Flexible Ways to Access your Retirement Income
  • 15th Jun 2016

With the introduction of the Government’s “Pensions Freedom” legislation on 6th April 2015, individuals now have a much wider choice of how they can take their pension benefits. In addition to the old method of using your fund to buy an annuity, there are two new ways to flexibly access benefits from your pension plans once you’ve reached age 55. One is known as ‘Flexi-Access Drawdown’ (FAD) and the other as an ‘Uncrystallised Funds Pension Lump Sum’ (UFPLS). These two methods are described below. 

 

FLEXI-ACCESS DRAWDOWN (FAD)

If you choose to use a Flexi-Access drawdown approach you will be allowed to make withdrawals from your pension fund in a ‘flexible’ way. This has replaced what used to be known as ‘Capped Drawdown’. From 6 April 2015 no new ‘Capped Drawdown’ plans can be set up, although existing plans can continue to be used (subject to the HMRC withdrawal limits) 

At any time after age 55 you can choose to take (or ‘crystallise’) benefits from part, or all, of your pension fund. If you move into Flexi-Access Drawdown this still allows you the option of taking up to 25% of the fund as a tax-free cash lump sum. The remainder continues to be invested and you are then able to withdraw as much, or as little, as you wish either as a regular income stream or as periodic lump sums. You can for instance choose to take nothing at all or, alternatively, the entire fund in one go. (A further FAD alternative is a ‘short term annuity’ although not every pension provider offers this option).

Importantly, the withdrawals are subject to income tax - at your highest marginal rate, so although it’s now possible to take a large sum out of the pension, it would also likely result in a large tax bill.

 

UNCRYSTALLISED FUNDS PENSION LUMP SUM (UFPLS)

If you want to access some or all of your pension savings without designating funds either for drawdown or to buying an annuity, then UFPLS is the way to do this.

When introducing “Pensions Freedom” the Government wanted people to have greater flexibility in retirement benefit choice. They didn’t want people to feel forced into taking pension income products and to be able instead to easily access funds as ‘lump sums’. In theory this greater flexibility (removing all requirements to take regular income) may encourage more people to save for retirement.

To qualify for a UFPLS if you are under age 75 you must have more standard lifetime allowance remaining than the amount of lump sum being withdrawn. If you are over age 75 you must have some lifetime allowance left. The standard lifetime allowance is currently £1 million.  (The lifetime allowance is a limit on the value of payouts from your pension schemes over your lifetime, whether lump sums or retirement income, that can be made without triggering an extra tax charge).

Every UFPLS will be made up partly of tax–free cash and partly of taxable income. The amount of tax will depend on the individual person’s circumstances. As an example, someone with a pension fund of £70,000 who wishes to withdraw £10,000 by means of an UFPLS (£2,500 of which will be the 25% Tax Free lump sum):

 

 

Non     Taxpayer

Basic-rate taxpayer

Higher-rate taxpayer

Taxable income

£7,500

£7,500

£7,500

Income tax

£0

£1,500

£3,000

Net income

£7,500

£6,000

£4,500

Tax free sum (25%)

£2,500

£2,500

£2,500

Net total

£10,000

£8,500

£7,000

 

 

Other considerations

  • In practice, whether the benefits are taken using FAD or UFPLS, the pension provider would initially apply an emergency tax code to the UFPLS payment, commonly known as “Emergency Month 1”. This essentially means any income is tested against 1/12th of the personal allowance, 1/12th of the basic rate band, and so on, so in the above example what the pension plan holder would initially receive would be:

     

 

Non     Taxpayer

Basic-rate taxpayer

Higher-rate taxpayer

Taxable income

£7,500

£7,500

£7,500

Income tax

£2,103

£2,470

£3,000

Net income

£5,397

£5,030

£4,500

Tax free sum (25%)

£2,500

£2,500

£2,500

Net total

£7,897

£7,530

£7,000

 

 

  • The overpaid tax can be recovered by means of completing an HMRC form (either P50Z, P53Z or P55 depending on the circumstances).

    Taking income either by FAD or UFPLS is a “trigger event” for the Money Purchase Annual Allowance (MPAA) which means any future annual contributions in excess of £10,000 would be liable to a surcharge. HMRC introduced this MPAA rule to ensure that there are no potential ‘recycling’ of pension lump sums with individuals claiming further tax relief on new contributions made to their plans having just taken benefits under the new flexibility rules.

  • Death benefits – using FAD, if you die before age 75 the remaining funds can be passed on to your nominated beneficiaries free of tax (providing payment is made within two years of death), whether it is paid as a lump sum or take as a drawdown income. If you die after age 75, the rules are different and tax could be payable –

ð  If the fund is paid as one lump sum it would be taxed at the beneficiary’s highest marginal rate of income tax.

ð  If the beneficiary takes it as a drawdown arrangement, the income will be taxed as their income.

ð  If there are residual funds left on the beneficiary’s death, then these can be passed on to nominated ‘successors’ and the same rules apply –i.e. tax free if the beneficiary died before 75, and taxable if after 75.

 

IN SUMMARY, WHAT IS THE DIFFERENCE BETWEEN THE TWO PLANS?

UFPLS is administratively simple, but also inflexible. If you draw a tax-free lump sum, then you also have to draw three times that amount at the same time in the form of taxable income. Where someone wants to withdraw the whole of their pension pot at once this is likely to be the favourite option.

The FAD approach offers far greater flexibility. You can draw some or all of the tax free cash without the need to draw income at the same time. Or you can draw income without taking the tax-free cash, or you can take some of each.

For anyone contemplating using drawdown as a long-term income strategy, flexi-access is the obvious solution. They can choose to have income in years when their tax rates are low and tax free PCLS (if there is any left) in years of high income and tax. It should also be noted that these two income options become even more effective where larger pension funds are concerned.

NB: Don’t forget that “drawdown” carries risks:

  • Longevity risk – you might ‘outlive’ your fund
  • Inflation risk –the impact of inflation can erode the value of your fund
  • Investment risk – markets go up and down, and you might take out too much income when markets are down
  • Tax treatment depends on individual circumstances and may also change in the future.

If this has article has sparked your interest and you would like to know more, please contact our Financial Adviser Team at ‘Raymond James Investment Services’ where they will be able to help you.

Their contact number is 01622 691600. 

Disclaimers:

You should not take, or refrain from taking, action based on its content and no part of this document should be relied upon or construed as any form of advice or personal recommendation. Accordingly, Raymond James has no responsibility whatsoever for all and any losses that may result from such action or inaction and it is essential that professional advice is taken.