Uncrystallised funds pension lump sums
Introduction
This briefing looks at uncrystallised funds pension lump sums (UFPLS). UFPLS were introduced in April 2015 as a key part of the pension freedoms reforms. They are one of the ways in which individuals can take benefits from their pensions.
Core considerations
- A UFPLS allows an individual to take withdrawals directly from their pensions without the need to move them into drawdown or buy and annuity.
- It offers a relatively simple way to take retirement benefits.
- 25% of the payment is usually tax-free and the rest is subject to income tax.
-
The tax-free element of an UFPLS is capped by the available lump sum allowance or lump sum and death benefit allowance.
-
There are no limits on the amount of UFPLS and up to the full value of the arrangement can be taken in this way.
-
Regular UFPLS payments can provide a source of income with 25% tax-free.
-
The payment of a UFPLS will trigger the money purchase annual allowance.
-
Where a fund is valued up to £10,000, a payment under the ‘small pots’ rules can offer advantages over a UFPLS.
Contents
Availability of UFPLS
The rules allow all defined contribution schemes to pay a UFPLS, however, there is no requirement for a scheme to allow it. However, most schemes will have this option although older schemes may restrict this to a full payment of the benefits and not allow partial UFPLS. Some clients may need to transfer in order to access UFPLS or other flexible benefits but should first review what benefits may be lost and the advantages of doing so.
UFPLS is not available from defined benefit schemes.
The Normal Minimum Pension Age (currently 55 but increasing to 57 from 6 April 2028) applies) applies to UFPLS payments unless the individual meets an ill health condition.
A UFPLS is not available in certain circumstances:
- If pension benefits have already been crystallised, e.g. drawdown
- Where a scheme includes scheme specific lump sum protection
- The individual has enhanced or primary protection with protected tax-free cash
- Where the assets include a disqualifying pension credit
Taxation of a UFPLS
25% of each UFPLS payment is usually tax-free and the remainder is taxed as income at the client’s marginal rate.
The tax-free element of UFPLS is not a pension commencement lump sum (PCLS). This means that those with scheme-specific lump sum protection must give up that protection to take an UFPLS.
The tax-free element of UFPLS is capped by both:
- the member’s available lump sum allowance
- the member’s available lump sum and death benefit allowance.
If the tax-free element would exceed either allowance then the excess is taxed as income at the marginal rate.
Payments of UFPLS will be made under pay-as-you-earn (PAYE), which means that the immediate tax situation is unlikely to reflect the final one.
The first payment of UFPLS from a scheme will usually be taxed on a ‘month 1’ basis (ie. using only 1/12th of the personal allowance, and 1/12th of the basic and higher rate tax bands to calculate the tax due, instead of the cumulative amounts normally allowed). This means that often too much tax will be deducted by the provider, particularly for large withdrawals. In some cases, individuals can make an in-year tax reclaim directly from HMRC or alternatively it will be recovered with adjustments to future withdrawals or at the end of the tax year.
The taxation of UFPLS could move a client into a higher tax band in the year of payment. Where this could occur consider spreading the payments over more than one tax year if possible.
Any payment of a UFPLS will trigger the money purchase annual allowance (MPAA). This will reduce the individual's annual allowance to £10,000 in respect of future payments to defined contribution schemes. Any unused MPAA cannot be carried forward.
Uses of a UFPLS
UFPLS can potentially be used to provide both lump sums and income. Often individuals will face a choice between UFPLS and flexi-access drawdown. In principle, there is nothing that can be done through UFPLS that is not possible by taking the pension commencement lump sum, designating three times that amount to drawdown and cashing it in straight away.
Flexi-access drawdown has the benefit of greater flexibility, particularly in managing when tax is paid, and also allows more to be retained in the pension if only tax-free cash is taken.
However, the UFPLS route is simpler, and may be available when drawdown is not. Moving to drawdown may also involve additional charges.
The following list of circumstances where UFPLS may be appropriate is not exhaustive.
1. Full encashment
For some people encashing the whole of a pension arrangement may be a sensible option. This could happen, for example, where they have a relatively small pension as part of overall provision.
2. Taking a lump sum with continuing contributions
A client may wish to draw a partial lump sum and keep the pension arrangement active. This may happen, for example, if a group personal pension (GPP) member wants to retain the benefit of employer contributions. In most cases, it would be possible to use drawdown instead, but that might require a partial transfer to a drawdown plan and the amounts involved might not meet provider minimum requirements, and drawdown often has higher charges.
Example
Frank is 58 years old and a member of his employer’s GPP scheme. He is taking a three-month break from work to visit Australia and New Zealand, but plans to return after that and wants to remain in the scheme. The total annual contributions to the plan are well below the £10,000 MPAA. He wants to cash in £14,000 of his pension plan using a UFPLS to fund his trip. Frank is a basic rate taxpayer.
Frank receives £3,500 of his UFPLS tax-free and is taxed at the marginal rate on £10,500. Once he reclaims any overpaid tax, this results in tax of £2,100 on the UFPLS. This provides him with £11,900 net of tax for his trip.
3. A tax-free element of income
For those who do not need an up-front lump sum when they approach or enter retirement, the 25% tax-free part of UFPLS can help them manage their tax liability. For example, if an individual has no other income they could take a UFPLS of £16,760. 25% would be free of tax and the remaining £12,570 would be within their personal allowance meaning no tax to pay.
This could be paid as a single UFPLS payment or arranged to take regular monthly smaller UFPLS payments that annually have the same result. This approach mimics monthly drawdown withdrawals but without the complication of moving assets into drawdown and the charges of doing so.
4. Short-term income
Many people need bridging income early in retirement, for example if they retire before state pension age or before their employer’s defined benefit pension is available without an actuarial reduction. UFPLS can be a relatively simple way of achieving this.
UFPLS compared with a payment under the small pots rules
Where a client requires a withdrawal of £10,000 or less, and the fund does not exceed £10,000, a payment under the small pots rules can offer advantages. Whist both will benefit from 25% being free of tax and the rest is subject to income tax, with a small pot:
- the MPAA is not triggered;
- there is no relevant benefit crystallisation event and it doesn’t use up any of the individual’s lump sum allowance or lump sum and death benefit allowance; and
- tax under PAYE is at basic rate (20%) rather than on a Month 1 basis.
However, a small pot payment must extinguish all benefits under the arrangement and no more than three small pots are available from personal pensions during an individual’s lifetime.
Small pots can be taken from defined benefit schemes, so some clients may be able to receive a small pot where they could not take a UFPLS.