Approaching LTA with DC pension

Including Financial Independence and Retiring Early (FIRE)
gadgetmind
Posts: 32
Joined: November 25th, 2016, 10:30 am

Approaching LTA with DC pension

Postby gadgetmind » December 17th, 2016, 4:19 pm

Thanks to the drop in sterling, the newly diminished £1M LTA is looming on the horizon for me.

I'm 53 now and intend to retire in early 2018 at age 55. My remaining contributions this tax year will take me to LTA unless the market drops.

I have never had >£1M in my pot so haven't been able to apply for any protection. My employer contributes to my pension, I contribute myself via sal sac *and* my employer boost my contributions by 10% as a thanks for saving them employer's NI. And finally my income is such that if I took the money instead, personal allowance clawback + NI would mean that I'd be taxed at 62%.

I'm inclined to keep on banging in the money as 55% tax doesn't look that bad when compared to the other options!

If markets don't drop such that I'm within the LTA at age 55, I'm thinking that my best option is to crystallise (say) 90% of the pot and then hope that markets have a "bad hair day" and that I can move fast enough to pull the rest through within the LTA. If they don't, there will be a point at which I'll have to decide whether to do the rest up to 100% LTA and then either face the age 75 BCE on what remains or decide that 25% + marginal for income is acceptable.

I'd love to know what others have done in a similar position.

And if my decision to keep on contributing seems wrong to anyone, then please shout.

TedSwippet
Posts: 43
Joined: November 4th, 2016, 12:57 pm

Re: Approaching LTA with DC pension

Postby TedSwippet » December 17th, 2016, 7:02 pm

gadgetmind wrote:I have never had >£1M in my pot so haven't been able to apply for any protection.

That's not really true. Although you may never have qualified for individual protections, you could have applied for any of the fixed protections, but only at the (perhaps prohibitive?) cost of no more pension contributions going forwards from the protection dates. Since you have -- presumably -- made pension contributions since April, FP2016 is now closed off for you.

gadgetmind wrote:I'm inclined to keep on banging in the money as 55% tax doesn't look that bad when compared to the other options!

It's better than 62%, but you'll want to make sure that your contributions sit within the 60% band, not above or below (if you reduce your hours further still, say). Outside of that 62% band the best approach is probably to only put in enough to capture the employer match, but no more. At a 40% tax rate, the uplift from NI in salary sacrifice alone doesn't appear to be enough to compensate for the 55% rate.

Also, note that 55% is the rate you would pay if you are in higher rate tax when you draw down. The actual mechanism here is 25% LTA charge off the top and then 'normal' income tax on the remaining 75%. So 25% + 0.4 * 75% = 55%, but 25% + 0.2 * 75% = 40%. What you actually pay in tax on withdrawals, then, is a function of your tax circumstances in retirement. As if prediction/forecasting here wasn't already difficult enough...

gadgetmind wrote:If markets don't drop such that I'm within the LTA at age 55, I'm thinking that my best option is to crystallise (say) 90% of the pot and then hope that markets have a "bad hair day" ...

Timing for market dips is a possible option. Personally I don't like the sound of it, but it's been raised a number of times by folk who may have thought more deeply about this than I have. It appears to be most useful for folk who perhaps cannot avoid breaching the LTA (DB scheme members, for example).

gadgetmind wrote:I'd love to know what others have done in a similar position.

Retired early, and took FP2016. I am two years older than you and my pension was already pushing £1m (now above, thanks to Brexit). To keep working would have cost me £63k in undesirable LTA charge. I had planned four more years of working, but I have more self-respect than to work those four more years for an approx 25% reduction in overall compensation.

gadgetmind
Posts: 32
Joined: November 25th, 2016, 10:30 am

Re: Approaching LTA with DC pension

Postby gadgetmind » December 17th, 2016, 7:45 pm

TedSwippet wrote:Although you may never have qualified for individual protections, you could have applied for any of the fixed protections, but only at the (perhaps prohibitive?) cost of no more pension contributions going forwards from the protection dates.


True enough, but yes prohibitive and pre-Brexit it all seemed so unlikely. Ah well.

It's better than 62%, but you'll want to make sure that your contributions sit within the 60% ban


I'm currently juggling days worked (4 currently), share incentives exercised, pension contributions (£40k max) etc, to hover at *just* under the £100k mark and also avoid pension taper.

The actual mechanism here is 25% LTA charge off the top and then 'normal' income tax on the remaining 75%.


How does it *actually* work? When does the money get taken from my pot? Is it when I crystallise and does it depend on whether I go for PCLS and drawdown or UFPLS?

Retired early, and took FP2016. I am two years older than you and my pension was already pushing £1m (now above, thanks to Brexit).


This is one of the few times that I wish I were slightly older. :-)

TedSwippet
Posts: 43
Joined: November 4th, 2016, 12:57 pm

Re: Approaching LTA with DC pension

Postby TedSwippet » December 17th, 2016, 8:38 pm

gadgetmind wrote:How does it *actually* work? When does the money get taken from my pot? Is it when I crystallise and does it depend on whether I go for PCLS and drawdown or UFPLS?

Your pension is measured against the LTA on any BCE. This paper from Intelligent Pensions and this one from Scottish Widows do a reasonable job of explaining. The pension provider is responsible for LTA charge collection, but there's also a self-assessment element to it. "Pension simplification".

UFPLS is just a salami-sliced version of PCLS and drawdown. Notice that the LTA is a de-facto hard limit on the PCLS element.

gadgetmind
Posts: 32
Joined: November 25th, 2016, 10:30 am

Re: Approaching LTA with DC pension

Postby gadgetmind » December 18th, 2016, 9:21 am

TedSwippet wrote:Notice that the LTA is a de-facto hard limit on the PCLS element.


So if I take any lump sum beyond LTA the pension provider takes 55% off before paying out? And for the other 75% of any UFPLS, or any drawdown from crystallised funds, they take off 25% and then tax as usual?

As 0.75*0.6=0.45 I guess it's neutral for someone paying HR tax in retirement (which I will strive to avoid) but 0.75*0.8=0.6 so a BR tax payer in retirement is better off using drawdown if beyond LTA. And if they have (effectively) avoided tax way beyond 40% while working, paying this 40% versus 20% on drawdown still means they are winning.

Leaving funds uncrystallised works well for beneficiaries assuming you don't make it until 75, by which time the rules may have changed another dozen times anyway!

Off to read those links, thanks.

gadgetmind
Posts: 32
Joined: November 25th, 2016, 10:30 am

Re: Approaching LTA with DC pension

Postby gadgetmind » December 18th, 2016, 9:56 am

Do these calculations look correct for accessing £1k of DC pension?

Under LTA for £1k with BR tax
£250 PCLS + £750*0.8 = £850, so effectively 15% tax

Over LTS with UFPLS for £1k with BR tax
£250*0.45+$750*0.75*0.8=£562.50 so 43.75% tax

Over LTS with drawdown and no lump sum, again BR tax
£1000*0.75*0.8=£600, so 40% tax

I see what you mean about £250k being the max PCLS under LTA rules! Looks like best options are 1) leave uncrystallised and see what comes along, 2) put "excess" into drawdown and accept that 25% tax is charged. Is this taxed when going into drawdown or as you draw down?

TedSwippet
Posts: 43
Joined: November 4th, 2016, 12:57 pm

Re: Approaching LTA with DC pension

Postby TedSwippet » December 18th, 2016, 11:22 am

Your numbers look about right to me, though you should double-check the UFPLS case elsewhere. I've only looked very briefly at that since it's not something I'm going to use.

As for actions once past the LTA, you could probably make good arguments for either of your options. On the one hand, the whole LTA edifice is such a horrid mess that it is possible it might be rationalised, scrapped, or somehow otherwise improved in future. On the other hand, whenever the government "improves" something it usually ends up worse, A-day "pension simplification" being a prime example. The operative phrase here is 'political risk'.

Here is how I frame this. Consider a pension pot as having three separate components -- PCLS taxed at 0%, drawdown taxed at (say) 40%, and excess above the LTA taxed at 55%. All grow at the same rate. But because the LTA is a fixed value, once the aggregate pension pot rises above the LTA threshold all of the growth from the PCLS and drawdown components flows into the excess component.

That suggests early rather than later crystallisation. Once crystallised, gains from the PCLS component become taxable annually, but at 40% on dividends and 20% (worst case) on eventual capital gains this still beats the 55% LTA charge (even allowing for tax-deferred rollup in the pension, which would take some two or three decades to overcome the lower rates outside the pension). The drawdown element can be deferred and so gain from rollup, and eventually it's taxed at 40%, but this still beats 55%.

Finally, whether one should crystallise the entire pension (including excess) or just to 100% of the LTA is a tricky call.

My sense would be to leave the excess component in the pension. You could be in a lower tax bracket later in life, or at least in a position to engineer one. The rules could change to your benefit. Some heir may later bless you at your funeral. And so on. Fortunately I don't have to make that decision, as I plan to crystallise my entire pension the moment it grows to its (protected) LTA, this being the apparent optimal course for my circumstances.

flyer61
Posts: 6
Joined: November 11th, 2016, 12:53 pm

Re: Approaching LTA with DC pension

Postby flyer61 » December 18th, 2016, 11:39 am

Gadgetmind..... a few musing's

I took fixed protection in 2014 at 1.5M as it looked likely I would get close to it with what I had (both DB and DC), combined with my employer would pay me salary instead of pension contribution it seemed the sensible thing to do. In all of this I have tried not to let the tax tail wave the dog too much but be pragmatic. There are fundamental problems with the UK pension system. To name a few, constant tinkering, along with if all the money is in pension pots this is where the Government will come a calling. It is very easy to say as a minister if you are on 25K - 30K a year you are wealthy and you must support all those 'have not's'. The fact you have probably gone without to achieve this doesn't even feature.....

Given I took my fixed protection at 53 I elected to keep 30 -35% in cash through to 55 (which was 2 months ago). Have taken the tax free cash at the earliest opportunity. The growth over the two years still worked out at 9% per annum however heavily biased by Brexit, Bonds and a sizeable exposure to the USD.

If your plan is to access your lump sum at the earliest opportunity I would keep a goodly amount of cash. You can tinker all you like but an emergency budget or even a normal one! could put all your plans up in smoke.

Take the cash at 55 and do something else with it. Leave the rest to grow if you don't need the income. I have been building a pension for my wife, VCT's, ISA's and Property oh and a little bit off shore. With luck i will have the bases covered by my funeral :shock:

Wishing your life away to 55 is the reality sadly.

TedSwippet
Posts: 43
Joined: November 4th, 2016, 12:57 pm

Re: Approaching LTA with DC pension

Postby TedSwippet » December 18th, 2016, 11:51 am

TedSwippet wrote:...All grow at the same rate. But because the LTA is a fixed value, once the aggregate pension pot rises above the LTA threshold all of the growth from the PCLS and drawdown components flows into the excess component.

I should probably nuance this slightly. "Growth" here is real growth, excluding inflation.

The LTA is supposed to move upwards with inflation after 2018 (but then again so was the original LTA of £1.5mm set in 2006, and look what happened). So any upwards drift in the LTA shifts the boundaries on the three pension components. However, all real growth still flows into the excess component. Outside the pension both real and nominal growth is taxed, but things like the CGT allowance and lower CGT rates ameliorate this.

ursaminortaur
Posts: 3
Joined: November 4th, 2016, 3:26 pm

Re: Approaching LTA with DC pension

Postby ursaminortaur » December 18th, 2016, 2:03 pm

gadgetmind wrote:
TedSwippet wrote:Notice that the LTA is a de-facto hard limit on the PCLS element.


Leaving funds uncrystallised works well for beneficiaries assuming you don't make it until 75, by which time the rules may have changed another dozen times anyway!



It already has changed. As far as how death benefits are paid is concerned there is now no difference between crystallised and uncrystallised funds.
From

http://adviser.royallondon.com/technica ... pril-2015/

"
Before 6 April 2015 what benefits could be paid depended on whether the funds were crystallised or not. From 6 April 2015 it depends on the age of the current beneficiary of the pension benefit as at the date of death. The tax treatment of the benefits is no different for crystallised and uncrystallised funds. However, the lifetime allowance check still applies to uncrystallised benefits.
"

Dave

gadgetmind
Posts: 32
Joined: November 25th, 2016, 10:30 am

Re: Approaching LTA with DC pension

Postby gadgetmind » December 18th, 2016, 3:07 pm

Thanks all.

I do plan to crystallise as soon as possible and can debate whether to go 100% or back off to (say) 90% at that point. We already have three years of (pretty generous!) essentials money as cash, part as NS&I linkers and part in a mortgage offset account. Mortgage was for loan to daughter for her to buy her first home but she should soon qualify as a Doctor so should be able to mortgage in her name fairly soon.

Having the PCLS lying around isn't a great issue as between 2x £5k dividend allowances and the new allowances for interest we should be able to split between equities and bonds and avoid tax. The income on £250k at even 4% is only £10k pa, and we'll have 12 years between retirement and SP age to ISA this up.

My spreadsheet suggests I'll be able to draw down just over 6% of the post-PCLS pot from my pension over 12 years (until SP) without going into HR tax. This will do it some serious damage, but money is fungible, and this will let us leave ISAs etc. alone. I can then back off on the SIPP once SP comes on line.

I do wonder whether meeting a "wealth manager" of some kind at age 55 would make sense but have in the past found them to be a little more concerned with their own wealth than mine!

TedSwippet
Posts: 43
Joined: November 4th, 2016, 12:57 pm

Re: Approaching LTA with DC pension

Postby TedSwippet » December 18th, 2016, 5:01 pm

gadgetmind wrote:I do plan to crystallise as soon as possible and can debate whether to go 100% or back off to (say) 90% at that point.

One additional thought here on the tactic of waiting for a possible market dip so as to duck in under the LTA: after taking (say) 90%, you would need a much larger dip to avoid LTA charges.

Suppose your pension is valued at £1.1m. Before crystallising, a 9% market drop will take you out of LTA excess charge territory. If you crystallise £900k to use 90% of your LTA, you leave £200k in the pension. You now need a 50% market drop to reduce that £200k down to £100k and so get it within your remaining 10% LTA. A 9% drop is more likely than a 50% one.

You probably already had this worked out, but it seemed worth making it explicit.

gadgetmind
Posts: 32
Joined: November 25th, 2016, 10:30 am

Re: Approaching LTA with DC pension

Postby gadgetmind » December 19th, 2016, 9:45 am

TedSwippet wrote:You probably already had this worked out, but it seemed worth making it explicit.


Yes, but I probably need to sit down and play "what if". If I crystallised (say) 50%, I'd have enough to drawdown on for a fair few years, and I guess this bit could be bond/cash heavy. But I'd feel a bit of mug if the other 50% soared in value and/or the sodding LTA came down again!

I guess this is one where there is no single right answer and I'm 15 months off 55 anyway so who knows what the markets might do.


Return to “Retirement Investing (inc FIRE)”

Who is online

Users browsing this forum: No registered users and 2 guests