Pension consolidation and phased drawdown for ‘freedom and choice’
Not everyone will be able to access all the new pension freedoms through their current pension scheme. Consolidating older pensions into a more modern vehicle may not only allow greater flexibility on how income can be taken, but could allow flexible access without cutting funding limits.
A case study:
Julie is in her late 50’s with adult children. She has saved into a variety of pensions and a mix of cash and stock and shares ISAs which is her contingency fund. She plans to phase her retirement by reducing her full time hours to part time and supplement her income from her pension savings – using a combination of tax free cash and/or income.
Her existing pension contracts are a mixture of occupational and personal pensions valued at £600K.
Julie’s main aim is to be able to use all her savings to generate a tax efficient income, both in semi-retirement, and later in full retirement. Being able to take tax free cash and/or income from her pension as and when it’s needed is therefore a big draw for her. She also wants to have ready access to her funds. And she’d like to leave a legacy for the kids if she can.
Her adviser informs her that aside from higher charges and limited investment choice compared to some more modern pension contracts, the main problem for Julie is none of her pensions will allow the new flexi-access drawdown from April 2015.
The Occupational Schemes offer no flexibility at all, so an annuity is the only income option. The personal pension is a little more flexible as phased withdrawals can be taken using the new ‘uncrystallised funds pension lump sum’ (UFPLS) option. But this isn’t the same as flexi-access drawdown – each withdrawal will consist of 25% tax free cash the balance of the withdrawal taxed as income. Taking TFC and leaving the balance isn’t an option.
She could, of course, re-invest the UFPLS money, but returns would be taxable, no longer protected by the pension wrapper, and the capital would also potentially be subject to IHT. For example, let’s assume Julie reduces her hours and her income falls to £2,500 short of the higher rate tax threshold. If she wants to top up her net spendable income by £7,500 a year and she takes this from her existing personal pension using phased UFPLS, she’ll need to withdraw a total of £10,000 (see example 1*).
The other consequence of Julie drawing funds under UFPLS is her annual pension allowance will drop to £10k a year and she’d lose access to any unused relief through carried forward reliefs. This may be important to Julie if she wants to make any substantial contributions in the future, such as moving some of her ISA savings into her pension while she still has earned income.
The adviser suggests Julie keeps her options open by consolidating all her pensions into a SIPP that allows ‘flexi-access’ drawdown. This can be achieved using the following steps:
- Transfer at least one of Julie’s current pension funds into a SIPP before the end of the current tax year;
- Designate the SIPP for capped drawdown, again in the current tax year. This doesn’t mean that the whole fund has to be crystallised – if the SIPP has a single arrangement setup, even moving just a nominal value into drawdown will allow Julie to crystallise further funds later, without losing her £40k annual allowance.
- Consolidate all other schemes into the same SIPP. It won’t matter if this is done in the same or the next tax year.
This will provide the following benefits:
- Flexible access: Julie will have a flexi-access fund of £600k that she can draw on at any time. From this, she can take just tax free cash up to £150k, a mix of tax free cash and income, or just income on its own from any crystallised parts of the fund. This will allow her to plan her income tax efficiently, while giving her access to emergency funds should the need arise.
- Options open: If she’s likely to make a future contribution in excess of £10k, Julie should keep any income taken within the capped drawdown limit. This way she’ll retain an annual allowance of £40k, and still be able to carry forward any unused allowances from earlier years. This could be useful if, say, she wanted to use her ISA to make pension contributions while she still has earned income.
- Unlimited income: If she’s not likely to make future contributions, she can take whatever income she wants from crystallised funds.
- TFC only: Returning to example 1, if she still needed £7,500 of net spendable ‘income’ to supplement her salary, she could take this all out as tax free cash, meaning that she would only need to withdraw £7,500 from her savings, and not £10,000.
- Tax planning: Alternatively, she could take a mix of tax free cash and income, perhaps keeping the income element within the basic rate band, and so avoiding higher rate tax (see example 2**). In this way, only £8,000 needs to be withdrawn from the pension.
- Tax-efficient legacy: When she passes away, any remaining funds can be nominated for her children, free of IHT. The kids can access their inherited pension at any time. The funds will be tax free if Julie dies before 75. If she dies aged 75 or over, any withdrawals are only subject to income tax at the children’s marginal rates – and they can choose when to access them, giving some control over the tax they pay. The inherited funds can be cascaded down the generations in this way.
|* Example 1
|Withdrawal from personal pension
|Tax free cash = £10,000 x 25%
|Balance of £7,500 taxed as income:
|£2,500 @ 20%
|£5,000 @ 40%
|£7,500 – £2,500
|Total net spendable income
|* Example 2
|Withdrawal from SIPP
|Tax free cash
|Balance of £2,500 taxed as income:
|£2,500 @ 20%
|£2,500 – £500
|Total net spendable income
The content of this page is a summary of the law in force at the date of publication and is not exhaustive, nor does it contain definitive advice. Specialist legal advice should be sought in relation to any queries that may arise.
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