Take the hit on the lifetime allowance charge
I have written many articles on the Lifetime Allowance (LTA), including whether or not it is beneficial to continue to fund a pension when the individual expects to have an LTA problem, or in fact exceeds already have their LTA, either the Standard Lifetime Allowance (SLA) or their personal LTA due to one of the LTA forms of protection.
One scenario that I haven’t covered, although I’ve had questions about it, is where the person already has defined contribution arrangements that exceed their LTA, and they’re about to take benefits before the age of 75. The question posed, is it better to crystallize all of their benefits and take the ‘minted’ LTA charge now or crystallize up to their LTA and leave the balance above that figure until a later date, either the earliest of the individual’s death, i.e. the age of 75.
Weigh the arguments
The apparent rationale for the former is that it locks in the value of the crystallized fund, and if the member died before age 75, there would be no further LTA testing, and the flexible access levy d a beneficiary would be exempt from any income tax. if they choose this option. The inference for the latter was while there would most certainly be a future LTA charge, the compounded return on the initial untaxed amount would be a higher net amount at the time of the actual charge, than on the initially taxed compounded excess .
Is it better to crystallize all of their benefits and take the “hit” LTA charge now or crystallize up to their LTA and leave the balance that exceeds that figure until a later date?
Ultimately, the choice may depend on each client’s personal circumstances, needs, future plans and perhaps intentions as to how they wish to pass on their wealth. As I am not party to these nuances, I have always been concerned with finding common ground, suggesting that this is a discussion that the advisor needs to have with their client and that they may need to do some calculations.
To date, I haven’t had an adviser who told me that I had calculated the numbers, and that was the result of the exercise. So, out of curiosity, I thought I’d spend some time doing it myself.
Working through some scenarios, the approach I took was to crystallize the benefits, the 60 year old “person” took the maximum pension start lump sum (PCLS) and designated the remainder to be withdrawn. The starting income was 4% of the initial draw fund (75% of their LTA), increasing by 2% per year. They would still hold three years of cash income as a hedge against any market drops, although I didn’t factor any drops into the scenarios and just assumed a return on investment, net of fees, etc., 4% per year. I also assumed that there was no interest earned on the silver, since it is effectively neutral in each scenario. In the event of the death of the individual, I have assumed that the beneficiaries choose the withdrawal option, which means that any LTA charge would be at a rate of 25%.
Know the numbers (in practice)
Consider the situation in the first year for someone with a fund of £1.25m and an LTA of £1.0731m (the value of the pool is before taking income).
|60 years||Partial crystallization||Complete crystallization|
|LTA fees||N / A||£44,225|
|Net Drawing Fund||£706,302||£838,977|
|Rights not crystallized||£176,900||N / A|
If the person died before an income was withdrawn in the first year, the net amount of the partial crystallization would be the same as that of the full crystallization, i.e. the beneficiaries, after taking into account the LTA charge, would also have access to £937,500. .
Continuing with this approach, at 74, I get this:
|74 years old||Partial crystallization||Complete crystallization|
|Net Drawing Fund||£518,981||£748,731|
|Rights not crystallized||£306,334||N / A|
The uncrystallized rights would be subject to an LTA charge of £76,584. Adding the net amount after the charge to the levy fund gives £878,730, again the same as the full crystallization levy fund.
Intuitively you would think that composing on the uncrystallized element would ultimately produce a higher result, however, there seems to be no difference in the result no matter which approach you take. If so, that’s at least one less thing an advisor needs to worry about when discussing such scenarios with their clients.
One would think that dialing on the uncrystallized element would ultimately produce a higher result, however, there seems to be no difference in the result.
A few final points to point out, the LTA charge on death does not need to be paid by the “inherited” pension fund, which means that in the partial crystallization approach, more could be retained in a tax-efficient environment , which may be preferential in certain circumstances. Finally, the individual might also feel inclined to take a more aggressive investment approach for their £176,900 non-crystallized fund, with higher return potential, than they would for their fully crystallized drawdown fund. .
Neil MacGillivray is Technical Support Manager at James Hay