Case study: getting benefit crystallisation events in order
Each benefit crystallisation event (BCE), normally uses up a portion of an individual’s lifetime allowance (LTA). Where individuals with uncrystallised rights held under multiple registered pension schemes don’t have enough LTA to cover these rights, they may find themselves faced with a choice as to the order in which the benefits are taken. The question is, does the order in which the benefits are taken affect the amounts they receive?
To answer this, some detailed analysis is necessary and, unfortunately, it involves a fair bit of number crunching.
Jack’s pension savings are spread over two registered pension schemes, a SIPP and a SSAS. Under the SSAS he enjoys scheme specific lump sum protection and has no form of LTA protection.
The PCLS values in the table are those available assuming no LTA restriction applies.
Jack has no other pension rights and is about to fully crystallise all his benefits.
He needs to decide the order of the BCEs for the purpose of the LTA test. The BCE for the PCLS is always treated as occurring immediately before the BCE of the connected pension.
Taking benefits from the SSAS first
BCE 6 (PCLS): amount crystallised = £100,000
BCE 1 (drawdown): amount crystallised = £200,000
Combined LTA used up: £300,000/£1,073,100 = 27.95%
This leaves 72.05% of LTA to cover the BCEs under the SIPP. In monetary terms, the LTA available is £773,169, which is less than the value of the SIPP.
As Jack has no form of PCLS protection under the SIPP, the PCLS available is restricted to 25% of his remaining LTA:
25% of £773,169 = £193,292
Taking benefits from the SIPP:
BCE 6 (PCLS): amount crystallised = £193,292, using up a further 18.01% of LTA
SIPP fund left after PCLS = £1,000,000 – £193,292 = £806,708
LTA remaining = 54.04% of £1,073,100 = £579,903
Assuming that Jack will never be an additional rate taxpayer while drawing benefits, taking the LTA excess by way of income, rather than as a lump sum, could be more tax efficient.
BCE 1 (drawdown)
LTA charge = 25% of chargeable amount = 25% of (£806,708 – £579,903) = £56,701
Amount crystallised (net drawdown fund) = £806,708 – £56,701 = £750,007
PCLS from both schemes = £100,000 + £193,292 = £293,292
Drawdown fund from both schemes = £200,000 + £750,007 = £950,007
Taking benefits from the SIPP first
BCE 6 (PCLS): amount crystallised = £250,000
BCE 1 (drawdown): amount crystallised = £750,000
Combined LTA used up: £1,000,000/£1,073,100 = 93.18%
Therefore, 6.82% LTA is available to cover the BCEs under the SSAS.
Taking benefits from the SSAS:
Because he has scheme specific lump sum protection under this scheme, Jack is entitled to a PCLS of £100,000. However, in monetary terms he has only £73,185 (6.82% of £1,073,100) LTA remaining, meaning that £26,815 of the PCLS attracts an LTA charge at 55%. The net PCLS available from the SSAS is therefore £85,252.
There is no LTA available to deal with the remaining £200,000 under the SSAS. For comparison purposes, assume the remaining funds are retained within the scheme to provide an income, attracting an LTA charge at 25%. The net amount allocated for drawdown is therefore £150,000.
PCLS from both schemes = £250,000 + £85,252 = £335,252
Drawdown fund from both schemes = £750,000 + £150,000 = £900,000
Taking benefits from the SIPP first generates £41,960 more PCLS, but £50,007 less in drawdown. Jack’s circumstances and overall tax position may determine which is the most appropriate option.
For example, he could have debt to clear, and so the higher PCLS may be more attractive. Alternatively, he may not need much, or any pension benefit and so is looking to pass on wealth tax efficiently to his beneficiaries. Keeping funds within a pension scheme might therefore have more appeal.
This case study illustrates that in circumstances where benefits are available from multiple sources and there is not enough LTA headroom, the order in which benefits are taken may impact on benefit outcomes.
When presented with the scenario outlined in this case study, the optimal solution for maximising benefits is not immediately obvious. Therefore, the task advisers face can be a tricky one, as the analysis required is not straightforward. The number crunching is vital as advisers formulate their recommendations for clients, so hopefully this case study helps provides some insight into the calculations required, and how the findings are interpreted and can then be translated into advice.
This blog first appeared on Money Marketing