Contents

• When to access pension funds
• How much income is needed and for how long
• Factors to consider
• Defined benefit pensions
• Defined contribution (money purchase) benefits
• Lump sums
• Scheme pensions
• Pension annuities
• Flexi-access drawdown (FAD)
• Putting planning into practice

When to access pension funds

For clients at or approaching retirement the first aspect to consider is when should pension funds be accessed. Someone who has reached their retirement age or has started to wind down in their working life may intuitively look towards accessing their pension savings to boost their income, because that is what they have been saving for.  

However, pension savings are very tax efficient by allowing investment growth to be largely free of income tax and capital gains tax. 

Pensions are also largely excluded from inheritance tax (IHT), though there is a current consultation to bring pensions into assessment for IHT from April 2027. So, deferring pensions even if this is until age 75 may be viable for individuals who have other savings that can provide their income (such as in collectives, bonds, cash or ISAs) particularly when considering estate planning.

If pensions are to be drawn, then how much to draw needs to be determined. Individuals may have multiple pension pots allowing them to draw on their pension assets at different times. Even if only one pension fund is held there will usually be options to allow the fund to be drawn in stages (in some circumstances this could involve a transfer to a more flexible pension arrangement). This may be beneficial for individuals who want to manage tax, continue to accumulate funds in a tax-efficient environment and/or consider the impact on intergenerational planning. 
 

How much income is needed and for how long

What does the client need and do they know what that is? 

In some instances, a lump sum may be required for a specific purpose (for example to repay a mortgage) but others may have no capital needs, allowing a phased retirement strategy using the 25% pension commencement lump sum to provide tax-free retirement income. Retirement is unlikely to be a single event, there is likely to be phases of: partial retirement followed by a full and active retirement, and then a less active period which will impact on how much income is needed. 

Other sources of income such as: the State Pension, defined benefit pensions at the scheme normal retirement date, expected inheritances, downsizing a property and other savings may be factors on how much income to draw. Information about how to obtain a State Pension forecast can be found on GOV.UK. 

It is also important to consider health, family circumstances and longevity to help make sure that a client’s funds last as long or longer than they require them, not forgetting the potential impact of inflation over the longer term. Longevity is often underestimated, the Office for National Statistics life expectancy calculator may be a useful starting point in what may be a difficult subject to broach. Lifetime cashflow modelling may be beneficial because changes in income needs during retirement. The potential for long term care can be factored into a client’s financial plan, even more important in the wider considerations when advising a couple. What is certain is that things can and will change so a regular check in is likely to be vital, along with being able to flexibly adapt financially.   

Having considered how much to draw and when to draw it, the optimal strategy may be:

• one solution at day 1
• a combination of solutions at day 1
• a changing strategy over time (for example starting part annuity part drawdown and then moving to full annuity at age 75) 

The solutions that can be considered are:

• Lump sums e.g. pension commencement lump sum, or small pots
• Scheme pensions
• Pension annuities 
• Flexi-access drawdown (FAD) 
• Using non pension assets to provide required income

A secured pension can be paid directly from a scheme as a scheme pension which is paid by the scheme administrator or an insurance company chosen by the scheme administrator.  
 

Factors to consider

There are a number of factors that play a part in determining the right strategy and the outcome will depend on the relative importance of each to the client when they are weighed up against each other.  
 
These include an assessment of how much:

• flexibility the client wants and needs.

• security of outcome the client wants and needs.

• risk with their strategy the client willing and able to take.

• willingness and ability to commit to continue to monitor and maintain their strategy which may include paying for ongoing advice.

The impact of money purchase annual allowance (MPAA) should be considered if it's thought that future pension funding may take place. Taking an income on a flexible basis (such as through FAD) or an UFPLS will trigger the MPAA reducing the available annual allowance to £10,000 per annum currently. 
 

Defined benefit pensions

Defined benefit pensions are a type of safeguarded benefits. The Financial Conduct Authority (FCA) is clear that keeping safeguarded benefits will be in the best interests of most clients. Although transfers to flexible benefit schemes can be considered, the transfer values often represent less than would be required to purchase equivalent benefits. Advice is subject to stringent requirements and regulatory oversight set out in FCA guidance FG21/3.    

The options available in a defined benefit scheme may initially be seen as restrictive. However, in terms of guarantees, removal of exposure to longevity and investment risk and value for money compared to define contribution schemes, they are valuable for most clients. 

Which assets to draw from to provide income in retirement can differ significantly depending on whether a client has access to defined benefit pensions which are often an essential part of an individual’s retirement plan. 
 

Defined contribution (money purchase) benefits

As well as considering how much income is needed clients should also consider whether they require guaranteed income or would prefer the flexibility to change income as their circumstances change. The options available will depend on the provider, the product and the scheme administrator. 

Broadly speaking, if options are not available in the existing product (which is common for older products) they can be accessed on transfer. This is particularly important when assessing value and choice, such as annuity purchase. There are a few considerations before transferring however, such as whether the existing product offers a guaranteed annuity rate (which is another safeguarded benefit) or contains any scheme specific tax-free cash that could be lost, which can be valuable compared with the benefits on offer in the open market. 
 

Lump Sums

Pension commencement lump sum

Pension commencement lump sum (PCLS) allows up to 25% of a pension fund to be paid tax free up to the available lump sum allowance. PCLS is of particular use for clients with capital needs such as to repay a mortgage or to make home improvements.

PCLS must be paid within a period beginning six months before, and ending 12 months after, a member becomes entitled to a relevant pension. If these conditions are not met then any tax-free cash paid becomes an unauthorised payment. 

PCLS cannot be taken from a fund that has already been designated to drawdown, so clients must make the choice to take tax-free cash before they draw income. Clients who anticipate future capital needs may not wish to designate to drawdown and lose out on this option.  

There is an upper limit on the maximum amount of PLCS most people can access which is the Lump Sum Allowance (LSA) of £268,275. If an individual has transitional protection then their LSA may be higher. 
 

Small pot lump sums

An individual may be able to commute their small pension fund of up to £10,000 as a lump sum under this rule with 25% being paid tax-free, with 75% tax at the basic rate (with any additional tax or reclaim dealt with later). Clients can only take three small pot lump sums from non-occupational pension schemes. 

There are advantages of this option over an uncrystallised funds pension lump sum (UFPLS):

• It does not trigger the money purchase annual allowance (MPAA) 
• The tax-free portion of the small pot does not count against the lump sum allowance (LSA), and it can be paid even if there is no remaining LSA.

Uncrystallised funds pension lump sum (UFPLS )

This is an option where 25% of the payment is tax-free and the remainder taxed as income on a month 1 basis. This means using 1/12th of the personal allowance and 1/12th of the basic and higher rate tax bands to calculate the tax due. In practice UFPLS will achieve the same objective as taking a lump sum and three times that amount into drawdown and cashing it in straight away. However, the UFPLS option is simpler and avoids potential drawdown product charges. The MPAA is triggered when an UFPLS is taken. The tax-free part of the UFPLS is assessed against the LSA, and where the LSA is exceeded any remaining fund will be taxed. 

Many products and schemes will allow part of a fund to be paid as UFPLS, leaving the remaining fund to be used in the future without having to convert the whole fund to drawdown. 
 

Scheme pensions

A scheme pension provides a regular guaranteed income for life, it is the only way a defined benefits arrangement or a collective money purchase arrangement may provide its members with a pension benefit. It is also possible for a money purchase arrangement to provide a scheme pension.

A scheme pension must be paid for the life of the member, paid at least annually and be paid by the scheme administrator (or by an insurance company chosen by the scheme administrator). There will usually be options for guaranteed periods and it may come with pension protection. 

There may be limited options to vary the benefits provided, and the health of the client may have no bearing on the income provided, especially where benefits have accrued under a defined benefit scheme. The scheme benefits determine whether the income will be inflation linked. A scheme pension is taxed as income on a PAYE basis. 
 

Pension annuities

Annuities provide a regular guaranteed income for life through an insurance company and can take one of three main forms:

• a standard lifetime annuity, 
• an enhanced annuity or 
• an investment linked annuity.  

It is vital to consider the potential for enhancements due to health (even if only high blood pressure or high cholesterol) or lifestyle (such as smoking) as these factors are likely to provide for a higher level of income than a standard lifetime annuity of the same type with the same features. 

The features (or the shape) of the annuity also need to be considered. Should the annuity be single life or joint life with spouse, civil partner or dependant and, if so, at what level should the continuing income on death be provided and at what cost? Should the annuity include a guaranteed period, there are no longer limits on the duration of the guaranteed period. What about the impacts of inflation in the future, should increases to pensions in payment be included and, if so, at what rate and at what cost? The final aspect of the shape of annuity is the payment frequency, is this to be paid monthly, quarterly or annually for example.

Once the type and shape of annuity have been determined then shopping around can help the client get the best value from the market and so optimise their retirement income in the Open Market. MoneyHelper’s annuity comparison tool for conventional annuities may provide a helpful starting point.

Annuities are taxed as income on a PAYE basis and generally (unless the annuity decreases) do not trigger the MPAA.  
 

Advantages of an annuity

• Certainty of an income for life for peace of mind.
• Certainty of benefits in the event of death (guaranteed periods, joint life options).
• An element of investment exposure available through an investment-linked annuity.
• Simple and easy to look after, usually requires no ongoing maintenance or advice once set up.
• Annuities generally have no annual costs or charges.
• If death occurs many years after buying an annuity (particularly if average life expectancy is exceeded) the amount paid out in total may be more than the investment made. 
• Buying an annuity will usually not trigger the MPAA.

Disadvantages of an annuity

• Once taken out generally an annuity cannot be changed if circumstances change.
• Benefits on death are fixed and not flexible.
• Adding in a high level of benefits on death can be expensive and reduce the initial income paid.
• Adding in a high level of increases to pensions in payment can be expensive and significantly reduce the initial income paid.
• If death occurs in the early years of buying an annuity, the amount paid out in total may be less than the investment , unless annuity protection has been purchased which can guarantee a return of the investment.
• Very limited or no investment exposure.
   

Flexi-access drawdown

Flexi-access drawdown (FAD) is where an individual designates pension funds to drawdown to provide income withdrawals. Up to 25% of each designation can be taken as a pension commencement lump sum (PCLS). There is no requirement to take income from the FAD nor is there a maximum amount of income that can be withdrawn. Entering into FAD does not trigger the money purchase annual allowance (MPAA) but the payment of any income from the FAD will. Withdrawals are taxable on a PAYE basis.  

Whilst no new capped drawdown arrangements can be entered into, some clients may have existing capped drawdown arrangements that can be converted to FAD where they need to draw more income than is currently available from the capped drawdown. 

Remaining funds in FAD are available to provide death benefits if not drawn. Death before age 75 will generally not result in a tax charge, death benefits payable as a lump sum in excess of the Lump Sum and Death Benefit Allowance (LSDBA) are taxable as income. Benefits taken as beneficiary drawdown or annuity are tax free on death before age 75. On death after age 75 the beneficiary will generally be subject to income tax on any benefit they receive. 
 

Advantages of FAD

• Flexibility to manage withdrawals over time to match an individual's needs including drawing no income at all.
• Provides continued investment exposure in a tax efficient wrapper.
• The ability to change strategy to buy an annuity (lifetime annuity and/or a fixed term annuity) with some or all of the funds left undrawn at any time.  
• Death benefit will usually reflect the value of the investment fund left undrawn.  
• Flexible death benefits which, before age 75, are generally free of tax except for any lump sum payable in excess of the LSDBA which is taxed as income.  

Disadvantages of FAD

• Benefits remain subject to investment risk.
• There is a risk that the fund may be eroded meaning that withdrawals may reduce or stop altogether. This is particularly true if a high level of withdrawals are taken when there is an investment downturn. 
• Complex and generally requires ongoing maintenance/advice to ensure that an income plan remains on track.
• Higher annual costs and charges compared to annuity options. 
• Drawing income from FAD will trigger the MPAA.

Putting planning into practice

Below we look at two case studies to identify and establish client needs approaching retirement and the planning opportunities with pensions and other assets.