Mitigation strategy having exceeded the LTA

[bluemonday]

Having recently discovered this board, and found it extremely helpful and informative, I’m hoping that you can help me with a mitigation strategy.

For many years I have avoided IFA’s (having had a number of negative experiences) and put my excess funds into execution only ISA’s and SIPP’s. I’m now in the fortunate, but taxing, position of being well over the LTA (ironically an IFA would most likely have alerted me to this danger) and trying to determine my best course of action to minimise the LTA Excess Charge I will need to pay.

Until reading this board I had my head in the sand and was thinking I would just ignore my pension conundrum until I needed to start drawing it. I’m now a little better informed and coming to the conclusion that it would make sense to crystallise as much as possible as soon as possible to reduce the impact of compounding on the LTA Excess Charge.

I’m 58 years old, have recently retired and have sufficient funds in ISA’s and savings accounts to get me through to my normal retirement age of 67 but could use the 25% tax free sum to help my daughters get a foot on the property ladder.

In 2016 I took Fixed Protection which gives me a LTA of £1.25m

Current pension value (for LTA purposes) is around £2m made up as follows:
DB (Final Salary) Scheme - Estimated Value at Start Date (Age 65) £11,000 pa =£ 220,000
3 separate DC Workplace Pensions with L&G plus SIPP with HL =£1,780,000

My initial thinking was I should crystallise no more than £1m now, to allow headroom for the Final Salary Scheme BCE at Age 65, but maybe that is a red herring and it would be more advantageous to crystallise the full £1.25m now, given I could draw any future uplift out of the crystallised pension!? I guess the implication would be that I would have to pay income tax at my marginal rate on the full amount of the DB pension, rather than on just 75% of it!?

I don’t think there is much that I can do about the remaining uncrystallised amount above my Fixed Protection LTA beyond waiting until I’m 75 to take the hit?

Your input would be greatly appreciated.

[TUK020]

Having recently discovered this board, and found it extremely helpful and informative, I’m hoping that you can help me with a mitigation strategy.

For many years I have avoided IFA’s (having had a number of negative experiences) and put my excess funds into execution only ISA’s and SIPP’s. I’m now in the fortunate, but taxing, position of being well over the LTA (ironically an IFA would most likely have alerted me to this danger) and trying to determine my best course of action to minimise the LTA Excess Charge I will need to pay.

Until reading this board I had my head in the sand and was thinking I would just ignore my pension conundrum until I needed to start drawing it. I’m now a little better informed and coming to the conclusion that it would make sense to crystallise as much as possible as soon as possible to reduce the impact of compounding on the LTA Excess Charge.

I’m 58 years old, have recently retired and have sufficient funds in ISA’s and savings accounts to get me through to my normal retirement age of 67 but could use the 25% tax free sum to help my daughters get a foot on the property ladder.

In 2016 I took Fixed Protection which gives me a LTA of £1.25m

Current pension value (for LTA purposes) is around £2m made up as follows:
DB (Final Salary) Scheme - Estimated Value at Start Date (Age 65) £11,000 pa =£ 220,000
3 separate DC Workplace Pensions with L&G plus SIPP with HL =£1,780,000

My initial thinking was I should crystallise no more than £1m now, to allow headroom for the Final Salary Scheme BCE at Age 65, but maybe that is a red herring and it would be more advantageous to crystallise the full £1.25m now, given I could draw any future uplift out of the crystallised pension!? I guess the implication would be that I would have to pay income tax at my marginal rate on the full amount of the DB pension, rather than on just 75% of it!?

I don’t think there is much that I can do about the remaining uncrystallised amount above my Fixed Protection LTA beyond waiting until I’m 75 to take the hit?

Your input would be greatly appreciated.

A quality problem to have, but not one that is easy to resolve.
First thing I would suggest is that you leave your ISAs etc well alone, and extract the max out of your DC Pensions that is tax efficient - i.e. use your basic rate tax allowance to the full.
As to how much to crystallize now, that is a big question. You could wait for a market crash, then crystallize the lot. My crystal ball is not giving me the answers on this unfortunately...
I look upon the benefits tax regime as a game in how to extract the max while minimising the tax cut. Don't wait and miss out years of tax allowances.

[pochisoldi]

DB (Final Salary) Scheme - Estimated Value at Start Date (Age 65) £11,000 pa =£ 220,000

Is it worth commutating some of your DB pension for a lump sum?

See https://www.pruadviser.co.uk/knowledge- ... nce-qanda/
scroll down to
"Q. My client is about to take benefits from his defined benefit scheme. How will commuting some of his pension for a PCLS impact the LTA used?"

[parallellines]

Taking defined benefits at the earliest possible age is often an LTA - efficient strategy. This is because DB pensions are assessed for LTA purposes at the same 20:1 factor, whatever age the pension starts.

It relies on the early payment terms for the DB pension being fair, but suppose the scheme would pay (say) £8500 from age 58 as an alternative to £11,000 from 65, it will only use up £170K of the allowance.

If you take the tax free lump sum from the DB scheme that is assessed separately for LTA purposes, as explained in the link in the previous post, so the numbers work out a little differently. Whether taking the lump sum is a sensible thing to do depends on whether the pension to lump sum conversion terms are fair - obviously the fact that the lump sum is tax free helps, but there is a wide variety of terms .

There's no comparable advantage to taking the DC pensions early, although I agree with the post about making best use of tax bands/allowances.

[Kantwebefriends]

How big a market crash do you need to reduce your DC money to £1 million so you avoid the LTA? 44%.

Is that large a crash conceivable in the next two or three years? Yes.

So you could always wait and see.

[bluemonday]

“…..i.e. use your basic rate tax allowance to the full…………Don't wait and miss out years of tax allowances.” Very good points. A sensible thing to do – and one that I hadn’t previously considered! Thank you TUK020.

“Is it worth commutating some of your DB pension for a lump sum?” Great suggestion pochisoldi! I will further investigate this. Many thanks.

“Taking defined benefits at the earliest possible age is often an LTA - efficient strategy. This is because DB pensions are assessed for LTA purposes at the same 20:1 factor, whatever age the pension starts.” Another really helpful suggestion. Thank you parallellines

“How big a market crash do you need to reduce your DC money to £1 million so you avoid the LTA?” An interesting point Kantwebefriends! Conflicts with the principle of “getting on with it” and making use of annual allowances but I can see how it would be beneficial if there was a market crash lurking around the corner.

This is exactly the kind of input I was hoping for. Thank you all for taking the time to respond, your suggestions are much appreciated.

bluemonday

[Aegis]

Just in terms of administration, it's likely to be better to commence the DB scheme completely within your LTA. If you exceed the LTA with a DB scheme, the scheme is forced to pay the excess charge and will apply a commutation rate which may well not be favourable for you. On the other hand, DC pensions used to settle LTA charges just make a deduction from the scheme balance.

[bluemonday]

That's good to know. Thank you Aegis.

[CisforV]

This has been a helpful thread with some interesting comments. It has helped me connect a few dots regarding DB+DC pensions with respect to the LTA.

Here is my current, theoretical strategy. Bluemonday may find something of use.

(Note: I will be impacted by the increase in retirement age)

Age 57
- Leave ISA/GIA well alone.
- Take ~£67k from the DC pension each year.
- 25% of this will be tax free, leaving ~£50k taxable.
- This maximises the 20% tax band and works out around 11% tax paid.
- Put £20k of this into an ISA each year. Any left over into a GIA (taxable general investment account).
- Repeat until age 65.
- This will use up around (67,000 * 8) / 1,073,100 = ~50% of the LTA.

Age 65
- DB is available. BCE 2.
- This will use up (11,000 * 20) / 1,073,100 = ~21% of the LTA.
- DB+DC equates to around 71% of LTA used so far.
- Reduce DC withdrawal to: £67,000 - £11,000 = ~£56k/year.
- Again, add any unspent money into ISA/GIA each year.

Age 67
- State pension available (hopefully).
- We used up another ~10% LTA in the two years to get here. Taking us to ~81%.
- Reduce DC withdrawal to: £56,000 - 9,627.80 = £46,372.2/year
- This may cover ~4 years until LTA is reached.

Age 71
- LTA reached
- Withdraw income from DC pension and pay 25%+20% tax.
- Supplement or switch to ISA/GIA that have been building untouched for the last 14 years.


During this time frame, there will no doubt be inflation and changes or freezes to annual and/or life time limits and/or taxes to consider.

One option often mentioned is to (around age 57) increase the bond allocation in the DC pension(s) to curb growth and reduce the LTA excess. Since we will be using the pension rather than ISA/GIA for a number of years, the ISA/GIA equity allocation can be increased to maintain the desired overall target allocation for the whole portfolio. When we switch back to the ISA/GIA around age 71, flip the allocations back.

In bluemonday’s case, you may decide to leave more money in the pension for inheritance purposes. You also have a nice total portfolio value so could look at a higher SWR. This could mean not adding more into the ISA/GIA during pension drawdown and even potentially spending some from the ISA/GIA.

I place a very high value on the guaranteed annual DB pension. I would not want to reduce this amount by exposing this to be taxed, reduced by taking it early or taking part of it as a lump sump.

From my understanding, this means there will be a guaranteed DB pension of £11,000/year and this will not be tested against the LTA again. Since the full DB pension will be taken, it won’t be tested again at age 75. Is this correct?

I believe that if the LTA increases between age 57 and 65, the DB pension be calculated against the new LTA as it stands at age 65. I presume this doesn’t count if you already have fixed protection though.

[hiriskpaul]

This has been a helpful thread with some interesting comments. It has helped me connect a few dots regarding DB+DC pensions with respect to the LTA.

Here is my current, theoretical strategy. Bluemonday may find something of use.

(Note: I will be impacted by the increase in retirement age)

Age 57
- Leave ISA/GIA well alone.
- Take ~£67k from the DC pension each year.
- 25% of this will be tax free, leaving ~£50k taxable.
- This maximises the 20% tax band and works out around 11% tax paid.
- Put £20k of this into an ISA each year. Any left over into a GIA (taxable general investment account).
- Repeat until age 65.
- This will use up around (67,000 * 8) / 1,073,100 = ~50% of the LTA.

Age 65
- DB is available. BCE 2.
- This will use up (11,000 * 20) / 1,073,100 = ~21% of the LTA.
- DB+DC equates to around 71% of LTA used so far.
- Reduce DC withdrawal to: £67,000 - £11,000 = ~£56k/year.
- Again, add any unspent money into ISA/GIA each year.

Age 67
- State pension available (hopefully).
- We used up another ~10% LTA in the two years to get here. Taking us to ~81%.
- Reduce DC withdrawal to: £56,000 - 9,627.80 = £46,372.2/year
- This may cover ~4 years until LTA is reached.

Age 71
- LTA reached
- Withdraw income from DC pension and pay 25%+20% tax.
- Supplement or switch to ISA/GIA that have been building untouched for the last 14 years.


During this time frame, there will no doubt be inflation and changes or freezes to annual and/or life time limits and/or taxes to consider.

One option often mentioned is to (around age 57) increase the bond allocation in the DC pension(s) to curb growth and reduce the LTA excess. Since we will be using the pension rather than ISA/GIA for a number of years, the ISA/GIA equity allocation can be increased to maintain the desired overall target allocation for the whole portfolio. When we switch back to the ISA/GIA around age 71, flip the allocations back.

In bluemonday’s case, you may decide to leave more money in the pension for inheritance purposes. You also have a nice total portfolio value so could look at a higher SWR. This could mean not adding more into the ISA/GIA during pension drawdown and even potentially spending some from the ISA/GIA.

I place a very high value on the guaranteed annual DB pension. I would not want to reduce this amount by exposing this to be taxed, reduced by taking it early or taking part of it as a lump sump.

From my understanding, this means there will be a guaranteed DB pension of £11,000/year and this will not be tested against the LTA again. Since the full DB pension will be taken, it won’t be tested again at age 75. Is this correct?

I believe that if the LTA increases between age 57 and 65, the DB pension be calculated against the new LTA as it stands at age 65. I presume this doesn’t count if you already have fixed protection though.

Why not crystallise 79% of your LTA now, taking the 25% PCLS and putting the remaining 75% into flexi-access drawdown? Your DB pension will use up the remaining 21%. Assuming your investments continue to grow that approach should maximise your 25% tax free PCLS (the PCLS is capped at 100% of the LTA).

[TUK020]

This has been a helpful thread with some interesting comments. It has helped me connect a few dots regarding DB+DC pensions with respect to the LTA.

Here is my current, theoretical strategy. Bluemonday may find something of use.

(Note: I will be impacted by the increase in retirement age)

Age 57
- Leave ISA/GIA well alone.
- Take ~£67k from the DC pension each year.
- 25% of this will be tax free, leaving ~£50k taxable.
- This maximises the 20% tax band and works out around 11% tax paid.
- Put £20k of this into an ISA each year. Any left over into a GIA (taxable general investment account).
- Repeat until age 65.
- This will use up around (67,000 * 8) / 1,073,100 = ~50% of the LTA.

Age 65
- DB is available. BCE 2.
- This will use up (11,000 * 20) / 1,073,100 = ~21% of the LTA.
- DB+DC equates to around 71% of LTA used so far.
- Reduce DC withdrawal to: £67,000 - £11,000 = ~£56k/year.
- Again, add any unspent money into ISA/GIA each year.

Age 67
- State pension available (hopefully).
- We used up another ~10% LTA in the two years to get here. Taking us to ~81%.
- Reduce DC withdrawal to: £56,000 - 9,627.80 = £46,372.2/year
- This may cover ~4 years until LTA is reached.

Age 71
- LTA reached
- Withdraw income from DC pension and pay 25%+20% tax.
- Supplement or switch to ISA/GIA that have been building untouched for the last 14 years.


During this time frame, there will no doubt be inflation and changes or freezes to annual and/or life time limits and/or taxes to consider.

One option often mentioned is to (around age 57) increase the bond allocation in the DC pension(s) to curb growth and reduce the LTA excess. Since we will be using the pension rather than ISA/GIA for a number of years, the ISA/GIA equity allocation can be increased to maintain the desired overall target allocation for the whole portfolio. When we switch back to the ISA/GIA around age 71, flip the allocations back.

In bluemonday’s case, you may decide to leave more money in the pension for inheritance purposes. You also have a nice total portfolio value so could look at a higher SWR. This could mean not adding more into the ISA/GIA during pension drawdown and even potentially spending some from the ISA/GIA.

I place a very high value on the guaranteed annual DB pension. I would not want to reduce this amount by exposing this to be taxed, reduced by taking it early or taking part of it as a lump sump.

From my understanding, this means there will be a guaranteed DB pension of £11,000/year and this will not be tested against the LTA again. Since the full DB pension will be taken, it won’t be tested again at age 75. Is this correct?

I believe that if the LTA increases between age 57 and 65, the DB pension be calculated against the new LTA as it stands at age 65. I presume this doesn’t count if you already have fixed protection though.

Why not crystallise 79% of your LTA now, taking the 25% PCLS and putting the remaining 75% into flexi-access drawdown? Your DB pension will use up the remaining 21%. Assuming your investments continue to grow that approach should maximise your 25% tax free PCLS (the PCLS is capped at 100% of the LTA).

two other details:
- at ages 65 & 67, you may want to reduce your DC withdrawal by more than 11k/9.6k as the replacement DB & SP will not have a 25% tax free component.
- when you hit LTA, what you do with the rump of DC may be dependent of what you want to do from an Inheritance Tax perspective

[CisforV]

Why not crystallise 79% of your LTA now, taking the 25% PCLS and putting the remaining 75% into flexi-access drawdown? Your DB pension will use up the remaining 21%. Assuming your investments continue to grow that approach should maximise your 25% tax free PCLS (the PCLS is capped at 100% of the LTA).

two other details:
- at ages 65 & 67, you may want to reduce your DC withdrawal by more than 11k/9.6k as the replacement DB & SP will not have a 25% tax free component.
- when you hit LTA, what you do with the rump of DC may be dependent of what you want to do from an Inheritance Tax perspective

@TUK020
Good point about reducing the DC withdrawal by more than I originally stated. I hadn't considered the reduction in 25% tax free. That means a reduction by about £15k/£13k instead which could result in reaching the LTA at 72 instead of 71.

@hiriskpaul
I hadn't considered crystallising early on since I don't have a need for the lump sum. However, due to the above point about the DB+state pension reducing the 25% tax free, you appear correct in that an initial large crystallisation will maximise the 25% tax free vs taking the 25% as part of the annual withdrawal.

This would be more favourable to stepping into the 40% income tax band just to maximise the annual 25% tax free withdrawals. Investing the lump sum into an ISA then GIA would likely result in dividend tax+CGT, but these are taxed less than the 40% income tax band.

It does also provide @bluemonday with the lump sum to help his daughters. Given the freeze on LTA, I don't see the LTA being raised above his current fixed protection value by the time his DB becomes available.

Something to consider is if the DB pension increases annually (e.g. in-line with inflation). In this case, you will need to allow for a bit more headroom than the exact 21% of the DB LTA value today. So crystallise a large portion, but not up to 79%.

All that said, one downside to crystallising a large percentage at age 57/58 (if you don’t have fixed protection) is that you lock in the LTA at that age. By withdrawing and taking 25% annually, you benefit from being tested against the new LTA each year. You also benefit from any raises in tax bands. Not that these are scheduled to change for the next few years.

[CisforV]

I hadn't considered crystallising early on since I don't have a need for the lump sum. However, due to the above point about the DB+state pension reducing the 25% tax free, you appear correct in that an initial large crystallisation will maximise the 25% tax free vs taking the 25% as part of the annual withdrawal.

This would be more favourable to stepping into the 40% income tax band just to maximise the annual 25% tax free withdrawals. Investing the lump sum into an ISA then GIA would likely result in dividend tax+CGT, but these are taxed less than the 40% income tax band.

I had my numbers wrong when I was looking at comparing the large 25% initial lump sum vs 25% from annual withdrawal. 25% is 25% regardless of whether you take it initially or over ~15 years. The benefit of taking it early is that the money gets to grow outside the pension ASAP so won’t impact the check at 75. The downside is you lock in the LTA at that point in time (again, not an issue for those that have fixed protection), plus you open yourself up to dividend tax+CGT (which are less than the LTA excess/40% income tax).