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LTA with DB, US and Civil Service pension

JohnB
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LTA with DB, US and Civil Service pension

#423332

Postby JohnB » June 29th, 2021, 8:28 am

I'm FIRE, 53 with a £800k SIPP, a £6k preserved Civil Service Pension from 20 years ago (with extra £18k lump sum, all nominally payable at 60, but accessible now actuarially reduced) and a $80k DC pension in the US, and don't quite have enough income to pay tax. I don't need to draw a pension for a bit as I can spend unsheltered/ISA money. I assume for simplicity the DC funds will grow at 5%, the DB pension at 2%

With the freezing of the LTA at £1.071m, I'm getting very close to the limit. As I understand it the US pension can be ignored, and when I get to 55 the UK DC might be worth £880k, and at 60 the DB pension might have a LTA value of (6000*20+18000)*1.02^7=£158k.

Can I put all the SIPP into drawdown at 55, but leave it mostly there, taking no lump sum and extracting a small income to soak up 82% of the LTA, and then wait to 60 to draw the DB pension and take up 15% more. I'd rather spend unsheltered or ISA money than SIPP money for IHT reasons, but would I need to keep draining the SIPP to keep it under whatever LTA is in place when I'm 75, or does being fully crystallised avoid that?

I worry that if stock market surges, I'll be kicking myself for not getting the Civil Service pension now and locking in a smaller LTA fraction. Is there any reason not to crystalise, other than it foregoes the small £3600 non-earning contribution benefit.

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Re: LTA with DB, US and Civil Service pension

#423354

Postby TedSwippet » June 29th, 2021, 9:51 am

I don't have any DB pensions, only DC, so interactions between the two are very much not my territory. However, a couple of notes below on handling DC and crystallisations.
JohnB wrote:As I understand it the US pension can be ignored, ...

Right, provided that the US pension does not contain 'UK tax-relieved' contributions (see HMRC helpsheet). If it's from time spent working in the US and when you were non-UK resident for UK tax, that would put it outside the LTA. Otherwise, perhaps not so much.

[ Additional side thought. At the margins, have you looked at the possibility of Roth conversions on this US pension (assuming it's a pre-tax 'traditional' 401k or IRA)? This won't affect your LTA position, but conversion might reduce your overall future tax bill on this money. ]

JohnB wrote:Can I put all the SIPP into drawdown at 55, but leave it mostly there, taking no lump sum and extracting a small income ...

You can, but there are reasons why this might not be a good idea as stated.

Firstly, the act of moving a SIPP into drawdown (crystallisation) is your one opportunity to take the 25% tax-free lump sum. You cannot take it later. And not taking it then would mean that this money becomes taxable income when withdrawn. Far better to crystallise, take the 25% tax free and then reinvest that in ISAs and/or unsheltered accounts.

Secondly, there is no compulsion to take any taxable income from the remaining 75% drawdown element. And in fact, given that doing so triggers the £4k MPAA for any future pension contributions, some motivation to put this off, if only 'just in case'. Again then, this suggests crystallising the SIPP, taking the 25% tax-free lump sum, and then leaving the balance entirely alone until needed.

Take some time to fully understand the various BCE's outlined here:

https://www.aegon.co.uk/support/faq/pen ... event.html
https://www.gov.uk/guidance/pension-sch ... -allowance

For the above, BCE 1 and BCE 6 apply.

JohnB wrote: ... would I need to keep draining the SIPP to keep it under whatever LTA is in place when I'm 75, or does being fully crystallised avoid that?

You would need to draw down as much as is necessary to keep the gain in the drawdown element of the SIPP inside your remaining LTA by age 75. BCE 5A. Worst case; if you have used 100% of your LTA, then at age 75 you would face a 25% LTA penalty on every penny in the SIPP drawdown element in excess of the amount originally placed into drawdown (that is, the entire nominal gain).

There's no compulsion to take this income so as to avoid the LTA penalty, but given that most marginal income tax rates are lower than the LTA penalty rates, it usually makes sense. With full flexible drawdown, paying an LTA penalty at age 75 is somewhat voluntary.

Countervailing forces to all of this include a desire to pass on the pension outside of IHT. You didn't mention that in your post, but worth mentioning anyway.

JohnB wrote:I worry that if stock market surges, I'll be kicking myself for not getting the Civil Service pension now and locking in a smaller LTA fraction. Is there any reason not to crystalise, other than it foregoes the small £3600 non-earning contribution benefit.

I don't have any DB pensions, so the first part of this is outside my wheelhouse. However, on the £3.6k contribution, I'm not sure that taking pension benefits alone is enough to prevent this. However, it's not likely you would want to do this when above the LTA.

One way to help mitigate LTA issues is, to the extent that you hold bonds, gilts, or other 'stodgy' investments, bias these towards your pensions, and keep the 'racier' stuff in your ISAs, or even in unsheltered accounts. Once you hit the LTA, the effective tax rate on gains inside a pension tends to exceed pretty well all other marginal tax rates (with perhaps the exception of the effective 60% band at £100k-£125k of income). Potentially nuanced by IHT issues, and also the real possibility of dropping down a tax bracket or even two, later on in life.

The other way to mitigate LTA issues is to simply retire early. It looks like you've already started down that route! Taking your DB pension earlier rather than later will reduce its LTA impact, but only because it reduces the pension itself, albeit you collect it for longer. Planning the optimal outcome here seems to require a fully functional crystal ball.

Finally, I take it that it is too late for you to use Fixed Protection 2016. That is, you have made pension contributions since April 2016.

https://www.gov.uk/guidance/pension-sch ... -allowance

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Re: LTA with DB, US and Civil Service pension

#423360

Postby ursaminortaur » June 29th, 2021, 10:07 am

JohnB wrote:I'm FIRE, 53 with a £800k SIPP, a £6k preserved Civil Service Pension from 20 years ago (with extra £18k lump sum, all nominally payable at 60, but accessible now actuarially reduced) and a $80k DC pension in the US, and don't quite have enough income to pay tax. I don't need to draw a pension for a bit as I can spend unsheltered/ISA money. I assume for simplicity the DC funds will grow at 5%, the DB pension at 2%

With the freezing of the LTA at £1.071m, I'm getting very close to the limit. As I understand it the US pension can be ignored, and when I get to 55 the UK DC might be worth £880k, and at 60 the DB pension might have a LTA value of (6000*20+18000)*1.02^7=£158k.

Can I put all the SIPP into drawdown at 55, but leave it mostly there, taking no lump sum and extracting a small income to soak up 82% of the LTA, and then wait to 60 to draw the DB pension and take up 15% more. I'd rather spend unsheltered or ISA money than SIPP money for IHT reasons, but would I need to keep draining the SIPP to keep it under whatever LTA is in place when I'm 75, or does being fully crystallised avoid that?

I worry that if stock market surges, I'll be kicking myself for not getting the Civil Service pension now and locking in a smaller LTA fraction. Is there any reason not to crystalise, other than it foregoes the small £3600 non-earning contribution benefit.


You can crystallise the SIPP at age 55 which will trigger a test against the LTA limit. At that point you can either take the tax free lump sum (upto 25%) or lose it (as far as being tax free is concerned). It will count towards the percentage of the LTA used up at that point in either case so it is usually best with a DC pension to take the full 25% tax free lump sum*.

The crystallised pot will be tested again at age 75 but crucially the test will only look at growth which has occurred since crystallisation which remains in the crustallised pot at age 75 ie the test is against

( Value of crystallised pot at age 75 - ( value of pot when crystallised - ( any tax free lump sum taken) )

Since withdrawals from a crystallised pot are not tested against the LTA limit you can withdraw as much as you wish before age 75 and thus make sure that the growth remaining in the pot at age 75 is zero and hence that you don't use up any more of the LTA limit when that test occurs. These withdrawals will, of course, be taxed at your marginal rate so it is best to spread them over many years so as to minimise tax rather than taking it out all at once and being hit by a large tax bill.

Crystallising the pot does not stop you making further contributions to a SIPP/DC pension but if you take out anything more than the tax free lump sum then something called the MPAA kicks in and restricts your annual allowance to £4000 per year for future contributions to any money purchase/DC scheme and stops you using carry-forward. If unemployed you would still be able to make contributions of £3600 gross. However since you are trying to make sure you won't breach the LTA limit you would probably not want to make such further contributions anyway. Note. If you do take up employment you will want to make sure that you aren't automatically enrolled in NEST or a company pension scheme.

* If you are just wanting to use the SIPP as a means to pass on money outside of IHT to your beneficiaries then you could consider taking the 25% tax free lump sum and then gifting it to your beneficiaries during your lifetime. Such gifts are tax free and will fall outside of IHT so long as you survive for seven years after making the gift - this is known as a PET (potentially exempt transfer)

https://www.pruadviser.co.uk/knowledge-literature/knowledge-library/potentially-exempt-transfers/

Taxable drawdowns from a pension are consideed to be income and hence another thing that is possible to bypass IHT is to make regular gifts of this income to beneficiaries during your lifetime as gifts out of surplus income using the normal expenditure out of income exemption. The advantage of this is that you don't need to survive for seven years for it to bypass IHT.

https://www.pruadviser.co.uk/knowledge-literature/knowledge-library/normal-expenditure-out-of-income-exemption/?icid=banner_articles

JohnB
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Re: LTA with DB, US and Civil Service pension

#423456

Postby JohnB » June 29th, 2021, 2:05 pm

Thank you both for the detailed advice. The US pension was earned when I was a non-UK resident academic there, and its in a CREF, which is an academic 401k type thing. I've no idea how I could calculate the tax to pay to make it a Roth IRA.

I could not get either sort of protection in 2016, as either the fund was below the limit, or I was still paying into it heavily with salary sacrifice.

Its annoying that crystallisation forces 25% out of the pension, as the £220k would boost my taxable income by £8k, and most of it would be taxed at 20% until it could be ISAed

The remaining £660k might be growing at £33k, or 3% of a fixed LTA each year, so it would hard to keep it down without paying some HRT.

An early DB access option might be worth it if I can get more at BRT than HRT.

Oh well, perhaps the market will crash!

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Re: LTA with DB, US and Civil Service pension

#423632

Postby TUK020 » June 30th, 2021, 7:14 am

A couple of other points to consider.
The 25% tax free lump sum may be a political target to cap, and vulnerable to rule changes. There is value in seizing it while you can.
You made reference to spending ISA moneys to defer touching the taxable pension benefit. The lump sum unsheltered becomes the natural pot to spend, while to continue to salt away max ISA contributions.
Even if you haven't started to draw on DB etc schemes, you should draw down on your DC pot to max out your tax break (i.e 12.5k if you have no other income) as soon as you can


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