Pensions: to crystallise or not to crystallise, that is the question

Next week’s Budget is a reminder that chancellors can throw curveballs in the land of pensions planning. Last March, Jeremy Hunt, in a “Budget shocker”, scrapped the pensions lifetime allowance that had been introduced in 2006.

It was a welcome move because the £1,073,100 limit had penalised good investment decisions. Its removal allowed defined contribution pension investors to jettison any concerns of a tax charge should they breach the limit by picking a fast-growing fund or portfolio of shares.

It’s put a stop to the constant tweaking of the allowance, and the need to “help” people coming up against reductions. Under a horribly complex system, when the allowance fell, people could take out lifetime allowance protections that safeguarded their pension savings from penalty taxes.

Some pension providers were euphoric about the end to the lifetime allowance, perhaps anticipating the “fill your boots” impact on pensions savings among the wealthy.

Certainly, data from investment platform Hargreaves Lansdown shows people saved 18 per cent more into their self-invested personal pensions (Sipps) in this tax year up to the end of December compared with the same period the previous year. There was also a 53 per cent increase in the number of people contributing more than £60,000 (the current annual allowance), while the number contributing more than £40,000 grew three-fold.

Surprisingly, the rise in pension contributions has happened despite Labour’s instant post-2023 Budget promise to restore the lifetime allowance.

Now, less than a year from a general election and a few weeks from the end of the tax year, there’s a pressing question for wealthier pension savers of retirement age. How can they ensure excess funds (above the old maximum limit) are safe from being retested against a reintroduced lifetime allowance?

An FT Money reader got in touch. He wants to stay anonymous, so I’m going to call him Hamlet because he asks: “To crystallise or not to crystallise?”

Crystallising is the process of accessing the funds in your pension. Usually, to activate the process, you extract the first 25 per cent of the amount you hold in your pension as a tax-free lump sum. The remaining 75 per cent of your money can be drawn directly or used to buy an annuity.

Hamlet has three Sipps. One is already crystallised and big enough to use up all of his protected lifetime allowance. His two uncrystallised Sipps take him well over the old lifetime allowance.

Hamlet says: “With an impending election and the likelihood the new rules would be rolled back after the election, I think the best course of action is to crystallise the other two Sipps in April in the hope that following the election there would be no claw back of limits already taken. If I don’t do this the uncrystallised Sipps will again be above new lifetime limits and could incur higher tax in the future.”

Certainly, some advisers are recommending their clients crystallise excess funds to protect against a future tax charge, but with no guarantees. Wealth manager Tideway Wealth is advising clients in Hamlet’s position to crystallise ahead of any election and ideally before April 5. After that date there are some changes to pension death benefits which you may want to avoid by doing the crystallisation before then.

Despite the rhetoric, it’s impossible to predict what Labour may or may not do should they get into power

Sue Maydwell, senior wealth manager at Tideway Wealth, says: “The only disadvantage we can see is that post-crystallisation there would be no scope for a tax-free cash sum from crystallised amounts if the amount of tax-free cash allowable at any point in the future exceeded what has been taken already.” But I think it’s unlikely any government would raise the tax-free cash on pensions higher than 25 per cent.

Hamlet’s financial adviser is taking a wait-and-see approach. He’s not alone. Claire Trott, divisional director of retirement and holistic planning at St James’s Place, says: “This is a question we are asked all the time, and there isn’t a right answer as none of us have a crystal ball.”

Despite the rhetoric, it’s impossible to predict what Labour may or may not do should they get into power. The party may want to avoid a flood of NHS doctors retiring early. And could reintroducing a lifetime allowance prove too difficult? It has taken more than 100 pages of legislative change to remove it — and there’s no precedent for governments making retrospective changes to pensions.

But, in the weird world of pensions, relying on lack of precedent feels like naive denial. Tom Selby director of public policy at investment platform AJ Bell, says: “Labour could feasibly make changes to the new rules to capture any actions it feels were designed to dodge its policy intention.”

If this happened, Hamlet would not necessarily avoid a tax charge in the future.

Sir Steve Webb, partner at consultants LCP, and a former pensions minister, thinks the most likely scenario is the “scoring” of defined contribution pots which had been crystallised — perhaps especially those crystallised in the current tax year — against the reinstated lifetime allowance. Then Labour could inhibit the ability of people who had crystallised large amounts of pension wealth from undertaking further tax-privileged pension saving — even if they had crystallised their pensions at a time when there was no lifetime allowance.

The worst case for Hamlet would be if the old rules were reinstated. Ian Cook, chartered financial planner at Quilter Cheviot, warns: “You could be artificially building perceived security in your plans, only to find that you face a significant tax bill later in life.”

So perhaps Hamlet’s best course of action is to make plans based on the current legislation, while making decisions based on his personal circumstances and goals, rather than trying to second guess what a future government may or may not do, and risk a bad decision.

This may feel like a cop-out. But there have never been guarantees in pension planning.

If you’re approaching retirement age, your “pension journey could” last 20-30 years or more, so further changes to the rules are inevitable.

What’s also certain is that tweaking pensions policy means more work for financial advisers and pension schemes — putting into place complex transitional arrangements as the rules changes take time and incur costs. There may be method in this madness but it always means less money for you.

Moira O’Neill is a freelance money and investment writer. X: @MoiraONeill, Instagram @MoiraOnMoney, email: moira.o’neill@ft.com