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Discover useful guidance to help you consider whether flexi-access drawdown or UFPLS is the most appropriate route to achieve the client’s objectives for accessing benefits from their pension pot.
Taking taxable income may have an impact on how other sources of income are taxed.
Decision tree flowcharts may help to decide whether UFPLS, flexi-access drawdown or small lump sums (small pots) meet client objectives.
You should consider how much your client wants to withdraw and how the withdrawal will be taxed.
The process of deciding which method is suitable appears complicated, but it’s actually about using a number of decision points to help your clients decide the most appropriate method for them.
Deciding on an approach
Pension flexibility, introduced in April 2015, provides customers wishing to access their pension funds with a wide choice of vesting options. But which option do they select? Obviously this is a decision to be made after full consultation with their adviser, dependent on the individual’s situation, needs and requirements. Although we’ve titled this article as a comparison between flexi-access drawdown (FAD) and uncrystallised funds pension lump sum (UFPLS), there are a number of other options and issues to be considered – you’ll find full details of those options in our technical centre (links below). However, the purpose of this article is to cover the process you can use to help a client decide which of the various options are suitable for them.
Most major decisions are arrived at after contemplation of a series of smaller decisions. These smaller decisions can be mapped using various methods and in this article we will cover two such methods:
Basic question process
Decision tree example – the withdrawal process
We’ve put together a withdrawal process decision tree that addresses many of the smaller decisions you may wish to address, although there may be additional factors to consider. If future funding is a consideration, then remember the rules around pension recycling.
Basic question process and example
An alternative to the decision tree is a basic questioning process. Although the basic question process isn’t as visual, it allows us to run a case study alongside the process, to provide a worked example with the consideration of tax as an integral part of the process.
How much does the client wish to withdraw? If less than £30k, it’s worth considering small lump sums. Arrangements under £10,000 can be used for this, and a maximum of three small pots can be taken from non-occupational pensions. Small pots usage for occupational pensions is unlimited. If the withdrawal requirement is above £30k, consideration should be given to using small lump sums for the first £30k (using small pots isn’t regarded as accessing a pension fund flexibly, so they’re not a trigger event for MPAA purposes). Also, the payment of small lump sums isn’t a benefit crystallisation event, so the funds aren’t tested against the lifetime allowance. For this example let’s assume the client has already used their small pots.
Is the client withdrawing the full fund? If they are, an UFPLS provides the easiest option, although this can be replicated in flexi-access drawdown (FAD).
For this example let’s assume the client has a fund of £100k, but only wishes to withdraw £10,000 net of tax.
Of the required withdrawal, how much can the client tolerate paying tax on? Or conversely, how much of the withdrawal does the client need to be tax-free?
We need to be very aware that any taxed element of a pension withdrawal will slot into the client’s overall tax calculation – just above any earned income but before savings, dividends, etc. Taking a taxable withdrawal may not only incur tax in itself, but could also push income sitting above earned / pensions income into various tax bands / traps such as basic, higher and additional rate tax bands, child benefit charge and personal allowance reduction. However, clients may be able to tolerate a certain amount of tax, to use up say the basic rate tax band to prevent a larger future tax issue. Find further information on Individual rates and order of taxation.
(In this example let’s say the client is within £5,000 of being a higher rate tax-payer and is prepared to tolerate paying basic rate tax on this amount.)
Work out the net amount to be received from the amount the client is happy to pay tax on. Unless the portion of the withdrawal required to be tax-free is exactly 25% of the overall withdrawal, UFPLS are of little assistance and flexi-drawdown will be the approach. In this example the client is £5,000 under being a higher rate tax payer and will receive £4,000 net from the gross taxable amount of £5,000 – (£5,000 x 80%)
Calculate the amount the client requires to be paid tax-free to achieve their target withdrawal amount (in our example this would be £6,000, to top up the net £4,000 calculated in stage 4).
Take the amount of tax-free withdrawal required and multiply it by four, giving the amount to be crystallised for sufficient PCLS and the required tax-free PCLS payment (in our example this would be £24,000 i.e. 4 x £6,000). The balance to be designated to FAD after payment of £6,000 PCLS is £18,000. The client can then draw the gross amount (£5,000) required from their FAD plan to fund the taxable portion of the withdrawal.
In summary, the client crystallised £24,000 of his fund. This provided a PCLS of £6,000 and the client can draw £5,000 gross (£4,000 net)* from his crystallised drawdown fund to provide the full £10,000 required. This process keeps the crystallisation down to the minimum required to fulfil client requirements, leaving £76k uncrystallised which can be used to generate future PCLS / income as required.
In this example an UFPLS would not meet the clients objective of only having £5,000 of taxable income, as the gross UFPLS figure to produce this net amount is £6,666.66. So this would be below the net £10,000 the client requires.
Although the above calculations reflect the actual tax payable on withdrawal, we should also be mindful that emergency tax may be applied to the income payment by the provider. This should be checked with the provider in advance of any withdrawal, and even though any resulting overpayment can be reclaimed by the client, the initial impact of this shouldn’t be ignored. Our emergency tax tool may help you calculate the effect on withdrawals.
* Scottish taxpayers will pay the Scottish rate of income tax (SRIT) on non-savings and non-dividend (NSND) income. NSND income includes employment income, profits from self-employment (including sole trades and partnerships), rental profits, and pension income (including the state pension). Similarly, from 6 April 2019 Welsh Taxpayers pay the Welsh Rate of Income Tax (CRIT (C for Cymru)) on NSND income.
Other tax and deductions such as Corporation Tax, dividends, savings income and National Insurance Contributions etc. will remain based on UK rules. This could mean the amount of income tax relief which can be claimed on pension contributions by Scottish and UK tax payers may not be the same. For more info on SRIT and how this works in practice, please visit our facts page. For more info on CRIT and how this works in practice, please visit our facts page.
On the surface of it, the process of deciding which withdrawal method is the most suitable appears to be reasonably complicated. However, in reality it's about using a limited number of decision points to help your clients decide which withdrawal method suits them.