Regular UFPLS payments – an effective solution for accessing your pension?
Following the changes to pension legislation in 2015, over 90%* of people are accessing their pensions via one of the new flexible options introduced with pension freedoms. Whilst for some, the traditional annuity will still be the preferred route, providing a guaranteed income for life, the various alternatives still cause much confusion, with many uncertain which best meets their current and longer term needs.
These changes have brought pensions back to the forefront of both investment and retirement planning. Of course, some may be discouraged at being unable to access their funds until after age 55 (rising to 57 in 2028), and restrictions on the level of tax efficient pension contributions and savings, imposed by the annual and lifetime allowances, will also limit the amount you can effectively hold in a pension. Despite these restraints, given the various tax incentives, it is widely accepted though that financial advisers should always discount a pension before considering alternative product wrappers such as a Stocks & Shares ISA.
So, when it’s time to access your pension savings, which is the most appropriate and tax advantageous option? Many people will look to access all their 25% tax-free pension commencement lump sum (PCLS) at outset, and for some this will remain an appropriate solution, allowing them to fund that holiday of a lifetime, pay off an outstanding mortgage or even gift funds to their children. However, is this because they’ve always considered this the default option since they started their pension savings many years ago. Perhaps they aren’t fully aware of or don’t understand the alternatives now available. Time to consider regular UFPLS payments…
The financial services industry is renowned for its many acronyms and bewildering terminology, and yes, it has surpassed itself with ‘uncrystallised funds pension lump sum’ (UFPLS – pronounced ‘uffplus’). In layman’s terms, it’s simply drawing on your pension pot, with 25% of each payment being tax-free and the rest taxed at your marginal rate. Of course, some will be aware of the horror stories of people using this option to access all their pension funds at once, perhaps to purchase that Ferrari. Regular UFPLS, sometimes referred to as drip-feed drawdown, is simply a form of drawing a portion of your pension, often monthly, to support normal expenditure. So how does this work in practice?
Pension Income £20,000 per annum £1,666.67 per month.
25% Tax-free Cash £5,000 per annum £416.67 per month
Taxable Income £15,000 per annum £1,250 per month
So what makes this option so appealing?
- Of course, the first thing is you remain in control of the level of funds being drawn, and can increase or reduce this to meet your changing needs. Some people may want a higher level of income in the early years of retirement to support discretionary expenditure whilst their health permits. It’s also becoming more common, as the state pension age continues to rise, that people want the ability to change their pension income as they look to bridge the gap between retirement and receipt of the state pension. Regular UFPLS payments offer the flexibility to support this changing income need, allowing individuals to reduce pension withdrawals when the state pension commences.
- Being able to draw an income this way can also be very tax efficient, with only 75% of income drawn being taxable. Assuming you have no other taxable income, it is possible to draw an annual income of up to £16,760 without paying any income tax.
Pension Income £16,760
Tax-free Cash £4,190
Taxable Income £12,570
Personal Allowance £12,570
Net Income £16,760 per annum
Some may even look to draw a pension income of £67,026 (£50,270 taxable income) to ensure they maximise withdrawals within their basic rate band, thus potentially avoiding being forced to take higher income payments in the future and being caught in the 40% tax bracket.
- The remaining uncrystallised funds will continue to benefit from 25% tax-free cash, and if needed, this can still be accessed via the flexi-access drawdown route, either as a one-off lump sum or as a portion via partial drawdown. Importantly, the tax-free cash element of the pension will remain invested and benefit from any future investment growth.
- Given that funds held in a pension are outside your estate for inheritance tax purposes, so too is the remaining tax-free cash within your pension. In contrast, when accessing all your tax-free cash via flexi-access drawdown, your taxable estate will have increased by the equivalent sum. Financial advisers will now often look to exhaust other investments before any pension savings as part of any inheritance tax planning solution.
As with all pension income options, there are of course some potential disadvantages to accessing your pension via regular UFPLS payments:
- As you are accessing taxable income, it triggers the money purchase annual allowance (MPAA), reducing future tax relievable pension contributions to £4,000 per annum. This would be of particular concern for anyone considering partial retirement or returning to work in the future, as they may not be able to fully benefit from further employer pension contributions.
- Similar to flexi-access drawdown, you will need to monitor the investment performance and level of income to reduce the risk of eroding your pension too early. If investment returns are less than expected, or you withdraw too much, your funds could run out. Most financial advisers will have access to a cashflow modelling tool to help monitor the sustainability of income as part of an annual review process, adjusting income as your circumstances and the investment performance changes. A ‘safe withdrawal rate’ can be agreed at outset, but may need to be reduced in the event of poor investment returns.
- It is advisable to retain a larger emergency fund, in the event you need to pause income withdrawals during periods of market falls. Known as sequencing risk, or ‘pound cost averaging’, withdrawing income during periods of market falls can have a disproportionate effect on your pension savings. A financial adviser will agree an appropriate level of funds to be held in cash.
- As with flexi-access drawdown, many pension providers do not facilitate regular UFPLS payments and it may be necessary to transfer your pension to another provider. However, retirement is often considered a ‘trigger event’ for reviewing your finances, including your attitude to risk, which often reduces with age. It is also common that a tailored pension solution, offering flexible benefit options, can be secured at lower cost than some older pension plans. An independent financial adviser will be able to conduct research on various pension providers, and recommend a solution with consideration to cost, financial strength, flexible retirement options and underlying investment performance.
- The ability to pass on pension savings on death to your chosen beneficiaries is a valuable benefit. On death before age 75 the residual funds will be passed on tax-free, but after 75 any unused funds will be taxed on the beneficiary at their marginal rate. Possibly the greatest disadvantage of regular UFPLS payments is that any remaining tax-free cash will become taxable on the beneficiary following the member’s death after age 75. It is for this reason some people decide to cease regular UFPLS payments at age 75, moving funds into flexi-access drawdown thus drawing their remaining tax-free cash at this time.
Drawing an income via regular UFPLS payments is often overlooked, primarily due to a lack of understanding, but can help support a tax efficient income in retirement. As with all investment and retirement decisions, it is important to ensure you have a full understanding of the advantages and disadvantages of each. You also must appreciate that plans will often need to adapt in line with changes in your personal & financial circumstances, legislation, taxation and underlying investment performance. Regular financial reviews will remain an essential part of this retirement solution.
This article is for information purposes only and should not be relied upon to make a decision on how to access your pension. UFPLS is not permitted in certain circumstances. You should obtain advice from an appropriately qualified financial adviser or seek free and impartial guidance from pensionwise.gov.uk.
A pension is a long term investment, the fund value may fluctuate and can go down. Your eventual income may depend upon the size of the fund at retirement, future interest rates and tax legislation.
Information is based on our current understanding of taxation legislation and regulations. Any levels and bases of, and reliefs from taxation, are subject to change.
Specialism – Retirement planning and wealth management.
Trevor joined Platinum Financial Planning in 2020 and brings a wealth of knowledge with almost 20 years’ experience providing financial advice within the UK’s leading banks. Trevor has attained Chartered status, which is widely accepted as the 'gold standard' qualification for professional financial consultants in the UK. Additionally, he was awarded the Fellow of the Personal Finance Society. Trevor builds long term relationships with his clients by understanding their individual needs, delivering comprehensive solutions, and providing on-going support throughout the different stages of their lives.
Outside of work Trevor enjoys spending time with his wife and two children. Relaxing when he can, Trevor enjoys the odd round of golf and sea fishing of the North Coast of Ireland.