TECHTALK
APR 2015 – ISSUE 3 – VOLUME 14
PENSION FREEDOM & CHOICE SPECIAL EDITION
CONTRIBUTORS
Thomas Coughlan
Tom has spent over 14 years in technical roles.
He has wide experience including the provision
of technical support to financial advisers
covering life, pensions and investment
compliance. He currently specialises in pension
planning and automatic enrolment.
Ian Naismith
Ian is a senior manager in retirement income
& planning. He also writes and presents
extensively on pensions as well as representing
Scottish Widows on trade bodies and in
consultations with Government.
Chris Jones
Chris joined the group in 1996. He’s worked in a
number of technical roles in marketing, product
development and technical support. After many
years specialising in life and investment products
his recent focus has been on the new pension
reforms.
Bernadette Lewis
Bernadette joined the group in 2006 and has
over 30 years experience in the financial services
sector, gaining a broad experience across both
life and pensions while working for providers
and intermediaries. She now specialises in
pension planning and automatic enrolment, while
maintaining her expertise in tax and trusts.
CONTENTS
4
2 techtalk
Chris Jones
The new pensions Freedom and Choice reforms are
now in force bringing two new ways for your clients
to take money from their pension fund flexibly.
Here we look at how each of them works.
7
RECIPES FOR SUCCESS – USES
OF DRAWDOWN AND PENSION
ENCASHMENT
Ian Naismith
The choice between flexi-access drawdown and
pension encashment is not always straightforward.
This article uses case studies to explore some of
the issues.
11
14
CAPPED DRAWDOWN: ONGOING
BENEFITS IN THE NEW REGIME
Bernadette Lewis
We explain the basics of the retirement planning
opportunities open to those who stay in the capped
drawdown regime after April 2015.
LIMITING FACTOR: THE £10,000
ANNUAL ALLOWANCE
Thomas Coughlan
Accessing pensions under the new flexible pension
rules imposes a reduced annual allowance on the
member. How this allowance operates is explained
in detail.
18
PENSION DEATH BENEFITS
– THE NEW RULES
21
23
25
27
FAQS: FREEDOM & CHOICE
Lynn Graves
Lynn has 15 years experience in financial services,
specialising in marketing, strategy and business
development roles. MBA qualified, with a career
dedicated to the B2B sector, Lynn is a senior
manager within the Corporate Pensions, Market
Development.
FLEXI-ACCESS DRAWDOWN AND
UNCRYSTALLISED FUNDS PENSION
LUMP SUMS EXPLAINED
Chris Jones
A key part of the Freedom and Choice in pensions
reforms were significant changes in the taxation of
pension death benefits. The new rules are far more
generous than many thought would be the case and
offer up some new planning opportunities.
Thomas Coughlan
A summary of some of our recent FAQs on the new
pension freedoms.
CHOOSING THE RIGHT FUND FOR
THE ACCUMULATION PHASE
Lynn Graves
A look at employer considerations when selecting
default funds for workplace pension schemes.
DECISION OF A LIFETIME
Ian Naismith
We look at planning considerations in advance of
the lifetime allowance reducing to £1 million in
April 2016.
EXTENDING PENSION FREEDOMS
TO EXISTING ANNUITANTS
Bernadette Lewis
A summary of the government’s consultation on
creating a secondary market in annuities.
WELCOME
TO THE APRIL
EDITION OF
TECHTALK
Welcome to the ‘Pension Freedom and Choice’
special edition of Techtalk. The full details of
these radical reforms have emerged piecemeal
over the twelve months since they were first
announced in March 2014. Therefore, we’ve
created this special issue of Techtalk to update
you about the final rules. We also take a look at
some future developments arising out of George
Osborne’s last Budget announcement before the
election.
Chris explains the new ways to access pension
benefits, looking at taking money using
flexi-access drawdown versus encashment of
uncrystallised funds pension lump sums. Ian
Naismith explores these two methods further by
using case studies to illustrate some of the
trickier decisions that are likely to have to be
made. He also looks at the likely impact of the
April 2016 reduction to the lifetime allowance
that was announced in the recent March 2015
Budget.
Bernadette addresses capped drawdown and
explains the benefits of retaining it for those
who are able to continue in capped drawdown
after 5 April. She also examines the previous
Government’s plans to create a secondary
annuity market in 2016 as confirmed by George
Osborne in his March 2015 Budget speech.
Chris also updates us on the generous new
pension death benefit rules and explains the
pros and cons of using a bypass trust under the
new regime.
And Lynn Graves explains the issues facing
employers choosing default funds in light of the
new pension flexibilities and a charge cap.
I hope you will find this Pension Freedom and
Choice special edition both a useful guide and an
interesting read and that we will have helped
you in your discussions with your clients on this
important and very topical subject.
For more information on this topic please take a
look at our extensive range of support at: www.
scottishwidows.co.uk/retirementincomeplanning
And
for
more
information
on
the
March 2015 Budget announcements please
also take a look at Adviser Extranet:
www.scottishwidows.co.uk/budget
Sandra Hogg
Tom explains how the new £10,000 money
purchase annual allowance operates. He’s also
pulled together a handy summary of frequently
asked questions covering all aspects of the new
Pension Freedom and Choice rules.
techtalk 3
FLEXI-ACCESS DRAWDOWN AND
UNCRYSTALLISED FUNDS PENSION
LUMP SUMS EXPLAINED
Chris Jones
The new pensions Freedom and Choice reforms are now in force bringing two new ways
for your clients to take money from their pension fund flexibly. Here we look at how each
of them works.
4 techtalk
FLEXI-ACCESS DRAWDOWN (FAD)
Flexi-access drawdown replaces capped drawdown which
FAD AND THE MONEY PURCHASE
ANNUAL ALLOWANCE (MPAA)
will no longer be available for new arrangements. All new
If a member simply designates into FAD and takes the tax free
drawdown arrangements set up from 6 April 2015 will be FAD.
cash then they keep the standard £40,000 annual allowance.
At any time from a client’s minimum retirement date (normally
55) onwards they can choose to move some or all of their
pension fund into FAD.
However, as soon as they take any income from the drawdown
fund the money purchase annual allowance will apply. This
restricts future tax relievable money purchase contributions
to £10,000 a year. Carry forward is not available with the MPAA.
Normally 25% of the amount can be taken as tax free cash.
The rest remains invested in a drawdown plan. Clients can
then take as much or as little income from the fund as they
The normal annual allowance and carry forward rules remain
available for defined benefit accrual.
choose. They can choose to take nothing at all or the entire
FAD AND DEATH BENEFITS
fund in one go. Any income payments will be subject to
If your client dies before age 75, any funds can be paid to
income tax and taxed at their marginal rate (s).
their nominated beneficiary free of tax whether it is paid as a
lump sum or income. If they die aged 75 or over any remaining
funds will be subject to income tax at the beneficiary’s
marginal rate if paid as an income. Lump sums will initially
be taxed at 45% instead but the government intends this to
be temporary (until 2016/2017). My article on page 18 covers
death benefits in more detail.
FAD AND BENEFIT CRYSTALLISATION
EVENTS
Tax-free lump sum
Moving into FAD will trigger a benefit crystallisation event
Taxable withdrawals
and funds will be tested against the lifetime allowance (LTA).
The LTA charge will apply in the normal way for example 55%
The graph shows how clients can take a
if the excess over the LTA is taken as a lump sum or 25% if
tax free lump sum when they first move
taken as income.
into drawdown but the rest of the
A second LTA test applies to any growth in the drawdown fund at
money they take is taxable.
annuity purchase or if the member is still in drawdown at age 75.
FOR EXAMPLE
UNCRYSTALLISED FUNDS PENSION LUMP
SUMS (UFPLS)
Michael has a pension fund worth
£200,000. If he moves all of this
into FAD he can take £50,000 as a
UFPLS is the alternative option to FAD. This also allows your
clients to take money from their pension funds flexibly.
tax free lump sum. The remaining
At any time from a client’s minimum retirement date (normally
£150,000 can be used to either:
55) onwards they can choose to take lump sums directly from
• provide a regular income
• take payments from the fund
their pension fund. 25% of any amount taken is tax free cash
and the rest is taxed as income.
as and when he needs them
• take nothing from the fund and
leave it all with the potential
to grow.
However if Michael takes the rest of
his fund, it will be subject to income
tax in the year he takes it.
If at any point Michael decides he
wants a fixed amount of income for
the rest of his life he can use any
remaining funds to buy an annuity.
Tax-free portion
Taxable portion
The graph above shows how 25% of each payment will be
tax-free and the rest taxed as income.
techtalk 5
UFPLS AND THE LIFETIME ALLOWANCE
EXAMPLE:
A lifetime allowance test will occur whenever an UFPLS is
Michelle has a £100,000 pension pot. She takes a
taken. To take a UFPLS clients under 75 must have enough
withdrawal of £25,000 using UFPLS. That leaves
available LTA to cover the full payment. Clients aged 75 or
£75,000 in her pension fund.
over must have at least some LTA available before the
• £6,250 of the UFPLS is tax free cash.
• £18,750 is taxable.
Michelle’s taxable income including the UFPLS is within
the 20% tax band so she pays £3,750 income tax on
payment is taken.
UFPLS RESTRICTIONS
As well as the availability of the LTA described above the
the UFPLS.
rules also prevent certain members with primary protection,
Taking £25,000 by using UFPLS leaves her with £21,250
affecting their tax free cash entitlement from using UFPLS.
after tax.
Michelle can continue to use UFPLS to take lump sums
as and when she needs them.
She can also consider moving her remaining pension
pot into flexi-access drawdown.
If at any point Michelle decides that she wants a fixed
amount of income for the rest of her life, she can use
any remaining funds to buy an annuity.
Note: the figures reflect the client’s final tax position after any tax
reclaims or payments due to the PAYE coding applied to the encashment.
UFPLS AND THE MPAA
enhanced protection or lifetime allowance enhancement factors
“FAD GIVES GREATER
FLEXIBILITY BY
GIVING COMPLETE
CONTROL OVER THE
LEVEL OF INCOME”
Once clients take any funds using the UFPLS option the
reduced MPAA applies, restricting any further tax relievable
money purchase contributions to £10,000 a year with no carry
forward available. The normal annual allowance and carry
forward rules remain available for defined benefit accrual.
UFPLS AND DEATH BENEFITS
If your client dies before age 75, any remaining funds can be
paid to their nominated beneficiary free of tax whether it is
paid as a lump sum or income. If they die aged 75 or over any
remaining funds will be subject to income tax at the beneficiary’s
marginal rate if paid as income. Lump sums will initially be
taxed at 45% instead, but the Government plans for this to be
temporary (until 2016/2017).
6 techtalk
WHAT’S THE DIFFERENCE?
With a UFPLS your clients always have to take the tax -free
cash and the income element at the same time. Every withdrawal
must be made up of 25% tax- free cash and 75% taxed income.
FAD gives greater flexibility by giving complete control over the
level of income and so allows clients to take the tax free cash
without having to take any income. This will be particularly
helpful where clients are considering further significant pension
funding in the future. However, clients in this position also
need to consider the tax free cash recycling rules.
In practical terms there may be other differences in terms of
product cost, availability and ease of administration.
Iain Naismith’s article on page 7 looks at planning in more
detail.
RECIPES FOR SUCCESS –
USES OF DRAWDOWN AND
PENSION ENCASHMENT
Ian Naismith
The availability of two options for taking pension benefits flexibly will create many advice
opportunities for advisers.
UFPLS
FAD
techtalk 7
Clients can either :
• make withdrawals direct from pre-retirement pension
through an uncrystallised funds pension lump sum
(UFPLS) with 25% tax-free, or
• draw tax-free pension commencement lump sum (PCLS)
and move the remainder into flexi-access drawdown.
In both cases, this can be done on a phased basis to manage
the move into retirement. But which will be best for an
individual client?
There’s a school of thought that says UFPLS is unnecessary
and dangerous – unnecessary because the same outcome can
be achieved by going into flexi-access drawdown and
immediately cashing in. And dangerous because it will make
it too easy for individuals to cash in pensions and potentially
fritter them away, or even be caught up in a scam. There’s no
denying the risks, but I would dispute the suggestion that
UFPLS is unnecessary. I’ll use a baking analogy to explain that.
FLEXIBILITY OR SIMPLICITY?
If I have a box of eggs, there are essentially two ways in
which I can use them for baking.
1 I can carefully separate out the whites and the yolks and
use the former to make meringues and the latter for custard.
In the world of pension freedom, UFPLS is simple and flexiaccess drawdown is flexible. While there are complications
over the immediate PAYE tax treatment, the concept
of drawing money out and paying tax on 75% of it is quite
a straightforward one for consumers to grasp. Taking
PCLS then moving money into flexi-access drawdown and
potentially encashing immediately is more complex, and
potentially also more expensive if drawdown has higher or
additional charges.
However, drawdown undoubtedly offers greater flexibility,
including the ability to manage tax liabilities. With no
maximum or minimum withdrawal level, it’s possible to take
as much or as little taxable income as desired, until the
uncrystallised (pre-retirement) fund is all used up. For every
tax-free element of payment, three times as much must be
moved to drawdown. As a bonus, using PCLS to provide income
leaves more in the pension than if the same net amount was
taken as taxable income. This is a significant benefit of the
new death benefit rules where drawdown proceeds are tax-free
under age 75. Finally, taking PCLS and entering flexi-access
drawdown without drawing any income doesn’t trigger the
£10,000 money purchase annual allowance, whereas any
UFPLS withdrawal does.
The following case studies illustrate some of the considerations.
2. Or I can break them all into a bowl and make a flan.
Separating out whites and yolks gives flexibility. If I make my
meringues and then decide I’d rather have ice cream than
custard, I can easily change my mind. But mixing the whole
egg together from the start is much simpler and less fiddly.
I could in theory separate out the whites and yolks carefully
and then throw the whole lot into a bowl and make a flan, but
that would be a waste of time and effort. Sometimes simplicity
is preferable to flexibility.
CASE STUDY 1: LUMP SUM WITHDRAWALS – TAX RATE REDUCING
Donald is 60 years old, and earns £45,000 a year. He expects to retire in 5 years’ time, and to have yearly income of £22,000
then. He has a personal pension worth £40,000 and wants to cash in half of that now and half in 5 years to fund capital needs.
Table 1 shows the net income if Donald uses the encashment (UFPLS) option both times, and if he takes the maximum £10,000
PCLS at the start and takes the remainder from drawdown. He benefits overall because more of his taxable withdrawal is at basic
rate with flexi-access drawdown.
Table 1
Encashment
Tax-free
Taxable
Tax
Net amount
Now
£5,000
£15,000
£6,000
£14,000
In 5 years
£5,000
£15,000
£3,000
£17,000
£31,000
Total
Drawdown
Now
£10,000
£10,000
£4,000
£16,000
In 5 years
£0
£20,000
£4,000
£16,000
Total
Ignores growth and charges, and assumes current tax rates continue to apply.
8 techtalk
£32,000
EXAMPLE 2: SHORT-TERM INCOME – CONSTANT TAX RATE
Rebecca is 62½ years old and reaches her state pension age on 6 May 2015, when she plans to retire. Her main income will
be a defined benefit pension of £30,000 a year.
Rebecca’s financial adviser has told her about the generous terms for deferring state pension, and she decides to do that for
5 years. She has a personal pension valued at £50,000 and decides to use that to provide income to replace state pension
over that period. Her adviser tells her that, as a basic rate taxpayer, she can draw £8,500 a year, even if her fund doesn’t
grow. While she could take her PCLS in the first two years and taxable drawdown income after that, she agrees it will be
much simpler to take a series of UFPLS encashments – see table 2.
Table 2
Encashment
Drawdown
Year
Cashed in
Tax-free
Tax
Cashed in
Tax-free
Tax
1
£10,000
£2,500
£1,500
£8,500
£8,500
£0
2
£10,000
£2,500
£1,500
£9,625
£4,000
£1,125
3
£10,000
£2,500
£1,500
£10,625
£0
£2,125
4
£10,000
£2,500
£1,500
£10,625
£0
£2,125
5
£10,000
£2,500
£1,500
£10,625
£0
£2,125
CASE STUDY 3: MAXIMISING DEATH BENEFITS
Mohammed is 57 years old and has a SIPP valued at £600,000. He has yearly earnings of £55,000 and expects these to continue
for the foreseeable future. However, he would like £80,000 immediately to make a business investment. As well as minimising
income tax, he is keen to preserve as much as possible in his pension for the benefit of his family if he dies.
If Mohammed were to take the £100,000 through a UFPLS partial encashment, he would need to cash in £120,344 of his pension,
as demonstrated in Table 3.
Table 3
Without UFPLS withdrawal
With UFPLS withdrawal
Earned income (a)
£55,000
£55,000
Pension withdrawal (b)
-
£120,344
Taxable income( c = a + bx0.75)
£55,000
Personal allowance (d)
£10,600
Taxable at 20% (e)
£31,785
Tax at 20%
Taxable at 40% (c-d-e)
£145,258
£31,785
£6,357
£12,615
£6,357
£113,473
Tax at 40%
£5,046
£45,389
Net income
£43,597
£123,598
If Mohammed uses PCLS with flexi-access drawdown, he takes only £80,000 out of his pension (with £320,000 going to
drawdown), compared to over £120,000 with UFPLS. The amount available from his pension, tax-free on death before age 75,
is therefore £40,000 greater. While income tax has been deferred rather than avoided completely, if he takes drawdown income
after he stops work it may not take him over the threshold for losing personal allowance, and he may even be a basic rate taxpayer
for part of it. Finally, he is not subject to the money purchase annual allowance and could make contributions over £10,000 a year
in the future if he wishes to.
techtalk 9
EXAMPLE 4: MIXING DRAWDOWN AND UFPLS
Margo is 55 years old and has a defined contribution pension fund of £120,000. She is still working and earning £50,000 a
year. Her main pension provision is from a defined benefit scheme, and she expects to access this at the normal retirement
age of 65. Margo also has a personal pension arrangement during a period when she was doing freelance consultancy. The
current fund value is £120,000. She wants to take that out in two stages, and is looking for £54,000 (after tax) immediately,
with a further £35,000 in 5 years’ time.
Table 4 outlines three possible courses of action for Margo now, and table 5 the resulting positions in 5 years. Simply using
two UFPLS encashments or flexi-access drawdown will not provide the required amounts on the assumptions used, in both
cases because taxable income is taken over £100,000 either now or in 5 years. However, using a combination of the two,
where she hits exactly £100,000 in the current tax year, avoids this issue and enables Margo to achieve her objectives.
Table 4 – situation now
Encashment only
Drawdown only
Mixed
UFPLS
£80,000
NIL
£64,000
Drawdown
NIL
£120,000
£32,000
Tax-free
£20,000
£30,000
£24,000
Taxable
£60,000
£40,000
£50,000
Tax
£26,000
£16,000
£20,000
Net Payment
£54,000
£54,000
£54,000
Fund Left
£40,000
£50,000
£46,000
Encashment only
Drawdown only
Mixed
UFPLS
£48,666
NIL
£29,200
Drawdown
NIL
£60,833
£26,766
Tax-free
£12,167
NIL
£7,300
Taxable
£36,499
£60,833
£48,666
Tax
£14,600
£26,500
£19,466
Net Payment
£34,066
£34,333
£36,500
Fund Left
NIL
NIL
NIL
Table 5 – situation in 5 years
Assumes 4%pa net growth and no changes to taxation.
CONCLUSION
The most common use of UFPLS is likely to be to cash in relatively small pensions completely, as an alternative to buying an
annuity. For those with more substantial pension funds, drawdown offers greater flexibility and will often be the most tax-efficient
option. However, where circumstances are relatively straightforward the simplicity of UFPLS may make it attractive, and sometimes
a combination of the two will be the best solution. As always, it is a case of looking at clients’ individual circumstances and
developing the right strategies to optimise their finances.
10 techtalk
CAPPED DRAWDOWN: ONGOING
BENEFITS IN THE NEW REGIME
Bernadette Lewis
Although no-one can set up a new capped drawdown arrangement from 6 April
2015, there are planning opportunities for existing members.
From 6 April 2015:
• it’s not possible to set up new capped drawdown
arrangements
• existing capped drawdown arrangements can continue
• it’s possible to increment existing capped drawdown
arrangements if the product design allows for this
• it’s possible to transfer existing capped drawdown
arrangements between providers
• existing capped drawdown arrangements convert to
flexi-access drawdown (FAD)
–– at the member’s request
–– if the member withdraws more than 150% GAD.
techtalk 11
CAPPED DRAWDOWN
Members who designated funds for capped drawdown by 5
April 2015 and took their tax free cash don’t have to take any
income. They can leave the remaining capped drawdown fund
invested. If they do take income, any income payments will be
subject to income tax and taxed at their marginal rate(s).
The member must restrict any income withdrawals to a maximum
of 150% GAD to remain within the capped drawdown regime.
‘GAD’ refers to the 2011 Government Actuary’s Department (GAD)
tables and the cap on each member’s income is linked to the
member’s age, fund value and the prevailing long term gilt yield.
Three yearly reviews to recalculate maximum income normally
apply while they are under age 75. Annual reviews apply after
age 75. Some actions, such as designating new funds into an
existing drawdown arrangement, trigger an immediate review.
“FROM 6 APRIL 2015,
THERE ARE PLANNING
OPPORTUNITIES FOR
EXISTING MEMBERS”
EXAMPLE
Jen was aged 60 in December 2013 when she designated
a £50,000 pension fund with provider A for capped
drawdown, taking 25% as tax free cash. The structure
of the plan means it’s possible to designate further
funds for drawdown in the same arrangement. She
hasn’t taken any income to date. Jen’s recently retired
from full time employment, but is hoping to continue
earning irregular fees from contracting.
Jen still has an uncrystallised fund with provider B of
£450,000. She wants to crystallise £200,000 of this
fund in May 2015 when she’ll be 62. Jen wants to use
the tax free cash to clear credit card debts and pay for
a luxury holiday. She also needs to start taking an
income to cover her outgoings until she starts earning
significant fees.
Jen would like to keep the option of making substantial
pension contributions in future. If she crystallises into
FAD with provider B and takes any income, she’ll be
caught by the £10,000 money purchase annual
allowance (MPAA). However, she has the option
of transferring her uncrystallised pension funds to
provider A and crystallising further funds into her
existing capped drawdown arrangement.
Existing capped drawdown plan:
• Her fund is now valued at £40,300.
EXAMPLE
Trisha was 58 when she designated a pension fund for
capped drawdown in June 2013. After taking tax free
cash, £142,500 remained invested. Her capped income
limit is currently £9,832 a year. She can use the fund to:
• provide a regular income of up to £9,832 a year
until the next review in June 2016
• take nothing from the fund and leave it all with the
potential to grow
• convert the fund to FAD, so that she can take
payments from the fund as and when she needs
them.
If Trisha converts to FAD and takes the rest of her fund
in cash, it will be subject to income tax in the year she
takes it.
If at any point Trisha decides she wants a fixed amount of
income for the rest of her life she can use any remaining
funds to buy an annuity.
Members who are able to designate further funds for capped
drawdown via an existing arrangement can normally take
25% of the newly designated amount as tax free cash. This is
provided they have sufficient remaining lifetime allowance
(LTA). Designating new funds to an existing drawdown
arrangement triggers an immediate review of the income
limit. This normally results in an increase in the maximum
amount that can be withdrawn, but gilt yield fluctuations
mean this doesn’t always follow.
12 techtalk
• Her capped income limit is currently £2,981 a year.
• Her first triennial review is due in December 2016.
Transferring from provider B to provider A, then
designating a further £200,000 for capped drawdown:
• Allows her to take £50,000 tax free cash.
• Triggers an immediate recalculation of her GAD
limit.
• Her new GAD limit will be based on a fund of
£190,300 (£40,300 plus £150,000).
• If the gilt yield used to calculate maximum GAD is
2%, her new capped income limit will be £13,987
a year.
• If it’s 3%, her new capped income limit will be
£15,699 a year.
• Her first triennial review will now be in May 2018.
By transferring from provider B and using her existing
capped drawdown arrangement with provider A instead
of setting up FAD, Jen can now withdraw an income up
to the GAD limit without triggering the MPAA. She
retains the full £40,000 annual allowance and the
option to use carry forward.
If she does want to make pension contributions, she’ll
need to consider the tax free cash recycling rules for
the next two years.
Jen can still convert from capped drawdown into FAD
in the future, or purchase an annuity if she needs a
secure income.
MOVING FROM CAPPED DRAWDOWN
TO FAD
CAPPED DRAWDOWN AND THE MONEY
PURCHASE ANNUAL ALLOWANCE
A member can convert a capped drawdown arrangement into
FAD if they need the greater flexibility. The member can ask
their provider to convert a capped drawdown arrangement
into FAD. If the member withdraws more than 150% of GAD
from a capped drawdown arrangement, it automatically
converts to FAD.
So long as a member remains in capped drawdown they can
receive income and keep the standard £40,000 annual
allowance. In contrast, taking any income from FAD triggers the
MPAA. A capped drawdown member can still trigger the MPAA
by taking other pension benefits flexibly. Where the MPAA
does apply, it restricts future tax relievable money purchase
contributions to £10,000 a year. Carry forward is not
available with the MPAA. The normal annual allowance and
carry forward rules remain available for defined benefit accrual.
EXAMPLE
Leonard and Terry were both 63 when they crystallised
their pension funds in June 2014. After taking tax free
cash, each of them had a fund of £180,000 and their
current maximum income limit is £15,120 a year.
If they want to take advantage of the new pension
freedoms by converting their capped drawdown
arrangements into FAD, the legislation offers them two
options.
1. They can withdraw more than the current GAD
CAPPED DRAWDOWN AND DEATH
BENEFITS
If a member dies before age 75, any funds can be paid to their
nominated beneficiary free of tax whether it is paid as a lump
sum or income. If they die aged 75 or over any remaining
funds will be subject to income tax at the beneficiary’s
marginal rate. In this situation, one off lump sums will initially
be taxed at 45% instead, but the Government plans for this to
be temporary (until 2016/2017).
limit of £15,120 in a pension year.
2. They can request their capped drawdown provider
to convert the arrangement to FAD.
Leonard converts to FAD by withdrawing more than the
current GAD limit, triggering the MPAA from the day
after making the excess payment.
• Leonard receives drawdown income of £1,260 on
the 15th of each month starting in June 2014.
• He requests an ad hoc payment of £5,000 which
he receives on 20th May 2015.
• The total income paid to him in the pension
year ending June 2015 is 12 x £1,260 + £5,000
= £20,120.
• He’s treated as converting his capped drawdown
arrangement into FAD.
• The MPAA applies to him from 21 May 2015.
Terry tells his provider that he wants to convert a
capped drawdown arrangement to FAD, triggering the
MPAA the day after making the first income payment
following the conversion.
• Since June 2014, Terry’s been receiving £1,260 on
the 15th of each month.
• He asks his provider to convert his capped
drawdown arrangement to FAD with effect from
1 May 2015.
• He makes no changes to his income payments so
“ONCE THE MEMBER
REACHES AGE 75,
ANY EXCESS OVER
THE LTA CAN’T BE
PROVIDED AS
A LUMP SUM”
CAPPED DRAWDOWN AND BENEFIT
CRYSTALLISATION EVENTS
Designating funds for capped drawdown triggers a benefit
crystallisation event and funds are tested against the LTA.
A second LTA test applies to any growth in the drawdown
fund at annuity purchase or if the member is still in capped
drawdown at age 75. The LTA charge will apply in the normal
way ie 55% if the member takes the excess over the LTA as a
lump sum or 25% if taken as income. Once the member
reaches age 75, any excess over the LTA can’t be provided as
a lump sum.
he still receives income payments of 12 x £1,260
= £15,120 in the pension year ending in June 2015.
• Even so, the MPAA applies to him from 16 May 2015
as this is the day after he’s treated as receiving his
first FAD income payment.
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LIMITING FACTOR:
THE £10,000
ANNUAL ALLOWANCE
Thomas Coughlan
To counter possible abuse of the new pension
freedoms, the money purchase annual allowance
– a £10,000 allowance for money purchase
contributions – was introduced. This measure
will apply indefinitely to an individual who
accesses their money purchase pension “flexibly”.
Since 6 April 2015, it’s been possible to access money purchase
pension savings in their entirety. Access isn’t entirely unfettered
though, as full vesting will result in the fund value in excess of
the tax-free cash, being subject to income tax at the member’s
marginal rate of income tax.
The money purchase annual allowance (MPAA) – of £10,000
– generally applies from the day after benefits have been
accessed flexibly.
The MPAA is an anti-avoidance measure intended to restrict
the opportunity to take large amounts from a pension and use
this to fund further pension savings and so artificially inflate
the tax benefits. For example, a higher rate taxpayer could –
in the absence of the MPAA rules – take £50,000 from their
pension and be subject to £15,000 income tax. They could
then use this to pay a net contribution of £35,000, which
would receive £17,500 income tax relief.
The MPAA rules will, from 6 April 2015, restrict the tax benefits
in the above scenario. The gross contribution of £43,750 would
exceed the £10,000 allowance by £33,750 giving rise to a tax
charge of £13,500 (40% x £33,750). So, any tax benefit to be
derived from recycling must be based on total contributions
of no more than £10,000.
The existing lump sum recycling rules will continue to apply
alongside the MPAA rules. The only change is that those rules
apply where the lump sum exceeds £7,500 rather than 1% of
the lifetime allowance. There continues to be no equivalent
income recycling rules, but the MPAA now restricts both types.
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techtalk 15
WHO DOES THE MONEY PURCHASE
ANNUAL ALLOWANCE APPLY TO?
THE REMAINING ALLOWANCE AND
CARRY FORWARD
Accessing a pension fund in full from this tax year onwards
will be possible by one of a number of new product types.
A drawdown contract entered into will be termed a ‘flexiaccess drawdown fund’. Alternatively, access to money
purchase pension savings may be possible via an
‘uncrystallised funds pension lump sum’ that allows pension
savings to be accessed without designating all or part of the
fund to a drawdown contract. Other options include
maintaining a capped drawdown contract that was in
existence at 5 April 2015 or taking out an annuity that
accommodates the new more flexible annuity rules. The
MPAA rules apply depending on which of these product types
is accessed and whether income is received or not.
Invoking the MPAA does not restrict all pension savings to
There are a number of situations in which the £10,000 limit
will apply:
• Where an individual received a flexible drawdown payment
before 6 April 2015, the MPAA will apply from then on.
• When an individual begins a new flexi-access drawdown
fund (or converts their capped drawdown contract to a
flexi-access drawdown fund) and then draws income
from the fund.
• When an uncrystallised funds lump sum is received.
• When a capped drawdown member receives income above
the maximum income limit after 5 April 2015.
£10,000 each year. Benefit accrual in a defined benefit scheme
of between £30,000 and £40,000 is possible on top of the
contributions within the MPAA.
EXAMPLE
Mike, aged 57, earns £50,000 a year. He received a
flexible drawdown payment in 2014/2015, and so has
been subject to the £10,000 MPAA since 6th April 2015.
In 2015/2016, he pays £11,000 into a personal pension,
giving rise to a tax charge of £400 due to exceeding
the MPAA:
40% x (£11,000 - £10,000) = £400
Mike has an annual allowance of £30,000 remaining if
he was able to accrue benefits within a defined benefit
arrangement. This is £30,000 rather than £29,000
because the £1,000 excess above the MPAA does not
reduce the normal annual allowance as it has already
been subject to a tax charge:
Remaining annual allowance:
£40,000 – (£11,000 - £1,000) = £30,000.
• When a flexible annuity is accessed.
• When a payment is received from a scheme pension with
fewer than 12 members that was set up after 5 April 2015.
In all cases, a £10,000 annual allowance will apply only to
money purchase contributions. Carry forward will not be
available in conjunction with the MPAA. The client may also
fund a defined benefits scheme up to £40,000 less any
money purchase contributions within the MPAA of £10,000
before an annual allowance charge applies. This is explained
in more detail further on.
WHEN DOES THE MONEY PURCHASE
ANNUAL ALLOWANCE NOT APPLY?
Clients that don’t want to be restricted by the MPAA can
usually do so, with the exception of those who have received
a flexible drawdown payment. They’ll be subject to the
£10,000 MPAA from 6 April 2015 onwards.
Henrik, aged 58, earns £65,000 a year. He commences
a flexi-access drawdown contract in June 2015 taking
tax-free cash and £1,000 income drawdown. He is
subject to the £10,000 MPAA from the following day
onwards.
In 2016/2017, he pays £4,000 into a personal pension,
staying within the MPAA.
An annual allowance of £36,000 remains for benefit
accrual within his defined benefit arrangement:
Remaining annual allowance:
£40,000 – £4,000 = £36,000.
Henrik has £70,000 annual allowance available from
The MPAA will not apply in the following circumstances,
provided that the member does not trigger it due to activity
in a separate scheme / arrangement:
the previous three tax years, which can be used to
• An individual commences a flexi-access drawdown fund
Carry forward cannot be used to increase the MPAA.
(or converts a capped drawdown contract to a flexi-access
drawdown fund) and does not receive any flexi-access
income.
• An individual holds a capped drawdown contract (that
increase the annual allowance available for defined
benefit accrual to £106,000.
APPLYING THE MONEY PURCHASE
ANNUAL ALLOWANCE
must have been in existence on 5 April 2015) and does
not receive income above the maximum income limit as
calculated for the contract after 5 April 2015.
When the MPAA is triggered it applies from the following day.
• When a payment is received from a standard lifetime
on how the individual’s pension input period(s) (PIP) falls in
annuity.
16 techtalk
EXAMPLE
Which pension savings the allowance is applied to depends
the tax year and the date that the MPAA is triggered.
There are three possible scenarios:
1. A PIP has already closed in the tax year when the MPAA
is triggered.
2. The PIP has not yet closed when the MPAA is triggered
but is due to close before the tax year ends.
3. The PIP has not yet closed when the MPAA is triggered
and is not due to close until after the tax year ends.
Any savings that were made prior to the MPAA being triggered
are not penalised. So when the PIP has already closed when
the MPAA is triggered (as in 1. above) the amount paid during
that period is not tested against the £10,000 allowance.
Where the PIP has not yet closed (as in 2. and 3. above), the
PIP needs to be split to ensure that amounts paid in the part
that preceded the MPAA being triggered are not penalised.
EXAMPLE
Martha receives an uncrystallised funds pension lump
sum on 14 November 2015. This triggers the MPAA
EXAMPLE
Deepak takes out a flexi-access drawdown fund in
April 2015 and draws the tax-free cash and £1,000
income on 2 August 2015. This triggers the MPAA from
3 August 2015.
He also continues to pay to his personal pension plan
– his only pension. The PIP for the plan runs to 30
September each year and has been in force for 5 years.
Regular monthly contributions of £800 net per month
are being paid on the 29th of each month.
There were 12 contributions (12 x £800 x 100/80 =
£12,000) paid before the PIP ended on 30 September
2015, which is after the MPAA rules were triggered.
Two contributions were paid after the MPAA rules were
triggered, so £2,000 is tested against the £10,000
MPAA. As this is less than £10,000, the total contributions
of £12,000 are tested against the £40,000 allowance.
Deepak does not have an MPAA excess or an annual
allowance excess in 2015/2016.
from 15 November 2015.
She continues to pay to her only pension plan; a SIPP,
to which she pays £1,200 net per month. The PIP for
the plan runs to the 15th of July each year. The monthly
contribution date is the 1st of each month.
2015/2016
There are 12 contributions (12 x £1,200 x 100/80 =
£18,000) paid before the PIP ends on 15 July 2015,
which is before the MPAA rules were triggered. These
contributions are not tested against the £10,000
allowance.
2016/2017
Those who want to continue funding their pension by more
than £10,000 each year will need to be aware of the money
purchase annual allowance. By avoiding the MPAA triggers
discussed in this article they can ensure they get maximum
tax benefits on annual contributions of up to £40,000.
Those who want to receive their pension benefits under the
new flexible rules will have little choice, but continued
funding up to £10,000 will give them reasonable scope to
build up further benefits.
The small pot lump sum rules and transitional protection of
capped drawdown are also helpful to those who could
otherwise be restricted by the £10,000 allowance.
There are also 12 contributions (12 x £1,200 x 100/80
= £18,000) paid during the PIP that ends on 15 July
2016, which is after the end of the tax year in which
the MPAA rules were triggered.
The eight contributions paid between 15 November 2015
and 15 July 2016 (8 x £1,500 = £12,000) must be tested
against the £10,000 allowance. The four contributions
paid between 16 July 2015 and 14 November 2015
(4 x £1,500 = £6,000) are tested against the £40,000
annual allowance.
The money purchase annual allowance excess is:
• £12,000 - £10,000 = £2,000
There is no excess above the standard annual
allowance:
• £40,000 > £18,000
Assuming there are no other contributions, Martha has
a money purchase annual allowance excess of £2,000
in 2016/2017, but does not have an annual allowance
excess in 2015/2016 or 2016/2017.
techtalk 17
PENSION DEATH BENEFITS
– THE NEW RULES
Chris Jones
A key part of the Freedom and Choice in
pensions reforms were significant changes in
the taxation of pension death benefits. The
new rules are far more generous than many
thought would be the case and offer some new
planning opportunities.
Under the new rules the key factor is the age at which a
member dies.
OPTIONS AND TAXATION
Member’s age at
date of death
Options and taxation at date of
death
Pre age 75
• Tax free lump sum
• Tax free income via drawdown
• Beneficiary’s annuity free of tax
Age 75 or over
• Drawdown taxed at
beneficiary’s marginal rate
• Lump sum payment taxed at
45% (expected to be at
beneficiary’s marginal rate
from 2016/2017)
• Beneficiary’s annuity taxed at
marginal rate
18 techtalk
DEATH BENEFITS WHERE A MEMBER
DIES PRE AGE 75
A member will be able to nominate any beneficiary and payments
to that individual will be made free of tax, whether it is:
• taken as a lump sum
• accessed through drawdown or
• paid to a dependant or not.
The nominated person can take the benefits as they choose
either as a lump sum or a regular or flexible income. All
withdrawals would be free of tax.
lump sum payment subject to a tax charge of 45%. This option
is to allow for products that do not yet have the flexi-access
drawdown option available.
Where flexi-access drawdown is available and the recipient’s
marginal income tax rate is below 45%, taking the whole
lump sum via flexi-access drawdown would be the preferable
option. Note though that where a death benefits lump sum
takes the recipient’s total income over £100,000, the marginal
rate will be 60% on at least some of the benefits as this will
result in the loss of some or all of their personal allowance.
Beneficiary’s annuities will also be free of tax where the
annuitant or member dies under age 75.
Where a member or annuitant dies aged 75 or over ‘dependants’
annuity payments will continue to be paid at the beneficiary’s
marginal rate of income tax. The new rules will allow annuities
to be set up permitting any beneficiary to receive the income.
DEATH BENEFITS WHERE A MEMBER
DIES AGED 75 AND OVER
PASSING MONEY DOWN THE
GENERATIONS VIA DRAWDOWN
As above, the member will be able to nominate any beneficiary
to receive the death benefit. Payments to the chosen beneficiary
will be subject to income tax at the beneficiary’s marginal
rate where the funds are taken as income. There are no
restrictions on the level of withdrawals that can be taken ie
the nominated beneficiary can take the whole fund at once.
The new rules also allow the nominated beneficiary to pass
on any unused drawdown funds on their death to their own
nominated beneficiary, known as a successor. The same tax
treatment will apply but the relevant age will be the age of
death of the beneficiary rather than the original member. If
the original beneficiary dies below age 75 the successor can
receive a tax free lump sum or continue with tax free
drawdown. If the beneficiary dies age 75 or over then any
benefits can either be taken by the successor as taxable
drawdown income or a lump sum taxed at 45%.
There is also an alternative option which the Government
says it intends to be temporary (until 2016/2017). This
allows the beneficiary to receive the benefits as a one-off
techtalk 19
This gives the potential to pass pension funds down through
the generations without ever falling into anyone’s estate for
inheritance tax (IHT) purposes. In addition, the funds can
remain in a tax advantaged environment and have the
potential to provide a tax free income where the member or
beneficiary dies before reaching age 75.
Technically there is no end to this planning; a successor could
also pass their remaining funds down to a further successor
and so on. Of course, most members or their beneficiaries
will need the funds to provide an income in their lifetimes but
this does give clients who have other funds a very useful
planning option.
EXAMPLE
Simon dies at age 65 with a £200,000 fund.
He has nominated his wife, Lindsey aged 60 to receive
the funds as she will need them to supplement her
own relatively modest income. She decides to take
dependant’s drawdown so the funds can remain
invested in a tax efficient environment, remain outside
of her estate for IHT and she can benefit from tax free
income. Lindsey takes a tax free income of £12,000
a year until she dies at age 74. The fund is then
worth around £160,000*. Lindsey nominates her
daughter Andrea to be her successor. Andrea is aged 48
and a higher rate taxpayer. Andrea also decides to keep
the funds in drawdown. She plans to take a tax free
income later when she plans to reduce her working
hours. If there are any funds left on her death she can
pass them on again to her own nominated successor.
If Lindsey had survived to age 75 she could have
reviewed and potentially updated her nomination. As the
remaining funds would then be subject to income tax
she could have instead nominated her grandchildren.
Her grandchildren are aged 18 and 20. The funds could
have remained in drawdown and then used to help
fund them through university. The grandchildren could
draw funds using their personal allowances each year
and if so, minimise any tax payable.
*Figures are solely to illustrate the planning point and do not represent
indications of actual growth
BYPASS TRUSTS
The new rules will make bypass trusts less attractive and in
many cases unnecessary. One of the main uses of the trust
currently is to keep the pension funds outside of the spouse’s
estate whilst allowing them to maintain access to the funds
at the trustees’ discretion. Any unused funds can then be
passed down the generations with no IHT on second death.
As explained above, this can now be achieved by keeping the
funds in pension drawdown. The pension option has the
added benefits of the funds remaining in a tax advantaged
environment for growth and income. It also avoids any
potential IHT periodic and exit charges as well as the
administrative complexities of having to use a trust.
Of course there will still be situations where a bypass trust
may be suitable, for example, where clients have complex
20 techtalk
family situations. Here clients may desire a greater degree of
control over how assets are distributed. However, the
additional control will now usually come with a tax cost
rather than previously where there was often a clear tax
benefit. In addition, to achieve the required control in
complex situations, this may need to involve bespoke trusts
and the appointment of professional trustees which will
further increase the costs.
It may be worth reviewing any bypass trusts that have been
set up for existing clients to ensure they are still required in
light of the new rules. Where a bypass trust is no longer
suitable the member can simply change the nomination in
favour of their new chosen beneficiaries and the trustees can
distribute the nominal trust fund, normally £10 to one of
the beneficiaries.
DEATHS BEFORE APRIL 2015
The new rules will apply where the first payment is made on
or after 6 April 2015 regardless of the date of death.
However, the two year rule still applies to payments of benefits
(see below).
TWO YEAR RULE
The two year rule remains and to ensure the tax advantages,
payments to beneficiaries need to be made within two years
of the member’s death. The same rule will apply when the
nominated beneficiary dies and passes funds onto a successor.
The rule also applies where the beneficiaries wants to
continue in drawdown. However, they only need to make the
designation into drawdown, there is no requirement to take
any income.
LIFETIME ALLOWANCE (LTA)
The lifetime allowance still applies so if the benefits haven’t
already been tested against the LTA then they will be and any
excess will subject to the LTA charge in the normal way. New
benefit crystallisation events ensure that any uncrystallised
funds are tested when used to provide death benefits for the
nominated beneficiary.
NOMINATIONS
Where the member has not made a nomination and has left
any dependants, the scheme can only set up drawdown for
someone who is a dependant. Where the member has not
made a nomination and has not left any dependants, the
scheme can nominate any individual to receive drawdown.
Schemes retain any existing discretionary powers in respect
of lump sum payments.
Payments to individuals will be taxed in the same way as to
those nominated.
It will now be even more important to ensure clients’
nominations are up to date so that they can make the most of
the planning opportunities the new rules provide. It will also
be important to review nominations for any clients still
invested at age 75. The change in the taxation of death
benefits at that point may mean an alternative beneficiary is
more appropriate.
FAQS: FREEDOM & CHOICE
Thomas Coughlan
Following the Pensions announcement in the March 2014 Budget, the Scottish Widows
Financial Planning Helpdesk has received a significant volume of calls asking for information
and clarification on the new flexible pension rules from 6 April 2015.
Some of the questions received and the answers provided by the Financial Planning team
are summarised here:
Will it be possible to transfer a capped drawdown after
5 April 2015 and retain a £40,000 annual allowance?
If a flexi-access drawdown payment is received in
2015/2016 will this trigger the £10,000 money purchase
annual allowance? Can the small pots rules be used to
avoid this?
Yes. A member who has not flexibly accessed any of their
pensions under the new rules (including receiving a flexible
drawdown payment before 6 April 2015) and holds a capped
drawdown contract that never exceeds the GAD limit after
5 April 2015, will be entitled to a £40,000 annual allowance.
Transferring a capped drawdown post 5 April 2015 to another
capped drawdown contract won’t affect this position provided
that the GAD limit for the contract is observed.
Yes and it will apply in each subsequent tax year. If a client
wants to avoid the £10,000 money purchase annual allowance,
they’ll still be able to take up to 3 small pots of no more than
£10,000 each. So a client will be able to access up to £30,000
of their funds subject to product restrictions before the
£10,000 allowance is triggered.
Does the money purchase annual allowance apply only in
the year that flexi-access income is received?
Does the money purchase annual allowance apply when a
flexi-access drawdown policy is set up on a nil-income basis?
The money purchase annual allowance applies indefinitely.
So once it is triggered, it will apply for the remainder of that
tax year and each subsequent year.
No. Taking tax-free cash and setting up a flexi-access drawdown
account from which no income is paid, doesn’t trigger the
money purchase annual allowance.
techtalk 21
Can part of a pension be taken as an uncrystallised funds
pension lump sum (UFPLS), along with the full tax-free
cash entitlement?
Can the payment of death benefits be deferred where
death was before 6 April 2015 to benefit from the new tax
treatment?
No. Any payment of UFPLS will be made up of a 25% tax-free
payment and a 75% taxable payment. The full payment has to
be within the lifetime allowance where the member is under
75. The taxable part will be subject to income tax at the
member’s marginal rate of income tax. A member that wants
to take tax-free cash of greater than 25% of the total cash
received must go down the flexi-access drawdown route.
If the member died before age 75 and the payment has been
deferred until 6 April 2015 or later – but is made within 2 years
of notification to the scheme administrator of the member’s
death – it will not be subject to a death benefit tax charge. And
provided it’s within the member’s lifetime allowance there
won’t be a lifetime allowance charge either.
Can an UFPLS be taken in conjunction with protected
tax-free cash greater than 25%?
Only 25% of an UFPLS will be free of tax, provided that the
member has available lifetime allowance to cover the total
payment.
Can £10,000 or less be taken as an UFPLS to avoid the
money purchase annual allowance applying?
Only if they receive flexi-access income. Taking tax-free cash and
designating uncrystallised funds into flexi-access drawdown
does not trigger the money purchase annual allowance. It is
only when “flexible income” is received that it is triggered.
“Flexible income” means:
No. A UFPLS will trigger the money purchase annual allowance.
However, the small pots rules do not. So a client can receive
up to 3 pots of up to £10,000 in value without being subject
to the reduced annual allowance.
–– flexi-access drawdown income
What is the income tax position on the death of an
individual with a personal pension / drawdown, following
the recent changes?
–– flexible drawdown income that was received
before 6 April 2015.
If a scheme member dies before reaching age 75 then all
payments to their nominated beneficiary would be free of tax.
The beneficiary can receive either a lump sum or a drawdown
income and there’s no requirement to be a dependent to
receive the latter.
If death is after age 75, the beneficiary can still receive income
or a lump sum payment. Income payments will be subject to
income tax at the beneficiary’s marginal rate. For 2015/16
the alternative is a lump sum taxed at 45%. This 45% rate is
intended to be temporary and payments are planned to be
subject to marginal rate income tax from 2016/17.
Can death benefits be passed down through the generations
tax-free, if the original member died before reaching age 75?
It’s the age of the most recently deceased individual that
matters. So, if the member dies before age 75, the payment of
death benefits to a nominated beneficiary will avoid income
tax charges. If the nominated beneficiary nominates a further
beneficiary (a “successor”) and dies before age 75, then
payments to the next beneficiary can also be tax-free. It can
continue in this way indefinitely, but of course, at some stage
someone is likely to survive beyond age 75 or the fund will be
exhausted.
22 techtalk
Does setting up a flexi-access drawdown after April 2015,
trigger the money purchase annual allowance? What else
triggers the reduced allowance?
–– uncrystallised funds pension lump sum
–– income from a flexible annuity
–– income from certain types of scheme pension
Does the £10,000 annual allowance affect a final salary
scheme member?
The £10,000 money purchase annual allowance only restricts
what can be paid to defined contribution (DC) schemes.
In addition to what is paid to DC schemes, an individual can
accrue benefits in defined benefit (DB) schemes up to £40,000
less the amounts paid to DC schemes within the £10,000
limit. So a member subject to the £10,000 allowance will be
able to fund DB schemes up to a maximum of between
£30,000 and £40,000. Carry forward can also be used to
increase the annual allowance for DB accrual, but not the
money purchase annual allowance. Our Retirement Planning
Technical Guidance no. 13 explains this in more detail.
Does a member with a capped drawdown contract who
stays within max GAD automatically retain the full annual
allowance?
Not necessarily. If the £10,000 money purchase annual
allowance is triggered, it applies to all of an individual’s money
purchase schemes. So if your client causes the £10,000 to be
invoked because of flexibly accessing another pension plan,
it will apply to all of their plans including the drawdown.
If your client does not flexibly access any other pension plans
and stays within the capped drawdown maximum income
limit, they will retain the £40,000 annual allowance.
CHOOSING THE RIGHT FUND FOR
THE ACCUMULATION PHASE
Lynn Graves
Budget flexibilities along with a charge cap mean many employers may start to reconsider
the default investment fund offered to members.
It’s often been said that change is constant and it’s certainly
been true in the corporate pensions market over the last few
years. Whether it was RDR, auto enrolment, or the changes
resulting from the DWP command paper, employers have had to
deal with more than their fair share of change. So when George
Osborne made his budget announcement there may have been
a collective sigh of relief that pension freedoms were aimed
squarely at the individual.
From April over 55s will be able to withdraw some or all of their
pension savings, or take several smaller lump sums over
numerous years, with 25% of each withdrawal being tax free.
They’re likely to follow one of three different retirement
journeys. People with smaller pots may take it all as cash, some
will still purchase an annuity – potentially a little later in life,
and we expect the majority to draw on part of their pot over
time, potentially saving and drawing down intermittently.
But with an increasing proportion of UK savers contributing to
a pension scheme through their employer, it was never going to
be that simple. Employers have an important role to play in
ensuring that those heading towards retirement are best placed
to make the most of their newfound pension freedoms. But it
doesn’t necessarily mean that they need to rush out and change
their default fund straight away.
So what does that mean for employers? The key thing is keep
calm and don’t rush. The reality is we really don’t know how
people will react to the new freedoms so it might be wise to wait.
techtalk 23
For many schemes the de-risking element will remain the
same, the area that needs attention is the ‘at retirement’ aspect
where individuals will have greater choice.
The immediate need is for those about to retire. This is likely to
be a small portion of workforces, but it’s important that providers
can support them in their choices. As long as this is the case
there’s no need to rush to change default funds immediately.
Understanding the needs of a whole workforce is key when
considering default funds and keep in mind that not everyone
will want the default option. So think about what can be done
for those who want something different.
Target Date Funds (TDF) are more common in the defined
contribution world and, interestingly, have been employed by
NEST. Conceptually, lifestyling and TDFs do the same thing –
growth phase followed by de-risking approaching retirement.
Lifestyling achieves it through a series of funds (that can be
individually benchmarked) whereas TDF is a ‘one fund’ concept
with a more sophisticated asset mix (eg non-traditional asset
classes). This may cost a little more; potentially has variable
annual fees depending on the mix; may be higher risk; and
may be difficult to benchmark or justify performance.
There’s a wide-spread appreciation of the risk-reduction benefits
of some multi-asset funds. A quality pension scheme default
has to balance the aim of achieving good member outcomes
alongside ease of understanding, and at an appropriate cost.
24 techtalk
The introduction of too many and, perhaps, esoteric assets
may run the risk of compromising these principles.
It’s also worth considering paying a little more for an ‘active’
or ‘managed’ fund versus a ‘passive’ one, which will adjust to
the market conditions offering a little more protection. There
are also self-investor funds or bespoke lifestyling where advisors
pick a number of funds for you. That approach is a little more
expensive but you gain the benefit of an advisor’s experience.
The key thing is to take your time to understand the options,
and see how people respond to the new freedoms.
Getting the right default is obviously important however it’s
only part of the equation. We have seen many ‘triple defaulters’
in the past (members who default into their workplace scheme,
into the default fund and then ultimately into an annuity) and
although many of the budget changes are designed to drive
people towards being more engaged with their pension
savings, workers are going to be expected to make more
complex decisions than ever before (and at an earlier stage).
While the law doesn’t require employers to give support for the
new freedoms, it’s become apparent from auto enrolment that
many people lack basic financial understanding, and may look
to their employers for support when making these decisions.
While the industry is improving access to information and
advice, there’s definitely a role for employers and advisers to
support and encourage engagement with these resources for
the financial wellbeing of their workforce.
DECISION OF A LIFETIME
Ian Naismith
The lifetime allowance reduction means clients need to plan carefully.
The further reduction to the lifetime allowance proposed in the
There will be protection measures similar to those that applied
Budget, has the feel of ‘death by a thousand cuts’ for substantial
from April 2014. Those who are willing to abandon future
pension provision. The cut from £1.25 million to £1 million in
pension provision may retain the current Lifetime Allowance
April 2016 will be the third in four years, leaving the allowance at
(Fixed Protection). And they have the alternative of locking in
less than half the level originally intended, when it was to be
the value at 5 April 2016 while retaining the ability to contribute
inflation-linked from 2011/12 onwards. Proposed linking to CPI
in future (Individual Protection). There may be some differences
from 2018 is only limited compensation.
from previous protections, perhaps to allow for post-2018
The proposed reduction doubles the percentage of those
escalation of the standard allowance.
approaching retirement affected by the lifetime allowance from
For some, funding fairly heavily for the next year then stopping
2% to 4%, but with many more at risk in the future. Particularly
future accrual will be appropriate. In doing that, they may be
if escalation is scrapped or the allowance reduced further in
able to carry forward unused annual allowance from previous
future years. However, the reduction is almost certain to go ahead
years to 2015/16 or 2016/17 input periods.
whatever the outcome of the General Election. Clients have a
year to take appropriate action.
Those who are over age 55 have other options. If their pension
schemes allow it, they can crystallise benefits using the current
lifetime allowance and fund further in future.
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CASE STUDY ONE: DC
CASE STUDY TWO: DB
Carolyn is age 58 with defined contribution pensions totalling
Similar considerations apply for Derek, who is 57 and a
£937,500. She plans to work for another 5 years, and is keen
member of his employer’s final salary pension. He estimates
to keep funding her pension in that period. However, Carolyn
that if he takes benefits at the normal retirement age of 60 he
is concerned that she could go over the new lifetime
will receive a pension of £60,000 a year. With a 20:1 valuation
allowance, even if she were to stop contributing.
factor, this will take him over the new lifetime allowance.
One option for Carolyn is to use a different vehicle for future
savings, and apply for Fixed Protection 2016 (assuming that
is available on a similar basis to previously). It’s likely, but
not certain, that this will mean she escapes a lifetime
Derek could continue to accrue benefits and accept that the
lifetime allowance charge will result in a pension reduction,
or he could become a deferred member with Fixed Protection
2016 and forgo three years of accrual.
allowance charge, and if things go wrong with her investments,
A third possibility allowed by Derek’s scheme is to take
she can give up protection and resume contributions.
benefits early and continue working. He again loses three
Perhaps a better course of action, though, would be to
crystallise her existing pensions, taking 25% as tax-free
pension commencement lump sum (PCLS) and placing the
rest in flexi-access drawdown with no income. Carolyn would
use 75% of her lifetime allowance (£937,500/£1,250,000),
leaving at least £250,000 (25% of £1 million) available for
future contributions. That should allow her to keep
contributing at a level close to the annual allowance
without suffering a lifetime allowance charge. Of course,
she would need to be sure that crystallising was the best
years of accrual and sees his pension reduced by 15% for
early retirement, leaving him with around £47,000 a year,
but starting three years earlier. This uses up just over 75%
of the current lifetime allowance. He can then join his
employer’s DC pension scheme, and also use part of his
pension income to fund heavily during the three years. Taking
a DB pension does not trigger the money purchase annual
allowance. Having talked through the options and risks with
his financial adviser, Derek decides this is the right course
of action for him.
thing for her, especially if she has guaranteed annuity rates
These case studies illustrate the potential benefits of starting
or exit penalties on her existing arrangements. And since she
to receive benefits before April 2016, even if clients are still
will face another crystallisation event at age 75, Carolyn will
working. Of course, individual and tax circumstances need to
need to keep an eye on growth in drawdown. She will also
be taken into account, and it is certainly not the right choice
need to find an alternative investment for the amount taken
for everyone, but there will be many people needing advice
as PCLS. But the additional funding flexibility could make
on lifetime allowance planning over the next year. Where
it worthwhile.
entering drawdown while still contributing is the best option,
the ideal product solution is one that allows both elements to
be held in the same pension plan.
26 techtalk
EXTENDING PENSION FREEDOMS
TO EXISTING ANNUITANTS
Bernadette Lewis
The Government has launched a consultation on allowing existing annuitants to
exchange their annuity for a lump sum or flexible income. The new rules won’t
come into effect until April 2016.
Any lump sums paid to the annuitant will be in their
inheritance tax estate immediately. The same death benefit
options will apply to FAD and flexible annuities as explained
in Chris Jones’ article on page 18.
The ongoing income received by the purchaser will be taxed
as trading or miscellaneous income, not as pension income.
POTENTIAL BARRIERS
Following the Freedom and Choice in pensions reforms in the
March 2014 Budget, there’s been concern in the consumer
media about people who consider themselves to be locked
into poor value annuities. The Government responded in the
March 2015 Budget by proposing further reforms from April
2016 that will enable individuals to sell their annuity without
incurring a penalty tax charge. The DWP has issued a
consultation to consider how best to implement the changes.
THE PROPOSALS
The Government proposes to remove the current tax charge
(which is normally 55%, but can be up to 70%) for those
assigning their annuity, and aims to encourage a secondary
annuity market.
It proposes that annuitants will be able to sell their annuity to a
commercial third party (not the current provider) in exchange for:
• a lump sum, taxed at their own marginal rate of income tax
• flexi-access drawdown (FAD) or a flexible annuity, with no
immediate liability to income tax. Withdrawals will be taxed
at their own marginal rate. There will be no entitlement to
any tax-free cash and there will be no test against the LTA.
The consultation also covered the range of potential barriers
to be overcome. There are significant consumer protection
considerations, as individuals will be giving up a guaranteed
income stream in exchange for a lump sum, without necessarily
appreciating the longevity risk. The Government may extend
the scope of the Pension Wise service, or even require compulsory
regulated advice for anyone considering selling their annuity.
There’s a need to take into account those other than the
annuitant who are provided for under the existing annuity.
For example, someone who could benefit from a dependant’s
provision or any guarantees.
The Government is clearly concerned that some people might
sell their annuity, spend their funds and increase their
reliance on means tested benefits such as Pension Credit or
Housing Benefit. So a possible restriction preventing anyone
receiving means tested benefits from selling their annuity is
also under consideration.
CONSULTATION DETAILS
The DWP consultation ‘Creating a secondary annuity market:
call for evidence’ is open for responses until 18 June 2015.
You can find full details here:
https://www.gov.uk/government/consultations/creatinga-secondary-annuity-market-call-for-evidence
techtalk 27
This publication represents Scottish Widows’ interpretation of the law and HMRC practice at the time of writing this publication.
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