveman8006
    • By caveman8006 18th Jun 19, 9:43 PM
    • 74 Posts
    • 13 Thanks
    caveman8006
    • #5
    • 18th Jun 19, 9:43 PM
    • #5
    • 18th Jun 19, 9:43 PM
    Silly mistake in my previous posting, I would only have crystalized 15 x 25k = 375k of my unused 500k LTA by 75 so would not have used up all my LTA at 70. Makes it even clearer to be a more efficient strategy than full crystallization at outset
    • EdSwippet
    • By EdSwippet 18th Jun 19, 10:54 PM
    • 987 Posts
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    EdSwippet
    • #6
    • 18th Jun 19, 10:54 PM
    • #6
    • 18th Jun 19, 10:54 PM
    Silly mistake in my previous posting, I would only have crystalized 15 x 25k = 375k of my unused 500k LTA by 75 so would not have used up all my LTA at 70. Makes it even clearer to be a more efficient strategy than full crystallization at outset
    Originally posted by caveman8006
    Aren't you still discounting the effect of above-inflation growth in your pension? Assuming your initial conditions -- that is, already at the LTA -- if you gradually UFPLS, by the time you hit age 75, investment growth in the uncrystallised bits should have caused you to handily exceed the LTA (unless you have invested in assets that have consistently returned less than inflation!). So now you have an LTA penalty to pay at the age 75 test.

    Once you reach exactly the LTA, the only way to truly avoid an LTA penalty is to crystallise everything, and then draw down all the nominal growth to age 75. Otherwise, investment growth will take you over it one way or another, and you then face LTA penalties either when you crystallise above it, or run out of time at age 75. To my mind, UFPLS is of no use to anybody whose pension pot is at or above the LTA. It just compounds the problem into the future.

    I should add that I do not know the full ins-and-outs of how this all interacts with IHT. I plan to draw my pensions, so my own planning does not consider using pensions as an IHT shelter. I also don't know well how DB pensions work into all of this. However, as someone now at the LTA with purely DC pensions, I am crystallising everything now. Tax rates outside a pension are almost all lower than those on withdrawals from a pension that is above the LTA.
    Last edited by EdSwippet; 18-06-2019 at 11:05 PM.
  • jamesd
    • #7
    • 18th Jun 19, 11:57 PM
    • #7
    • 18th Jun 19, 11:57 PM
    I have been told by AJ Bell/You Invest that they allow you to "crystalize" the SIPP into a "tax-free pot" and a "drawdown pot", but leave both invested and take income as required from either pot.
    Originally posted by caveman8006
    Did they say that:

    1. both pots would still be in a pension?
    2. not specify which would be in a pension?
    3. only say that the taxable portion will be in a pension and not where the other portion would be?

    You are not permitted to have a crystallised setup where the lifetime allowance has been calculated before age 75 and still have both 25% tax free and 75% taxable still in a pension. And they can't offer you that, nor can anyone else. So I think that they did 2 or 3.

    What is normally done if lifetime allowance use is needed but no income is desired is both:

    a. take the 25% tax free lump sum and place it into an ordinary investment account that's neither pension nor ISA. This is part of the estate unless the money is invested in things like many AIM shares that become exempt after a couple of years.
    b. place the 75% in a flexi-access drawdown account that is outside the estate and from which no money needs to be taken. At age 75 the value has the initial value subtracted from it. If the answer is positive the growth in value uses more lifetime allowance. So if lifetime allowance is a concern at least withdrawing growth tends to be appropriate.

    If it's desired to keep as much inside the pension as possible you can:

    C. used phased drawdown. This is taking 25% of part of it tax free and putting the 75% of that portion into flexi-access drawdown from which any desired amount can be taken.
    D. wait until 75 and pay any due lifetime allowance charge via BCE 5B. Note HMRCs observation that "For avoidance of doubt, for pension and lump sum purposes the 70,000 remains uncrystallised". Since they remain uncrystallised you can still take a PCLS (the tax free lump sum) if you want to take out some of the money. As HMRC illustrates here at age 76. Also observe how it's a bit fiddly to calculate the LTA used when crystallising older than 75. But entirely doable.
    E. do some combination of a+b, C and D.

    It may well be possible to keep most of the money uncrystallised in the pension until and after age 75 and do enough of a+b and C to pay no LTA charge. But...

    For death before age 75 the pot isn't taxable to the recipients. From age 75 it's added to their taxable income as taken (no 25%:75% split). Even babies have an income tax personal allowance and the taxable money can be withdrawn and used for their needs up to their personal allowance with no tax to pay. So after 75 skipping generations to help children via covering the costs of their children can be tax efficient.

    Even with the workarounds, taking the 25% tax free and giving it away as a potentially exempt transfer well before death may be best.

    I'm assuming that you're far from age 75 and AJ Bell weren't describing case D.
    Last edited by jamesd; 19-06-2019 at 12:48 AM.
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