Personal Pension  

Capped drawdown opportunity as tax ‘loophole’ remains

Providers have predicted more advisers may seek to move their clients into capped drawdown in advance of new pension freedoms coming into force next April, due to a carve-out in rules designed to close a tax loophole.

In its response to a post-Budget consultation which confirmed savers would be afforded full access to their pension from next year, the government said it would reduce the annual allowance to £10,000 for over-55s that have crystallised their fund.

The move followed concern over potential ‘recycling’ of income, whereby a saver could pay large contributions to their pensions up to the £40,000 annual limit and then encash their pot to get 25 per cent back tax free. Some had said that after age 55 this could have been done annually.

However, the reduction in the annual allowance will not apply to capped drawdown, rules governing which will be ‘grandfathered’ into the new regime. This means that savers in capped drawdown before April 2015 will retain their £40,000 annual allowance.

At the point a saver seeks to take advantage of the new freedoms and withdraw more than the capped amount - 150 per cent of GAD rates - they will immediately become subject to the £10,000 lower limit.

The government said it believes it would be unfair to apply the £10,000 annual allowance since they had entered into capped drawdown schemes without knowing that they would be subject to such a rule.

Andrew Tully, pensions technical director at MGM Advantage said: “It definitely gives people a choice in the run up to next April. If they go into capped drawdown they can keep their £40,000 limit.

“From an income perspective there is no downside in moving into capped drawdwon before next April but from a death tax charge point of view there might be.”

Steve Lowe, director at enhanced annuity provider Just Retirement, said it may be in customers’ interest to stay in capped drawdown in light of this nuance in the legislation.

He said: “Existing customers in capped drawdown schemes will be protected and won’t be constrained like new customers, so that’s the opportunity that these customers will have.

“For advisers this might be a tactical strategy to protect their clients from losing their £40,000 contribution limit from those that can afford to extract income from the capped drawdown limit.”

Earlier this week, the government confirmed three options for taking income post-April 2015, including the new ‘flexi-access drawdown’, a lifetime annuity, or simply taking uncrystallised lump sums. Under the third option a saver could defer taking the tax-free lump sum.

In the paper, the government confirmed that where a capped drawdown fund holds uncrystallised rights as at April 2015, “exiting tax rules (including the cap on pension payments) will continue to apply to those post 5 April 2015 designations”.