One great thing about pensions is that they’re often a lot more flexible than first thought.
I’m not talking about the pension freedoms here, but rather the pension rules themselves. Even when there is a way things ‘normally’ work, behind the scenes the rules often allow scope to do things a little differently.
One such example is when people can take a pension commencement lump sum (PCLS).
For the vast majority of individuals, there will be no reason to consider doing anything other than the ordinary process of taking the PCLS at the point they crystallise their pension benefits. In fact, many crystallisations take place solely because the person is looking to take a PCLS.
However, the rules state that a PCLS can be taken any time up to a year after the client becomes entitled to it. So why might someone want to delay taking a PCLS?
It could be that doing so will allow the client to make more efficient use of their personal allowance and tax bands, taking into account their income requirements and other earnings.
The one year period will almost always span two tax years, so taking some PCLS in each tax year might allow the client to reduce his or her overall tax bill compared to a scenario where they take a large tax-free amount in the first year and a greater amount of taxable income in the second.
Of course, you could simply complete a crystallisation in each tax year, and in many cases, this may be the simpler option. However, there may be good reasons for the client not to want to do so.
For example, let’s say the two tax years in question were 2013/14 and 2014/15 and a client was looking to crystallise £600,000 in total. If half had been crystallised in each tax year, the client would have used up 44% of the lifetime allowance: 20% with the first crystallisation, and 24% with the second, because of the drop in the lifetime allowance from £1.5m to £1.25m.
If the client had completed a single crystallisation in 2013/14 and delayed part of the PCLS to the second tax year, this only would have used 40% overall.
Making efficient use of tax bands aside, this still used to be a reason why someone might consider completing their crystallisation event before the PCLS was required. It’s the opposite idea to the notion of waiting to crystallise until the lifetime allowance has increased, in order to use a smaller percentage.
Crystallising just before a lifetime allowance drop has the same effect, and gives the person a year’s window to take the PCLS at the most efficient time.
There may also be investment-related reasons to delay a PCLS payment. Again, assuming the client wants to complete the crystallisation at a particular time for whatever reason, it may be that it isn’t possible or convenient to create the liquidity within the plan to pay the PCLS straight away.
The client might, for example, be waiting to finalise a commercial property sale or for a fixed term account to mature, to provide the necessary cash.
In most cases, then, delaying the PCLS isn’t actually the main objective: it’s simply a side effect of the person wanting to complete their crystallisation event before their pension is in a position to pay the PCLS, or at a time when they don’t yet want it.
It’s certainly a niche area which will only benefit certain clients in particular circumstances; but for those clients, it’s a handy rule to have available.
Jessica List pension technical manager at Curtis Banks