Freedom and choice

Flexi-access drawdown (FAD)

• All new drawdown plans taken out from 6 April 2015 will be flexi-access drawdown (FAD).

• There won’t be any limits on income levels.

• There won’t be any minimum secure pension income requirement.

• The member can take 25% tax free cash from their drawdown fund, subject to having available lifetime allowance (LTA).

• The balance of the fund can remain invested. It can be paid as a taxable lump sum. It can be used to provide taxable flexible income. Or any combination is possible.

• Once the member takes any income, the £10,000 money purchase annual allowance (MPAA) applies.

• All pre April 2015 flexible drawdown arrangements automatically become FAD.

Example

Ted has a personal pension valued at £200,000. He has no other sources of taxable income in 2015/2016. He has a number of options if he wishes to use FAD.

He could crystallise the whole fund via FAD then take £200,000 as a lump sum. However, this isn’t particularly tax efficient. He’ll receive 25% or £50,000 as tax free cash and the balance of £150,000 will be taxed as income. The £10,600 personal allowance reduces by £1 for every £2 of income over £100,000, to a minimum of nil. Therefore, Ted gets a nil personal allowance. As a result he receives:

25% tax free cash - £50,000

Taxable lump sum - £150,000

£200,000

Income tax: £31,785 x 20% (£6,357)

£118,215 x 40% (£47,286) (£53,643)

Net amount £146,357

£53,643 / £150,000 x 100 = 35.76% tax paid.

If he does want to rebuild his pension fund, he’s caught by the MPAA.

Ted could also use FAD to take his full tax free cash immediately and a tax efficient income as needed. He’d receive £50,000 tax free and could leave the remaining £150,000 invested in a tax advantaged pension environment. If he needs further income in 2015/2016, he could withdraw up to £10,600 without any income tax liability. In future years, provided he has no other taxable income, he could withdraw up to the amount of his personal allowance without triggering a tax liability. Ted needs to consider whether his withdrawals are sustainable.

Another option is for Ted to crystallise just some funds via FAD. He might designate £50,000 of his fund. He could take £12,500 tax free cash and leave the balance invested - £37,500 crystallised and £150,000 uncrystallised. He could access additional tax free cash by crystallising further tranches. At no point would the legislation require him to take an income from the crystallised fund.

With both these options, so long as Ted takes just tax free cash, he keeps the full £40,000 annual allowance and carry forward. This only changes once he actually withdraws any income. Many people will take a flexible approach to retirement, with periods of part-time employment or consultancy work. So this gives scope for further pension funding after starting to take money purchase benefits.

Capped drawdown

• No new capped drawdown arrangements can be set up post April 2015.

• Existing plans can remain in place and operate in the same way as currently, with three yearly reviews and income restricted to 150% of GAD.

• It will be possible to convert capped drawdown to FAD at the member’s request.

• Capped drawdown plans will automatically convert to FAD if the member takes income exceeding 150% GAD.

• The member retains the standard £40,000 annual allowance where their income remains within GAD limits, provided they don’t trigger the MPAA via other arrangements.

• It will be possible to transfer existing capped drawdown plans between providers.

Individuals aged 55 and over could designate some funds for capped drawdown before 6 April 2015, if they haven’t already done so. If their drawdown product allows, they’ll be able to designate further funds in the same arrangement post April 2015 and remain in capped drawdown. They can retain the full £40,000 annual allowance, while being able to take drawdown income within the 150% GAD limit. However, anti tax free cash recycling provisions will bite, amended from April 2015 to apply if someone takes at least £7,500 tax free cash over a 12 month period.

Uncrystallised funds pension lump sum (UFPLS)

• This is a new concept: a lump sum drawn directly from uncrystallised money purchase pensions.

• 25% of the lump sum is paid tax-free.

• The balance is taxed at the member’s marginal rate of income tax.

• It’s possible to take a series of UFPLSs, each treated as a mix of 25% tax free cash and 75% taxable funds.

• Unlike FAD, it isn’t possible to take the tax free cash without receiving taxable income.

• Once an individual takes a UFPLS, the £10,000 MPAA applies.

• Some restrictions apply to members with primary protection, enhanced protection or lifetime allowance enhancement factors affecting their tax free cash entitlement.

Example

Bill is 66 and needs approximately £20,000. His 2015/2016 income is made up of £6,029 state pension and £7,105 occupational pension. He’s got limited emergency cash funds. However, he still has an uncrystallised personal pension of £50,000. There

are no factors restricting his ability to use UFPLS.

To obtain just over £20,000 net, he’d have to withdraw a UFPLS of £23,600:

25% tax free cash - £5,900

Taxable lump sum - £17,700

£23,600

Income tax £17,700 x 20% (£3,540)

Net amount £20,060

His existing pension in-come totalling £13,134 uses up his £10,600 personal allowance. His total taxable income of £30,834 (£13,134 + £17,700) falls within the personal allowance plus the basic rate band (£42,385). So he’s liable to 20% income tax on the taxable element of the UFPLS.

The £26,400 balance of his pension fund remains invested. He can take further UFPLSs if wanted, each treated as 25% tax free cash and 75% taxable income.

He’s now caught by the MPAA. Bill might be able to avoid this if he can take the required funds as up to three small pots of up to £10,000 each.

New rules for lifetime annuities

The new flexibilities permit lifetime annuities to reduce as well as increase in value, outside the existing limited range of prescribed circumstances. Taking income from this new type of lifetime annuity will trigger the MPAA.

Money purchase annual allowance

The MPAA is a new anti-avoidance measure directed at income recycling. It’s set at £10,000 from 2015/2016. The MPAA can’t be carried forward. It only applies to money purchase contributions. Someone who’s affected can still fund a defined benefits scheme up to the normal £40,000 annual allowance, plus any carry forward allowance.

The MPAA applies:

• When income is taken from FAD.

• When income above 150% GAD is taken post 5 April 2015 from a capped drawdown fund.

• When a UFPLS is received.

• When a payment from a new style reducible lifetime annuity is taken.

• From 6 April 2015 for those already in flexible drawdown. They currently have no annual allowance.

The MPAA doesn’t apply:

• Where an individual commences FAD, but takes just tax free cash and no income.

• Where an individual is in capped drawdown and doesn’t receive income above 150% GAD after 5 April 2015.

• When an individual uses the small pots rules.

Death benefits

When death benefits are paid post April 2015, there’s no difference in treatment between crystallised and uncrystallised funds. The existing inheritance tax rules continue to apply.

• Money purchase death benefits can provide an annuity, FAD or a lump sum to any nominated beneficiary.

• Where the member dies before age 75, all types of benefit are tax free provided there’s sufficient LTA.

• If the member dies after age 75, annuity and FAD payments are subject to the beneficiary’s marginal rate of income tax. Lump sums are temporarily taxable at 45% until 2016/2017, when it’s planned they’ll be taxable at the recipient’s rate.

• Where FAD is used, the recipient can nominate their own beneficiary for unused funds, with the tax treatment based on their age at death.

• New LTA benefit crystallisation events test death benefits from uncrystallised funds.

• Dependant’s scheme pensions are still taxed at the recipient’s rate.

Bernadette Lewis is a Chartered Financial Planner at Scottish Widows

http://www.scottishwidows.co.uk/extranet/index