With the radical overhaul of the pensions system a matter of weeks away, the income drawdown market is ramping up for significant and complex changes.
Virtually every specialist provider has confirmed its new drawdown proposition, often as part of an ‘account’ solution offering various access options, along with most pension schemes. A number of legacy schemes may not be providing flexible access on the new terms.
Many existing providers, such as Axa Wealth, Alliance Trust, Old Mutual, Standard Life, have also scrapped set up fees for drawdown as competitive pressure push down pricing. Again, on the other hand some non-specialist schemes are charging far more than most, prompting pledges from the opposition to cap charges.
With divergent appeoaches being taken and with drawdown set to become according to some the default for at retirement income, let’s take a run through of the options for taking income using this option from April.
Capped drawdown
Yes, it’s not just about ‘flexi-access’ drawdown - Capped drawdown savers are being grandfathered into the new regime and it will continue to act in the way it did pre-April 2015. The caveat is that to use this option customers must have set up their drawdown contracts by April 2015, so it’s not going to be an option for new clients after this date.
Customers will be able to draw an income up to a pre-set maximum calculated by using Government Actuary Department tables. As of the 2014 Budget this upper limit was increased to 150 per cent of effectively an equivalent annuity, but this has changed a fair bit in recent years.
Why would you tolerate this limitation? Because you can take income from the fund without triggering the new money purchase annual allowance of £10,000 that will apply for anyone who has flexibility accessed their pension.
This means a saver in capped drawdown will still be able to contribute £40,000 under the prevailing annual allowance - though that might not last long - with a carry forward annual allowance for three years. But as soon as they take more than the upper Gad limit, they immediately enter flexible drawdown and this is lost.
The government has allowed this loophole as it said it would be unfair to apply the £10,000 annual allowance to those in capped drawdown, since they had entered those schemes without knowing that they would be subject this limit.
At present, GAD rates are based on gilt yields of 2 per cent, although this might increase to 2.25 per cent in April as there has been a slight rise in yields since the March rate was set on 15 February. So at the moment maximum income is 3 per cent.
Andrew Tully, pensions technical director at MGM Advantage says: “If a member wants to take some tax-free cash and/or income while still paying further pension contributions, capped drawdown may offer an advantage.”
Claire Trott, head of technical support at Talbot and Muir, points out that the crystallisation benefits in capped drawdown are scheme specific.
“For those that are already in capped drawdown, they can crystallise additional amounts into the drawdown which will result in the maximum income being recalculated on the whole amount. This is scheme specific, so if you are in capped with one provider it doesn’t give you the right to enter capped after April with another.
“There is always the option to transfer additional benefits into the capped plan.”
Flexi-access drawdown
Before April 2015, flexi-access drawdown does not exist. The current system has a flexible drawdown option that similarly allows unlimited income, but as of last March a saver had to prove a minimum income of £12,000 from other, secure sources.
From 6 April this option essentially becomes flexi-access drawdown. Anyone already in flexible drawdown post-April 6 will move automatically to the new regime, triggering the new money purchase annual allowance.
However, as the current annual allowance for flexible drawdown is zero, this represents a £10,000 increase in the amount the saver can contribute.
It will still be possible for those who have not crystallised any benefits to their tax-free entitlement up to 25 per cent and retain the £40,000 annual allowance, but as soon as any income is drawn the individual will be subject to the new limit.
Mr Tully says that flexi-access drawdown will be suitable for those who want the utmost flexibility to take their pension income as and when it suits them. “It also allows a member to take all of their tax-free cash and no income, leaving the fund invested to be drawn down at a later date.
“This is a unique facility – under uncrystallised funds pension lump sum [of which more below] the only way to access the full tax-free lump sum is to withdraw the entire fund.”
Ms Trott adds: “They will be taxed PAYE on these income payments, which means they will be taxed at their marginal rate. The way the tax is taken can mean that they initially pay too much tax on payments but it will eventually word itself out through the system.”
UFPLS (or Uf-plus, Uf-pulls, Flumps, Huffle-puffs)
OK, so it’s not drawdown - but it is a way of taking income. Under UFPLS, lump sums of up to 100 per cent of the fund can be taken as cash. In each case 25 per cent of the payment will be tax free and the remaining 75 per cent will be taxable.
As above, once you’ve accessed the pension fund this way you are subject to the £10,000 annual allowance.
There is a drawdown crossover here, though: you can actually take ad hoc lump sums, with 25 per cent tax-free for each payment, through flexi-access drawdown.
This would involve crystallising a portion of the fund equal to the amount the client wishes to withdraw and then using the new flexiblities to take 100 per cent of this immediately. Old Mutual Wealth has said this is how it will be handling ad hoc lump sum requests.
Intelligent Pensions’ David Trenner says the formally defined UFPLS will be attractive to occupational money purchase schemes who want to allow members some flexibility, but do not want to run PAYE systems as would be required to offer drawdown.
“From the client perspective using UFPLS will allow them to have part of each year’s income tax free, as they could do under phased capped or phased [drawdown] - and will ensure that each lump sum they take includes some on which they do not pay tax.
“However it will not be suitable for those who require all of their tax-free cash, or a major part of it, at the outset, perhaps to pay off their mortgage or for some capital outlay.”
You will need to check how flexible the access is under this option, as a number of major providers have said they may limit the number of payments in a given year, or set minimums on the amount that can be withdrawn in each case.
Generally, Ms Trott says that anyone with enhanced tax-free cash through scheme specific protection is unlikely to want to use this option because they would lose out on their entitlement to their protected tax-free element.
Additionally, those with primary or enhanced protection with associated tax-free cash protection or those with lifetime allowance enhancement features cannot take income this way even if they wanted to, because they would not have a 25 per cent tax free cash entitlement.
Ms Trott said: “UFPLS is an easier option for schemes that have never offered drawdown to administer and this was the reason for its invention. It gives schemes the option of providing some freedom without them having to deal with partially crystallised pots.
“It is likely to be most popular with people wanting the ease of accessing either their whole fund in one go of regular small amounts from a scheme that doesn’t offer Fad.”
