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Understanding the 25% SIPP tax free process
Money Spider
Posted: 03 November 2017 23:28:14(UTC)

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Soon to be Retired,
Wow, that's a short and simple question.........!!!
If you plan to set up as an Excel consultant then I would expect you to have this all modelled and to have tried 50 different 'what-ifs' by now ! ;-)

Summary/assumptions:
Pension fund = £1 million, LTA = £1 million
Your age = 55, intending to retire ASAP, state pension age = 67 (~2029). Assume £10k state pension from 2030
Desired income = £24k net i.e. about £27k gross
Desired income and state pension grow annually by inflation 2.5% (long term).
Fund growth = 7% p.a. (this is the big variable where most risk is - choose your own number)
No other investments.
Debt = £100k

If you currently have £100k mortgage debt, then I assume this is at a low fixed rate (if not, why ever not?). So, cheap debt.
LTA is tested each time you crystallise funds. As you are at the top limit for LTA, unless you are drawing more than the growth and yield you are going to pay tax on LTA at each BCE.

So, if I was in your position, I MIGHT:
1. Crystallise £900k (90%) to avoid LTA tax, but leave a 'placeholder' to take advantage of any future rises in LTA.
2. Draw £15k income, take £10k from the tax-free cash 'pool' each year.
3. Put £20k from tax-free cash into ISA each year.
4. In 2023 SIPP Capital should have grown from £100k (post BCE) to £140k (@7%). Crystallise another £100k.
5. In 2024 Cash fund will be £130k (ISA will separately be >£150k), so pay off £100k debt at this point. Stop taking £10k from tax-free cash at this point.
(numbers are approximate only)

In 2028 your LTA will be back to about £1 million at this point. So, increase drawdown to absorb the natural yield and growth. Two years later you start drawing your state pension, so increase drawdown from then and put the excess in your ISA.
Draw the remainder of the SIPP Capital fund when you're 70 when it will be about £80k.

So what does this tell you? It tells you what you already know: there are myriad solutions so you need to build your Excel model and play with the numbers. You'll need to update it regularly as tax rates are announced and you know what growth you are achieving. The only simple answers are sub-optimal.

For what its worth, I am considering another BCE tranche now, 4 months earlier than the latest version of my 'plan' suggested that I should (and before this month's budget). As Eisenhower said "Plans are nothing, PLANNING is everything".

Good luck. Once you have the model clear in your head (and on your PC) its easy to test your ideas.
2 users thanked Money Spider for this post.
Jim S on 04/11/2017(UTC), Soon to be retired on 05/11/2017(UTC)
Soon to be retired
Posted: 05 November 2017 20:01:44(UTC)

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Money Spider;52874 wrote:
Soon to be Retired,
Wow, that's a short and simple question.........!!!
If you plan to set up as an Excel consultant then I would expect you to have this all modelled and to have tried 50 different 'what-ifs' by now ! ;-)

Summary/assumptions:
Pension fund = £1 million, LTA = £1 million
Your age = 55, intending to retire ASAP, state pension age = 67 (~2029). Assume £10k state pension from 2030
Desired income = £24k net i.e. about £27k gross
Desired income and state pension grow annually by inflation 2.5% (long term).
Fund growth = 7% p.a. (this is the big variable where most risk is - choose your own number)
No other investments.
Debt = £100k

If you currently have £100k mortgage debt, then I assume this is at a low fixed rate (if not, why ever not?). So, cheap debt.
LTA is tested each time you crystallise funds. As you are at the top limit for LTA, unless you are drawing more than the growth and yield you are going to pay tax on LTA at each BCE.

So, if I was in your position, I MIGHT:
1. Crystallise £900k (90%) to avoid LTA tax, but leave a 'placeholder' to take advantage of any future rises in LTA.
2. Draw £15k income, take £10k from the tax-free cash 'pool' each year.
3. Put £20k from tax-free cash into ISA each year.
4. In 2023 SIPP Capital should have grown from £100k (post BCE) to £140k (@7%). Crystallise another £100k.
5. In 2024 Cash fund will be £130k (ISA will separately be >£150k), so pay off £100k debt at this point. Stop taking £10k from tax-free cash at this point.
(numbers are approximate only)

In 2028 your LTA will be back to about £1 million at this point. So, increase drawdown to absorb the natural yield and growth. Two years later you start drawing your state pension, so increase drawdown from then and put the excess in your ISA.
Draw the remainder of the SIPP Capital fund when you're 70 when it will be about £80k.

So what does this tell you? It tells you what you already know: there are myriad solutions so you need to build your Excel model and play with the numbers. You'll need to update it regularly as tax rates are announced and you know what growth you are achieving. The only simple answers are sub-optimal.

For what its worth, I am considering another BCE tranche now, 4 months earlier than the latest version of my 'plan' suggested that I should (and before this month's budget). As Eisenhower said "Plans are nothing, PLANNING is everything".

Good luck. Once you have the model clear in your head (and on your PC) its easy to test your ideas.


Money Spider - wise words from start to finish

I have one small question: How did you work out my LTA will be back to £1m by 2028?

As I've taken 900k I've used up 90% of LTA, leaving just 10% (£100k). Only unused LTA grows by inflation, so working on 2.5% inflation by 2028 my unused LTA will be £128k (compound 2.5% for 10 years)
Money Spider
Posted: 05 November 2017 20:52:09(UTC)

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Soon to be Retired,
Bear in mind that I created a 'quick and dirty' spreadsheet to give a rough idea of what you might achieve.

LTA (may be) increased by inflation each year - perhaps 2.5%. However this is not the CAGR for your fund(s). I used a CAGR of 7% (per my stated assumptions), so the SIPP 'Capital' Fund should look something like this:
(I always used financial/tax years, so 2018 = year ending April 2018)

Year 2018 2019 2020 2021 2022 2023 2024 2025 2026 2027 2028
£ k 100 107 114.5 122.5 131 40 43 46 49 52.7 56.5
^
£100k drawdown-----------------------------|


Income from SIPP 'Drawdown' Fund:
Year 2018 2019 2020 2021 2022 2023 2024 2025 2026 2027 2028
D/D 15 15.4 15.8 16.2 16.6 17 17.4 17.8 18.3 18.7 19.2
Cash 10 10 10 10 10 10 10 10 10 10 10
Inc. 25 25.4 25.8 26.2 26.6 27 27.4 27.8 28.3 28.7 29.2

£225k tax-free cash @ 4% = £9k p.a. Use this for 90% of the £10k used each year (above)

If you put £20k into your ISA each year and draw another £10k p.a. ten the £225k will be exhausted in 2024. So between 2024 and 2030 (when you receive state pension) you need to draw the annual £10k from your ISA.

My rough spreadsheet 'says' that your LTA will be £999,431 in 2029.

THIS IS ALL JUST A 'QUICK AND DIRTY' ROUGH IDEA and I don't pretend that it is completely accurate. Hence I DO encourage you to build an accurate spreadsheet using your numbers. Then check and double-check your assumptions (especially CAGR assumptions - 7% is not necessarily the right number to use). Then update your model each year when you can update it with the REAL growth numbers.

I hope this is useful to you. Good luck.
(I hope the tables format OK)

E & O E !!
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Soon to be retired on 05/11/2017(UTC)
SWWT
Posted: 03 January 2018 10:12:31(UTC)

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Apologies for troubling this forum (again!), but in tweaking around with my excel model re the LTA and what elements are material at age 75, I have come across a dumb question. Looking through the posts I see it having been answered in more than one way.

To recap my situation; age 64, no income, have SIPP + small DB total c£1.2m. No crystallisation to date. And c£400k liquid assets. No debt.

So, here is my understanding: There are two 'pots' (a bow to Money Spider...), uncrystallised and drawdown. In around 5 months time I am planning a first BCE (of between 75-90%, haven't decided exactly, still modelling, and will also start drawing on my DB) so will take the PCLS and move the balance from the uncrystallised pot to the drawdown pot. So I am left with a minor % of the original £1.2m remaining in the uncrystallsed pot with the balance either taken through activated DB, taken as PCLS or residing in the drawdown pot.

The next BCE (I have decided atm) will be an 'adjustment' just prior to reaching 75.

I have assumed/determined that the LTA in 2028 (when I am 75 and BCE5a is triggered) will be £1.225m. A bit fanciful maybe but taking the government at their word. 3% this coming April, 2.5% pa compounded thereafter.

So my understanding is that in determining whether or not I exceed the LTA current in 2028 I must set against the 1.225m - 1) the value of the DB, + 2) the total of the first (and only) BCE, + 3) the amount remaining in the uncrystallised pot, and + 4) any growth attributed to the amount within the uncrystallised pot.

And 4) is where I would value clarification. I am assuming it is only the growth to the uncrystallised pot that is material to LTA. Any growth to the amount within the drawdown pot is immaterial. Because it is generated from crystallised funds, it is out of the LTA equation, but not of course out of HMRC's radar as it will be liable to marginal rate tax when taken.

I hope my request for clarification comes across ok, having sacrificed brevity (apologies!) in the interests of clarity. Thank you in anticipation.

JW
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Jim S on 03/01/2018(UTC), dd on 03/01/2018(UTC)
Steve U
Posted: 03 January 2018 10:20:57(UTC)

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I believe any growth in the crystallised or drawdown pot will also count


https://www.sense-networ...igger-impact-on-clients/
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Jim S on 03/01/2018(UTC)
Money Spider
Posted: 03 January 2018 10:59:51(UTC)

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@SWWT
I agree with the previous post by Steve U (good link provided - I too believe that this issue will be come increasingly important in the future).

I understand that at age 75, the LTA is tested (BCE 5A) against:
(value of still uncrystallized funds) + (amount previously crystallized, including tax-free cash taken) + (growth in the crystallized funds).

** It is the last (3rd) element that will catch people out **
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Jim S on 03/01/2018(UTC)
Jim S
Posted: 03 January 2018 11:04:38(UTC)

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Thanks for these very illuminating posts!
Mikesmusing
Posted: 03 January 2018 11:36:58(UTC)

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This may help. The information was provided to me by a SIPP platform provider.

Question: I understand that my SIPP drawdown funds will be subject to a further LTA test at age 75. How much would the SIPP fund have to exceed to generate an excess-LTA tax charge, assuming I have no further unused LTA at age 75, please?

For example, if I’d crystallised £100k at outset and taken £25k as a tax free PCLS, would the maximum fund at age 75 be £100k or would it be only £75k before an excess LTA tax charge would arise then?

Answer: I can provide you with information regarding the aged 75 process. When there is a true Benefits Crystallisation Event (BCE) it is always tested against the LTA. There are 2 BCEs that can occur at age 75, BCE5a and BCE5b. The first tests the growth in funds already designated to drawdown and the second tests the value of any uncrystallised funds remaining at age 75.

In your example written above, you are referring to BCE5a. If you had crystallised £100,000 at outset, £25,000 would be your Pension Commencement Lump Sum and £75,000 would have been designated to drawdown. The test at aged 75 takes the current fund value minus the amount designated to drawdown initially and if the amount is greater than 0, this amount is tested against the LTA. So for example if you originally crystallised £75,000 but your fund value was now worth £80,000, £5000 would be tested against your LTA.

Generally, an amount is tested against your LTA at aged 75 where a customer has taken little or no income from their drawdown pot over time, or has had high investment growth within their drawdown pot.

My footnotes: The above is discussing a crystallised fund in drawdown. Uncrystallised funds are all subject to the LTA test at age 75. When a BCE occurs it uses up a percentage of the LTA at the time and the remaining available LTA is always expressed as a percentage of the LTA at the next LTA crystallisation event. So if the LTA at age 75 were £1.3m and you have 10% unused LTA, you have £130k LTA available at age 75. Drawing a DB pension for the first time is itself a crystallisation event and will use up a percentage of any available LTA at the time of crystallisation.

This repeats some earlier posted information. It's based on my understanding. It's not advice and you should seek professional advice if appropriate.
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Steve U on 03/01/2018(UTC)
SWWT
Posted: 03 January 2018 14:00:13(UTC)

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Thank you to all, as ever the information is very helpful indeed. The link too was useful. Am now well clarified and will apply myself to excel, add and populate a couple of rows, re-do a few others and see what the outcome is.

As an aside I had pondered some time ago whether to seek professional advice on this whole pension planning lark but using instead the 'wisdom of the crowds' approach via this and other forums (actually, primarily this one) I reckon the value gained is considerably better than paying someone for a couple of hours and all the time wondering if they are working primarily for you or for themselves. A bit cynical perhaps but one sadly, borne of experience.

A Happy New Year to all and may everyone's investments return double figures!

JW

PS. How did people do this stuff before spreadsheets were invented....?
SWWT
Posted: 03 January 2018 14:18:30(UTC)

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Err.. in re-reading my post my comments re financial advisors may come over as a crack at IFAs in general. Not so (actually, so not so!) as I understand there are several who contribute value to these forums and indeed I had the benefit being advised by one very erudite gentleman over the course of 10 years or so, until he went and most unreasonably retired on me! So apologies if offence taken, certainly none was intended.

JW
Steve U
Posted: 03 January 2018 14:47:04(UTC)

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SWWT;54900 wrote:
Err.. in re-reading my post my comments re financial advisors may come over as a crack at IFAs in general. Not so (actually, so not so!) as I understand there are several who contribute value to these forums and indeed I had the benefit being advised by one very erudite gentleman over the course of 10 years or so, until he went and most unreasonably retired on me! So apologies if offence taken, certainly none was intended.

JW



In my experience it depends on the individual financial advisor.
I'm a financial professional (though not an IFA) and needed the formal advice to unlock my DB pot - after much searching I found someone who was willing to advise without wanting too many thousands of pounds and he was reasonable - but I found that the real details of LTA etc. is a highly specialised area - I too learned much from this thread and also was pleasantly surprised to find this
https://www.pensionsadvisoryservice.org.uk/ to be a very useful resource on even complex questions by using their webchat service (again dependent on upon which advisor I got).
Soon to be retired
Posted: 03 January 2018 17:04:07(UTC)

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@SWWT

As I understand it, growth in LTA only applies to unused LTA, so based upon your outline scenario and presuming you have no LTA protection:

1. Current LTA is £1m and should be £1.030m in 5 months when you crystallise.
2. You indicate you plan to crystallise between 75%-90% of your fund - so let’s assume 75% which is £800k (75% of £1.2m pensions)
3. This would result in 77.66% of LTA being used (£800k of £1.030m LTA) leaving you 32.33% of your LTA unused.
4. If LTA grows as you hope, at age 75 you will have £396k of LTA unused (32.33% of £1.225m) which will be used for your age 75 LTA test

At age 75, uncrystallised funds + growth in crystallised pot, are tested against unused LTA and any amount over unused LTA is subject to LTA tax.
Soon to be retired
Posted: 03 January 2018 20:04:25(UTC)

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Money Spider;54882 wrote:
@SWWT
I agree with the previous post by Steve U (good link provided - I too believe that this issue will be come increasingly important in the future).

I understand that at age 75, the LTA is tested (BCE 5A) against:
(value of still uncrystallized funds) + (amount previously crystallized, including tax-free cash taken) + (growth in the crystallized funds).

** It is the last (3rd) element that will catch people out **


@MoneySpider

Does the LTA check really include “ (amount previously crystallized, including tax-free cash taken) ”??

My understanding is that the amount of unused LTA and this is compared against (value of still uncrystallized funds) + (amount in crystallised pot > than previously crystallized, including tax-free cash taken)

So if you had crystallised £800k and taken £200k as TFC, then as long as the growth in the crystallised fund and along with any drawdowns keeps the crystallised fund under £800k, then the 2nd part of the sum (amount in crystallised pot > than previously crystallized, including tax-free cash taken) would be zero.

If growth in crystallised fund was significant (say 50%) and there was no drawdown, then the crystallised fund would have £900k in it and the 2nd part of the sum would then be £100k (the amount above total crystallised)
Mikesmusing
Posted: 03 January 2018 21:30:08(UTC)

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@Soon to be retired

If £800k was crystallised of which £200k was taken as TFC then the amount designated for drawdown is £600k. The remaining fund at age 75 would be compared with £600k (note, not £800k) and the excess would be subject to the excess LTA tax charge. So if the drawdown fund had grown to £900k by age 75 then the excess LTA charge would be levied on £300k.

This is the same point as explained by the SIPP provider in my post above. I hope this helps.
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Soon to be retired on 03/01/2018(UTC)
Money Spider
Posted: 03 January 2018 22:46:56(UTC)

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I don't think that we are in disagreement. I think the confusion occurs depending on how you 'visualise' the LTA test in your mind. Let me explain:

The actual LTA test is done on a 'reducing balance' basis (my words). At each BCE you use up a percentage of your LTA and your SIPP provider tells you this. For example (LTA = £1M), if you crystallise £600k, usually taking £150k as tax-free cash whilst moving £450k into Drawdown. You have now used up 60% of your LTA.
At each future BCE you will use up some more of your remaining LTA percentage.
Discussions (here and elsewhere) often refer to the remaining percentage.

I tend to think about total LTA. It seems more logical to me and this is how I visualise it. So, at each BCE I think about the total picture:
What is the total, cumulative amount that I have crystallised so far, perhaps in multiple BCEs (tax-free cash + amount taken into drawdown).
I 'visualise' the amount of LTA used up so far, rather than 'How much of the LTA is left unused'?

Example:
If 4 separate BCE's of £200k each time are executed, then these would look like:
BCE(i) £50k tax-free; £150k moved into Drawdown LTA used = 20%, LTA remaining 80%
BCE(ii) £50k tax-free; £150k moved into Drawdown LTA used = 40%, LTA remaining 60%
BCE(iii) £50k tax-free; £150k moved into Drawdown LTA used = 60%, LTA remaining 40%
BCE(iv) £50k tax-free; £150k moved into Drawdown LTA used = 80%, LTA remaining 20%

So for BCE5A you would have 20% of the LTA available to accommodate the
Uncrystallised funds + Growth in crystallised funds(beyond original amount moved to drawdown)

However, I tend to think of BCE5A like this:
LTA used = (value of still uncrystallized funds) + (amount previously crystallized, including tax-free cash taken) + (growth in the crystallized funds).
*This what I was trying to convey earlier*

The end result will be the same, but using my algorithm, the amount above 100% is the excess percentage.
If you follow the logic through then it should be clear.
THE IMPORTANT THING IS that the BCE5A test INCLUDES the growth, if any, in the Drawdown fund over and above their value when originally moved into Drawdown (crystallised)

I hope that I've helped, rather than confused you further. Here's an analogy to the two thought processes:
If I have a full glass of water and drink 50% then: i) has half the water been drunk or ii) is half the water left in the glass? :-)
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SWWT on 04/01/2018(UTC)
Tyrion Lannister
Posted: 03 January 2018 23:27:12(UTC)

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Money Spider;54934 wrote:
I don't think that we are in disagreement. I think the confusion occurs depending on how you 'visualise' the LTA test in your mind. Let me explain:

The actual LTA test is done on a 'reducing balance' basis (my words). At each BCE you use up a percentage of your LTA and your SIPP provider tells you this. For example (LTA = £1M), if you crystallise £600k, usually taking £150k as tax-free cash whilst moving £450k into Drawdown. You have now used up 60% of your LTA.
At each future BCE you will use up some more of your remaining LTA percentage.
Discussions (here and elsewhere) often refer to the remaining percentage.

I tend to think about total LTA. It seems more logical to me and this is how I visualise it. So, at each BCE I think about the total picture:
What is the total, cumulative amount that I have crystallised so far, perhaps in multiple BCEs (tax-free cash + amount taken into drawdown).
I 'visualise' the amount of LTA used up so far, rather than 'How much of the LTA is left unused'?

Example:
If 4 separate BCE's of £200k each time are executed, then these would look like:
BCE(i) £50k tax-free; £150k moved into Drawdown LTA used = 20%, LTA remaining 80%
BCE(ii) £50k tax-free; £150k moved into Drawdown LTA used = 40%, LTA remaining 60%
BCE(iii) £50k tax-free; £150k moved into Drawdown LTA used = 60%, LTA remaining 40%
BCE(iv) £50k tax-free; £150k moved into Drawdown LTA used = 80%, LTA remaining 20%

So for BCE5A you would have 20% of the LTA available to accommodate the
Uncrystallised funds + Growth in crystallised funds(beyond original amount moved to drawdown)

However, I tend to think of BCE5A like this:
LTA used = (value of still uncrystallized funds) + (amount previously crystallized, including tax-free cash taken) + (growth in the crystallized funds).
*This what I was trying to convey earlier*

The end result will be the same, but using my algorithm, the amount above 100% is the excess percentage.
If you follow the logic through then it should be clear.
THE IMPORTANT THING IS that the BCE5A test INCLUDES the growth, if any, in the Drawdown fund over and above their value when originally moved into Drawdown (crystallised)

I hope that I've helped, rather than confused you further. Here's an analogy to the two thought processes:
If I have a full glass of water and drink 50% then: i) has half the water been drunk or ii) is half the water left in the glass? :-)


When you talk about growth of funds in drawdown, my understanding is that means net growth, ie growth minus withdrawals?

So, once a fund is in drawdown, it’s the total of the fund at the second BCE that counts, irrespective of the investment growth or income taken.
Money Spider
Posted: 04 January 2018 00:21:06(UTC)

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@Tyrion Lannister

Terminology is a barrier to us all! :-)

By 'Growth' in the Drawdown Fund I mean the difference between the final value at the point of BCE5A and the 'starting point' when the funds are first moved into Drawdown.

Example:
At age 65 you have a £1M SIPP. You crystallise the the whole amount with 25% being taken tax-free, then the Drawdown Fund = £750k, and 100% of the LTA has been used up.

Over the next 10 years (until age 75) the Drawdown Fund varies between £700k and £800k depending upon the amount taken in drawdown (i.e. withdrawals) and the growth/dividends.

At age 75, BCE5A takes place. The Drawdown Fund is (for example) £830k. So, the LTA excess = 830k-750k = 80k
This is the amount on which you will be taxed at 25% (£20k tax) if no withdrawal of this excess is made, or 55% (£44k tax) if the excess is withdrawn.

The simple moral is clear (to me):
Once you have used up 100% of your LTA, you should withdraw all the growth/income (if you can) to avoid tax on the LTA excess. The only exception is if you are using your SIPP as an IHT mitigation strategy and think paying 25% tax is better than any other options that you have. Managing your SIPP is a lifelong, continuing process.

I am not a financial professional, merely a layman. I think this thread has exhausted my knowledge on this subject. :-)
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Mikesmusing
Posted: 04 January 2018 08:59:50(UTC)

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@Tyrion Lannister

I believe your understanding is correct as is Money Spider’s example in post 139. The conclusion in that post is also, I believe, correct.
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Tyrion Lannister on 04/01/2018(UTC)
Michael Grimes
Posted: 04 January 2018 10:16:09(UTC)

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A couple of points spring to mind from reading about this complex LTA

1) Is there a template spreadsheet that anyone would be willing to share

2) I have c £35k in cash in my SIPP from previous disposals but also the last couple of years £3600 contributions (includes 2x £780 HMRC contribution) not yet invested.

Can I take the £35k as a cash drawdown and thus only have to move the necessary investments into a drawdown pot without the necessity of selling any to fund the £35k
Money Spider
Posted: 04 January 2018 10:52:07(UTC)

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@Michael Grimes

1). Re. spreadsheet. Inevitably a spreadsheet includes a lot of personal information and also possibly (likely?) mistakes. I take responsibility for my own mistakes, but avoid imposing them on others. Plus, I wouldn't want to have to explain (often?) how it works.
Equally importantly, I think that the process of creating such a spreadsheet is invaluable in creating an understanding of how this process works. I have said "creating an understanding", rather than "understanding" on purpose.

However, some months ago I did try to describe the structure of my spreadsheet in order to help others. I don't know if it does ;-)
It's in this posting:

http://moneyforums.cityw...ng-off-investments.aspx

2). I am not sure that I understand your question and you don't say if the cash is in a crystallised fund (Drawdown), or not. Recent SIPP contributions (i.e. the £3,600 x 2) will presumably still be uncrystallised. However, the basic process applies:

a) You can take as much money as you like out of your crystallised (i.e. Drawdown Fund), subject to your marginal rate of income tax.

b) You can buy/sell assets and hold money in your uncrystallised SIPP fund, but you cannot access that cash until you crystallise it in a BCE. You can 'crystallise' investments (in a BCE) and take no tax-free cash which would, in effect, move them from the uncrystallised SIPP to the crystallised Drawdown fund. However, I cannot see why you would want to do this unless you want to access any future income stream from those assets as it occurs. This would seem to be rather tax inefficient though.
1 user thanked Money Spider for this post.
Michael Grimes on 04/01/2018(UTC)
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