Your IndustrySep 12 2013

Tax treatment of flexible drawdown

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Any benefit that is part of the tax-free lump sum entitlement is free of tax. The MIR will be taxed under PAYE, as will any other income drawn.

On death any remaining fund paid out as a lump sum death benefit is taxed at 55 per cent.

Dependent on the structure of the client’s existing money purchase savings, Adrian Walker, retirement planning manager of Skandia, says there were potentially two components that can be used to provide the flexible drawdown income that a client may apply for.

If the client has any untouched pension savings, then Mr Walker points out up to 25 per cent of those savings can be taken as a pension commencement lump sum, which is tax-free. The remainder of their fund must provide income and the capital used from the element providing income will be taxed at the highest marginal rate that the client pays, he adds.

One of the key criteria for flexible drawdown is that the individual cannot make further contributions or accrue further pension benefits, warns Mike Morrison, head of platform marketing of AJ Bell.

If they do accrue further pension benefits in the tax year they enter flexible drawdown then it is invalidated. Mr Morrison adds in later years the individual would face annual allowance charges.

Mr Morrison said: “It is well worth making sure that an individual in flexible drawdown is not accidentally auto-enrolled into a pension scheme.”

As part of the conditions for eligibility for flexible drawdown, Adrian Walker, retirement planning manager of Skandia, notes clients will lose their annual allowance entitlement in future years.

Therefore, he says any contributions paid to a registered pension scheme once in flexible drawdown will mean that the client will be subject to an annual allowance tax charge equal to any tax relief given on personal contributions made into a registered pension scheme.

In the case of any employer contributions made on behalf of the individual who is in flexible drawdown, Mr Walker explains the contributions will be added to the client’s taxable income and the appropriate level of annual allowance charge will be levied on the client in respect of those contributions.

Therefore, in most cases, Mr Walker suggests it would be unattractive from a client’s personal tax perspective to make further contributions after entering flexible drawdown.