The Government has published the Draft Taxation of Pensions Bill, which will implement the flexibilities announced in the 2014 Budget and introduce anti-avoidance measures. If an individual does not wish to buy an annuity with his money purchase pension savings he will have two new options available: flexi-access drawdown and uncrystallised funds pension lump sums.
Following the current consultation, the actual Bill is expected to begin its progress through Parliament “in the Autumn”.
Flexi-access Drawdown
The Bill introduces a new type of drawdown – flexi-access drawdown – under which the member may draw down his pension as he wishes, with no restriction as to amount or timing. Putting one’s funds into drawdown counts as a “benefit crystallisation event” for tax purposes so, under this route, the individual can take a tax-free lump sum of 25% of the value of his funds at the time they are put into drawdown. On his death any funds remaining may be paid to a dependant as a lump sum, in which case they will be subject to the special lump sum charge (currently 55%), though not also to income tax.
Existing flexible drawdown arrangements will convert automatically into flexi-access drawdown arrangements on 6 April 2015.
Uncrystallised Funds Pension Lump Sum (“UFPLS”)
This is the snappy title for the new lump sum that may be paid out of a member’s uncrystallised funds (those that have not yet come into payment or been designated as drawdown funds) as long as the member has sufficient lifetime allowance remaining to cover it and is over age 55. 25% of the lump sum will be paid tax-free and the remaining 75% will be subject to income tax at the individual’s marginal rate. This is in contrast to the “up-front” nature of the tax-free lump sum under a drawdown arrangement.
Annuities
Annuities will be able to be much more flexible than previously:
- guarantee periods in excess of 10 years will be allowed and
- the periodic payments from the annuity will be allowed to reduce.
Thus insurance companies will be able to design annuities that are far more suitable to individuals’ spending requirements in retirement.
Where the annuitant dies within the guarantee period, the annuity may continue to be paid to another individual until the end of that period.
Reduced Annual Allowance for Money Purchase contributions
Where an individual accesses his savings on or after 6 April 2015
- through flexi-access drawdown,
- through payment of a UFPLS or
- by drawing down more than the permitted maximum under a capped drawdown arrangement,
a £10,000 annual allowance will apply to future money purchase pension saving. However, such individuals will retain an annual allowance for defined benefit pension savings of at least £30,000, depending on the value of new money purchase pension savings. Unused annual allowance brought forward from earlier tax years will not be available to increase the £10,000 annual allowance for money purchase pension savings.
The new allowance of £10,000 will be available to those using flexible drawdown who, currently, have no annual allowance. However, this will not create annual allowance for years prior to April 2015 for carry forward.
Other Changes
With effect from 6 April 2015 money purchase arrangements will no longer be able to pay trivial commutation lump sums, although “small pots” of up to £10,000 may still be taken in full.
For defined benefit schemes (which can still pay trivial commutation lump sums) the limit for triviality of a death benefit will be increased to £30,000 (from £18,000).
Schemes will be given the overriding ability to make certain payments permitted by this legislation, even if their current rules do not so permit. However, trustees will be able to choose whether to offer this flexibility; it will not be compulsory.
Comment
For those who wish to take advantage of the new flexibilities to access their pension savings as a series of lump sums, it would appear to be worth considering the amount of tax that would be paid under each of the options. As an example, consider an individual with savings of £200,000 who wishes to take the benefits over 4 years in four payments of £50,000 each. For simplicity we will assume that the 2014-15 personal tax allowance of £10,000 and basic-rate band of £31,865 apply throughout and that our individual has no other income.
If he puts his funds into flexi-access drawdown, the first payment of £50,000, being equal to 25% of his total savings, may be taken wholly as a pension commencement lump sum, tax-free. Each subsequent payment will be taxed as income, so:
- the first £10,000 will be tax-free,
- the next £31,865 will be subject to basic-rate tax, amounting to £6,373 and
- the remaining £8,135 will be subject to higher-rate tax, amounting to £3,254.
Thus the total tax paid over 4 years will be 3 x (6,373 + 3,254) = £28,881.
If instead our individual elects for a series of 4 UFPLSs, there will be no pension commencement lump sum but 25% of each payment will be free of tax. So each payment of £50,000 will comprise a tax-free payment of £12,500 and a payment of £37,500 that is taxed as income. Of that £37,500:
- the first £10,000 will be tax-free and
- the remaining £27,500 will be subject to basic-rate tax, amounting to £5,500.
Thus the total tax paid over 4 years will be 4 x 5,500 = £22,000, a saving of £6,881 compared with flexi-access drawdown.