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Understanding the 25% SIPP tax free process
David 111
Posted: 26 November 2016 17:36:45(UTC)
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My wife will, in about a years time, be retiring and starting to take money from her SIPP.

It will probably make sense for her to withdraw the tax free money in several tranches. However, I am unclear exactly how this works in practice.

Say, for the sake of illustration her SIPP is worth £400,000. She decides to take 10% out (£40,000) tax free, leaving £360,000 in her SIPP. A year later she decides to take out 15% (to give a total of 25%), but by that time her SIPP has grown to £380,000. Is the 15% she can take 15% of £360,000 (£54,000) or 15% of £380,000 (£57,000)?

I have kept the illustration above fairly simple, but in practice she is likely to take her tax free money in several tranches.
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roydo2
Posted: 26 November 2016 19:51:59(UTC)
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In theory, yes. But she needs to check that her pension provider has the IT system to be able to cope with the transaction.

So make a phone call on Monday.
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David 111
Posted: 26 November 2016 21:47:00(UTC)
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In theory yes? Which one is correct?
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Jon Snow
Posted: 26 November 2016 23:52:16(UTC)
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David,

Your wife should speak to the administrators of her SIPP and ask for a few worked examples.

It gets very complicated, very quickly.

BTW, why would she not take the full 25% tax free amount?
David 111
Posted: 26 November 2016 23:56:09(UTC)
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The reason for not taking the full tax free amount in one go would be to stay below the income tax threshold for several years in a row.
Jon Snow
Posted: 27 November 2016 00:20:44(UTC)
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David,

The 25% tax free lump sum doesn't count towards your wifes income in the year she takes the lump sum.

It is paid to her as a lump sum that does not need to be declared to HMRC and she can do whatever she wants with it, including investing it into an ISA so she can have some tax free income on top of her pension income.

As I suggested, talk to the SIPP administrator.

These things are complicated, we make assumptions based on half facts, newspaper articles, friends comments and drivel from online forums, I know what I said above is correct but I sure as heck wouldn't rely on my word if it was my missus and her SIPP.

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David 111
Posted: 27 November 2016 08:20:10(UTC)
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25% of her SIPP is likely to generate far more than can be invested in an ISA in one year.
roydo2
Posted: 27 November 2016 09:22:56(UTC)
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David 111;39847 wrote:
In theory yes? Which one is correct?



In theory, the rules allow you to take segments of TFC out of a pension in the way you are looking to do.

However, the older IT systems at many pension companies were built years ago, way before the "new" rules came in, so would struggle to accommodate the transaction(s).
Money Spider
Posted: 27 November 2016 10:39:27(UTC)
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Each time you take money out of your UNCRYSTALLISED SIPP fund it is known as a 'benefit crystallisation event' (BCE). You can have as many BCEs as you like and they can be invoked whenever you like.

At each BCE you can take 25% of the amount being taken out of the uncrystallised SIPP fund tax-free. You will receive this as cash and you can decide what you do with the other 75% being crystallised in each BCE (e.g. buy an annuity, move to your drawdown fund or take as cash. Any of this 75% will be subject to tax if you take it out of the SIPP i.e. as an EXTRA cash lump sum or as income from drawdown.

When deciding how much to crystallise you need to decide:
1. Do I need a minimum amount of drawdown income (if you are going that route). In which case you need to crystallise sufficient funds such that the 75% not taken as tax-free cash can generate that income.
2. What will you do with the tax-free cash? If you intend to re-invest it then it would be prudent to take no more than can be invested in an ISA(s) - (yours and your wife's?) in the near term. All assets still in the SIPP (uncrystallised and drawdown funds) will continue to grow tax-free.
3. Consider you position re Lifetime Allowance (LTA) charge. It is measured at each BCE AND on your 75th birthday. Better to progressively move money out to ISAs if you think you will exceed your LTA.
4. There is always a risk that future governments may change the 25% tax-free rule (cap it or remove it).

I am following a strategy of staged crystallisation myself. I find that it's quite straightforward if you plan beforehand and remember that your provider will require that you have the 25% already in cash when you give your instruction (which must also include a detailed list of those securities that you want to comprise the BCE).

@David 111
If your objective (in your example) is to take £40,000 tax-free then you will need to crystallise £160,000 of the SIPP. You can then take £40,000 tax-free (25% of the amount being crystallised) and the other £120,000 will be moved to a drawdown SIPP. You would now have:
£400,000 -£160,000 = £240,000 in an uncrystallised SIPP fund and
£120,000 in your SIPP drawdown fund.
At the next BCE you can crystallise a further proportion of the uncrystallised fund.

I am not a tax or pension professional, but the above is based on my experience. I hope that helps you.
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Law Man
Posted: 29 November 2016 18:34:16(UTC)
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Broadly there are two methods:
.
(1) that suggested by David 111. Once you have taken your 25%, every drawing after then is subject to income tax, including future growth in the fund.
.
(2) Uncrystallized Pension Lump Sum draw down, as suggested by Money Spider.
.
I use the latter UPFLS method. To keep it simple, assume I have the Personal Allowance amount (£11,000) from other pensions and income.
.
If I take £40,000 then £10,000 is tax free, and the balance of £30,000 is taxed at 20%; provided I keep my total taxable income under £42,000 (above then it is 40%). Thus I pay tax of £6,000, an effective rate of 15%.
.
The benefit is that the rest of my fund (say £360,000) grows in the fund free of tax.
.
Next year the fund is worth £380,000, say. I can take another £40,000 and pay income tax of £6,000 as above.
.
Imagine that after 10 years I have drawn £40,000 p.a. for 10 years (£400,000) and the remaining fund is £100,000. I can still draw up to that sum, and the first 25% is tax free.
.
You can see the benefit of UPFLS in that the untouched fund grows tax free, and you can treat 25% of every future drawing as tax free.
.
Another benefit of not drawing out more than you need is that you can leave the fund to your beneficiaries, on your death, with no IHT and favourable income tax treatment e.g. no income tax if you die aged under 75.
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Money Spider
Posted: 29 November 2016 19:15:31(UTC)
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Actually, I don't use UPFLS, I use Drawdown. My process is similar to that which you describe. Using your example figures to illustrate (assume SIPP starts at £200,000):

Year 1
1. I crystallise £40,000 from my uncrystallized SIPP.
2. I take £10,000 (25%) of that amount tax-free.
3. I draw down an amount equal to my Personal Allowance (£11,000) tax-free
4. I have £19,000 remaining in my SIPP Drawdown fund and £160,000 in my uncrystallized SIPP fund.

Year 2
1. Assume SIPP Drawdown grows 5.3%, or £1,000 (for simplicity). It is now £20,000. Growth is tax-free.
2. Assume uncrystallized SIPP fund grows 5.3% too (tax-free) and is now £168,480
3. Crystallise another £40,000 from uncrystallized SIPP fund.
4. I take £10,000 (25%) ofthat amount tax-free.
5. I draw down an amount equal to my Personal Allowance (£11,500) tax-free
6. I have £38,500 remaining in my SIPP Drawdown fund and £128,480 in my uncrystallized SIPP.

Repeat until 100% of SIPP has been crystallized.

Note: I do not receive the state pension yet.
The model above maximises the amount that is growing tax-free. Each person's tax position is different so you need to figure out the most effective way (and numbers) for you. It is worth noting that if you stop working before you receive your state pension then I believe this route is better than taking the full 25% tax-free sum alone to live off as it better utilises your Personal Allowance in the years before receiving the state pension. It is also a good idea to familiarise yourself with the various tax allowances (Starting Rate for Savings, Savings Allowance, Dividend Allowance) - it is possible to receive £22,000 of income tax-free this year, depending what you're invested in. See the previous posts by me and Jon Snow.
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PaulMTC
Posted: 29 November 2016 22:04:53(UTC)
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Hi Money Spider,

Is there any difference (from a tax free perspective) to going down the "drawdown" route that you use versus going down the UPFLS route?

they both seem the same to me - ie. any growth in the "drawdown" fund is tax free and any growth in the "uncrystalised" fund is tax free.

i guess i'm wondering why there is a distinction (available choice) between the UPFLS method and the drawdown method.

the UPFLS method just seems a more "restrictive" version of the drawdown method?

Thanks,

PC




David 111
Posted: 29 November 2016 23:19:58(UTC)
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Thank you Money Spider and Law Man. Do you know if there is some official web site where this is all explained?
Money Spider
Posted: 30 November 2016 00:25:36(UTC)
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We've really been discussing two topics:
1. Evolving pension legislation/rules, especially post the April 2015 changes.
2. Income tax legislation/rules.
There is no single place (of which I am aware) where this is all definitively explained - I think some is now on Pension Wise and tax should be on HMRC. I found HL's website fairly good (for SIPP info) along with HMRC (for tax), plus googling anything that I didn't understand.

I built myself an Excel workbook whilst in the pension (drawdown) planning process, about 4-5 years ago. It runs from that year through to a time beyond my forecast demise(!). This building process was invaluable as it makes you think, ask questions and look for answers - you end up with a very good understanding of your position and it prepares you for the continuing adjustments in the years ahead (anything in the future is a forecast and likely to change!). To quote Eisenhower: "Plans are nothing; planning is everything".

In the spreadsheet(s) I included: uncrystallized SIPP, Drawdown SIPP, other investments, state pension, planned annual drawdown amounts, annual income tax forecasts, LTA calculation etc. It means that you can update it and experiment (what-if) with various BCE values (amounts, timing), drawdown amounts etc. as 'real life' events evolve (e.g. the recent Autumn Statement). I expect to use this spreadsheet tool for the next 30+ years. I recommend anyone to do this (the technique and maths is not complicated, just comprehensive) - you learn a lot and can quickly understand any changes (types of tax, tax rates etc.), far more than by just reading a single source.

Good luck.
P.S. A third topic I believe it is worth understanding is Inheritance Tax(IHT), but that's a whole separate topic.
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Jon Snow
Posted: 30 November 2016 01:08:15(UTC)
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Did I say that it gets complicated pretty quickly.
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Jon Snow
Posted: 30 November 2016 01:10:54(UTC)
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And,

Horses for courses again.

All this stuff depends on your individual preferences, views on government taxation policy and personal circumstance.

I was offered a cash out sum from one of my DB pensions this year, I took the 25% tax free because I’m paranoid about HMG being bust and needing new ways to cream it off folks who bothered to save and invest. Eg. the new 7.5% dividend tax.

I put it into our (myself and the Duchess) ISA allowances for 16/17 and the balance into a share account to be transferred on 6 April 2017 into our new ISAs for 20K each.

ISAs, get ‘em while you can IMHO their days are numbered, or at least capped.
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kWIKSAVE
Posted: 30 November 2016 20:07:53(UTC)
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Bear in mind for those with deferred DC pensions (before 6.4.2006) may be able to take out more than 25% cash
Mikesmusing
Posted: 04 December 2016 18:04:26(UTC)
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Money spider makes the remark that 'Growth is tax free' referring to investment growth within a SIPP. That's only true if you can drawdown that growth tax free. In most cases 75% of the growth will be subject to income tax. If the growth takes your fund above the Lifetime Allowance (LTA) then that growth will be subject to tax rates of up to 55% (or more if you an additional rate income tax payer). The myth that growth in pension funds is tax free is just that - a myth, in most cases.
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Andrew May
Posted: 05 December 2016 13:03:46(UTC)
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Great inputs from Money Spider and Law Man - thank you both. I'm 55 in June and am considering crystallising my entire sizeable SIPP and taking the tax free 25% whilst leaving the rest of it invested as probably the last asset to be lived off owing to its efficient inheritance tax treatment. I'd need to buy a car and would feed the max into ISAs (as always) and use the rest mainly to buy stocks outside of either tax wrapper, but aiming to earn my £5k of tax-free dividend and my £11k of capital gains allowance from it.

The drive behind this would be to avoid the risk of the government suddenly capping the tax-free element of SIPPs or some similar scheme. I doubt they would make the change retrospective, but I guess I'm not alone in not wanting to risk one of the main reasons I've been saving in this way for 34 years. How likely do other think this is?

My main question, which I'm confident that the mentioned contributors can give me pointers on is how my (now) Lifetime Allowance of a £1M pot works. For example, if at the point of 100% crystallisation my pot is worth £900k (and I take the £225k tax free), then I hope to leave the balance inside the crystallised SIPP for a long time. For simplicity, assuming I add no more to it and ignoring the index linking of the Lifetime Allowance, if my investments do well would I be facing some punitive tax (55% I believe) if the SIPP goes above £1M? Or, should the number be above £775k? OR once I've crystallised and taken 100% of the tax free element, does the government not concern itself with the investment performance of what would be a 100% taxable SIPP?

Hope that makes sense!

Andy
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Mikesmusing
Posted: 05 December 2016 15:28:41(UTC)
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@andrew may

If the example that you describe
- you would have used 90% of your LTA at age 55; you would have 10% of the LTA still available
- you would have a drawdown fund of £675k at age 55
- any growth in your drawdown fund of £675k is tested against your remaining LTA at age 75 i.e. Value of fund at age 75 less £675k is tested against 10% of the then LTA
- if that amount exceeds the available 10% of LTA it is subject to a 25% tax charge deductible from the fund
- the balance of the fund, after any excess LTA charge at 25%, remains subject to income tax when drawn from the fund
- tax rules are always subject to change, but the above is the current position
- the key point would be to draw sufficient from the £675k drawdown fund, before the age of 75, to avoid the excess LTA charge at age 75
- the 55% effective tax charge on excess funds at age 75 arises from the 25% tax deduction from the fund and an assumed 40% income tax charge on the balance (75%) of the fund as it is drawn out of the fund

The above is not tax advice and is only my understanding of the position.
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