FLEXIBLE ACCESS TO YOUR PENSION FROM AGE 55
What has Changed?
Most pension investors aged at least 55 now have total freedom over how they take an income or a lump sum from their pension. If you need a regular guaranteed income throughout retirement, an annuity is the only way of providing a guaranteed income from your pension, regardless of how long you live or market movements. Every other option covered below carries a greater degree of risk, but equally offers the opportunity for an income as well as capital growth. Whilst we seek to cover many of the options, and have a specific section of the Blog about the risks involved, do please take proper finacial advice if you plan to opt for one of the drawdown options.
So, wealth warning over, let’s look at the main options for taking lump sums and income from your pension pot. Essentially there are four ways in which you can withdraw lumps sums. You can choose to:
a. Take the whole fund as cash in one go – 25% will be tax free and the rest will be taxed as income.
b. Flexible Access Drawdown or ‘FAD’ – take up to 25% tax free initially and a regular taxable income from the rest.
c. Uncrystallised Funds Pension Lump Sum (UFPLS) – take smaller lump sums, as and when you like, with 25% of each withdrawal tax free and the rest taxed as income.
d. Trivial Commutation Lump Sum – If your total pension benefits are worth less than £30,000, you can take them all as a trivial commutation lump sum.
e. ‘Small Pot’ – if your pension pot is worth less than £10,000 you can request it to be paid as a lump sum
Whilst many of the changes have been communicated in rather dry prose, Nucleus Financial, an adviser platform has created this rather nice graphic to bring the changes to life (we like Infographics). They also have 11 fact sheets on the new changes (in dry prose) on their site if you want some more reading material.
Using an option known as flexible or flexi drawdown, which existed before the new rules came into force, you can draw what you like directly from your pension pot while the remainder stays invested. You don’t have to move all of your pension into drawdown in one go – you can phase the process. Each time, usually up to 25% of the funds used for drawdown is taken as tax-free cash straight away.
If after taking the tax-free cash you decide to start drawing an income, you can choose to withdraw regular, periodic or one-off lump sum payments from the remaining drawdown funds. These withdrawals will be subject to income tax at your marginal rate. You can start, stop or vary the amount you take at any time, which can be tax efficient. Once a taxable income is taken from the drawdown fund, future pension contributions to personal pensions and SIPPs will be restricted to £10,000 a year.
This may appeal to investors who only want to take their tax-free cash entitlement to begin with, those who want the potential to make larger pension contributions before taking a taxable income, or those who simply want flexibility over the income they take
This is a new option, made possible by new pension rules on 6 April 2015. It allows investors to draw lump sums directly from their pension, without first going into drawdown or buying an annuity. With an UFPLS payment, 25% of each lump sum will normally be tax free and 75% taxed as income (if you have reached 75 and used most of your lifetime allowance the tax-free percentage could be lower). Like drawdown, any remaining pension funds stay invested and will rise and fall depending on the performance of the underlying investments. As soon as a UFPLS payment is taken, future pension contributions to money purchase schemes will be restricted to £10,000 a year.
It is possible to take more than one UFPLS payment. This may appeal to those who want to access their tax-free element in stages, with the potential to increase the overall value, or who do not yet require a regular income.
UFPLS is simple in concept, but frequently complex in application. Whether or not UFPLS is right for you depends on many factors related to your personal financial circumstances. For a detailed discussion of UFPLS have a look at fellow financial blogger Monevator’s article on UFPLS and then read the well informed comments section at the bottom of the post to appreciate the complexities.
Trivial Commutation Lump Sum
If your total pension benefits are worth less than £30,000, you can take them all as a trivial commutation lump sum. (Before 27 March 2014, the trivial commutation limit was £18,000.) This is possible as long as:
- no other trivial commutation lump sum has previously been paid to the client
- the total value of the client’s pension benefits are less than £30,000
- the client has enough lifetime allowance available
- it extinguishes the client’s entitlement to defined benefits under that scheme
- all the benefits are taken within a 12-month period, and
- the client is aged 55 or older (or earlier if the client is in ill health or has a low protected pension age).
The Small Pot Rule (Pensions under £10,000)
There is another option for taking lump sums; those whose pension pot is worth less than £10,000 can request their entire pension is paid to them as a lump sum. You can only receive payments of this type from personal pensions up to three times. If you are able to take your pension in this way, 25% of the payment will be tax free and the rest subject to income tax.
When taking a lump sum it may be beneficial to use this “small pot rule” where possible rather than UFPLS or drawdown. All options mean that income is taxable after the tax-free element but, under the small pot rule, the payment is not measured against the lifetime allowance, which is currently £1.25m (set to reduce to £1m in 2016/17). Nor are future contributions to money purchase pensions restricted in the same way as they are following a drawdown or UFPLS withdrawal.
Key Differences between Flexible Drawdown and UFPLS
On the face of it, UFPLS and Flexible Drawdown (FAD) look very similar. The key difference between an UFPLS withdrawal and drawdown however is how the tax-free portion is treated. With drawdown you typically receive the whole of your tax free sum in one go. Any withdrawals in excess of the tax-free amount will be all taxed as income at your marginal rate. So, if you are a basic-rate (20%) taxpayer, any income you draw from your pension will be added to any other income you receive (e.g. your salary) and this could push you into the higher (40%) or even top rate (45%) income tax bracket.
Who is Affected
Anybody with a defined contribution pension – e.g. individual or group personal or stakeholder pensions, Self Invested Personal Pensions (SIPPs), some Additional Voluntary Contribution (AVC) schemes,
etc. – could benefit. If you are aged over 55 now you should be able to take advantage of the increased flexibility straight away.