The New Rules on Accessing Tax-Free Cash and Income

Significant pension reforms imposed as of April 2015 have brought about significant changes in how pension holders may access and utilise their pension pots.
Uncrystallised Funds Pension Lump Sum (UFPLS)

An entirely new idea as of the 2015 reforms, a UFPLS refers to lump sums taken from uncrystallised money purchase pensions.

  • 25% of the sum accessed is free of taxation
  • The policy holder’s prior rate of income tax is used to tax the remaining 75%
  • In contrast to the Flexible Access Drawdown (FAD), individuals cannot access untaxed cash without receiving taxable income
  • The £10,000 money purchase annual allowance (MPAA) applies when a UFPLS has been taken.

EXAMPLE

Chris turns 66 during the 2015/2016 financial year and needs to gain access to about £20k to pay for much-needed repairs and improvements to his home. During the 2015/2016 financial year, his total income incorporates £7,105 from his index linked occupational pension and £6,029 by way of state pension contributions. This amount of cash is sufficient for covering his living expenses. By choosing to pay off a series of debts with the tax-free cash he took from his occupational pension scheme, he doesn’t have a great deal of instant-access cash. Nevertheless, he does have £50,000 in an uncrystallised PPP fund. He has in excess of 60% of the LTA available and falls into the bracket where UFPLS could be used.

The simple and obvious solution would appear to be that of tapping into his pension fund and directly taking out the funds he needs. Nevertheless, getting to grips with taxation can be rather difficult – it isn’t necessarily common knowledge that if he were to tap into his funds for £20,000 net, this would actually mean withdrawing a UFPLS to the value of £23,600.

25% tax free cash £5,900
Taxable lump sum £17,700
  £23,600
Income tax £17,700 x 20% (£3,540)
Net amount £20,060

His combined £7,105 and £6,029 pension income – totalling £13,134 – eats up his personal allowance, which in turn leads him in a situation where the taxable proportion of the UFPLS comes in at 20%. If he was to withdraw these funds, he would have a balance of £26,400 left over with which he could continue taking additional UFPLS with a 25% tax-free allowance on each withdrawal. You may however have the opportunity to use the small pots rule to avoid the £10,000 MPAA.

Money Purchase Annual Allowance (MPAA)

In order to ensure that the new level of flexibility isn’t abused routinely, the government also introduced an anti-avoidance measure in the form of the money purchase annual allowance (MPAA), which as of April was set at £10,000 per year.

The MPAA is applicable when:

  • Income is taken from a flexi-access drawdown
  • The UFPLS principle is used
  • Payment from a new style reducible lifetime annuity is taken
  • Income above 150% of GAD is taken after 5th April 2015 from a capped drawdown fund.
  • As of April, the situation for those with a flexible drawdown improves due to having zero financial allowance.

Information Source: Scottish Widows