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December 10, 2024Drawdown Pension

Why you need to know

In order to understand the income withdrawal options regarding pensions.

What you need to know

An individual is able to take income withdrawals from any money purchase pension arrangement, provided the scheme rules permit such a benefit to be taken.

Since 6 April 2015 withdrawals have been available through “flexi-access drawdown”, where there is no limit on yearly income withdrawals. However, the first withdrawal from flexi-access drawdown will trigger the money purchase annual allowance (MPAA).

Those who had existing “capped drawdown” arrangements at 6 April 2015 can continue them or convert to flexi-access drawdown.  Income from capped drawdown taken each year is subject to a set maximum, but enables significant pension funding to continue as long as the member does not access his/her pension flexibly in another way.

Both flexi-access and capped drawdown can continue indefinitely.

Before 6 April 2015, there was a third form of drawdown called “flexible drawdown”.  This had no income limits, but was only available to those who were already receiving at least a minimum level of secure retirement income.  Anyone in flexible drawdown automatically converted to flexi-access drawdown at 6 April 2015, and the money purchase annual allowance was also triggered from the same date.

The basics

Currently, from age 55 or earlier in the case of ill health or a protected pension age, a member can choose to designate all or part of the funds under his/her arrangement to provide income withdrawals through flexi-access drawdown.  Those who already have a capped drawdown arrangement may be able to designate further funds to it.  At each designation, 25% of the value can be taken as tax-free pension commencement lump sum (PCLS) as long as there is sufficient lifetime allowance remaining.

Any benefits crystallised to provide income withdrawals are kept separate from any other uncrystallised benefits under the member’s arrangement. Where the member has any uncrystallised benefits remaining in an arrangement, further contributions may be paid to that arrangement.

There is no need to take an income each year if the member does not wish to do so.

Flexi access drawdown contribution restrictions

Anyone with a defined contribution pension can use flexi-access drawdown without meeting a minimum income requirement or having to stop paying into a pension.  However, as soon as the first income withdrawal is taken from flexi-access drawdown the member is subject to a money purchase annual allowance of £4,000 a year across all defined contribution pensions.

Prior to the 2017/18 tax year the MPAA was £10,000, but this was reduced to £4,000 as the Chancellor felt it was too generous.

The MPAA is also triggered by a number of other events which involve flexibly accessing pension funds, including taking an uncrystallised funds pension lump sum (UFPLS).  However, the act of taking the tax-free pension commencement lump sum and placing the remaining fund in flexi-access drawdown without making any withdrawals will not trigger the MPAA.

The MPAA is measured over pension input periods.  Following the 2015 Summer Budget, input periods are always aligned with tax years.

Where contributions exceed the MPAA, the excess is taxed as income at the member’s marginal rate of income tax, effectively removing the benefit of pension tax relief.

The MPAA sits alongside the standard annual allowance, which is currently £40,000.  It also applies where the annual allowance has been tapered. This means that once the MPAA is triggered, members who are building up defined benefit pension rights can accrue benefits within the annual allowance with a deemed value of up to £36,000/£40,000 depending on the level of defined contribution payments, plus any amount of unused annual allowance carried forward from the previous three tax years.

Capped drawdown income limits

The maximum permitted income that can be taken each year from capped drawdown is 150% of a “relevant annuity” (also known as the Government Actuary’s Department (GAD) basis amount), calculated using tables published by HMRC based on the individual’s age attained and current long-term gilt yields, but not on gender.  The member can, subject to the rules of the scheme concerned, vary the amounts and timing of income payment taken each year within the maximum.

The maximum permitted income must be reviewed every three years before age 75 and every year thereafter.  A more frequent review is not allowed unless one of the following three events occurs, or the member nominates a different review date:

• A lifetime annuity or a scheme pension is purchased with part of the member’s capped drawdown fund.

• Further monies are “designated” (crystallised into an existing drawdown arrangement) to provide additional income withdrawals (“Additional Fund Designation”).

• A member’s capped drawdown fund is reduced following a pension debit as a result of a pension sharing order.

In such cases the member’s maximum permitted income is recalculated based on the value of the capped drawdown fund and the individual’s age immediately after the event concerned.  This maximum permitted income will apply for the remainder of the three-yearly review period concerned commencing:

• in the capped drawdown year in which further monies are “designated” to provide an income, unless the maximum income falls in which case the reduction applies from the following year;

• in the capped drawdown year following that in which a scheme pension/lifetime annuity is purchased, or a pension debit is made against the member’s benefits.

Where a yearly or three-yearly review is due, the scheme administrator can nominate that the calculation is undertaken within a 60-day window in advance of the due review date.  The review will be undertaken using the member’s capped drawdown fund, and based on his/her age, at the date of calculation. The revised maximum income limit itself will not, however, take effect until the review date and subsequent reviews will continue to be on the appropriate yearly or three-yearly anniversary of income commencing.

Reviews can be undertaken before age 75 at the end of each capped drawdown year but only at the request of the member and subject to the consent of the Scheme Administrator.  In such cases a new three-year review period will commence on an anniversary of the current reference period.  The following example will explain this.

Example

Winston Brown commences drawing a capped drawdown pension on 1 November 2014, when aged 60. The first three-yearly review of his maximum income is due on 1 November 2017.  Winston asks for this to be brought forward to 1 November 2016, and the scheme administrator agrees.

The scheme administrator nominates 10 September 2016 as the calculation date for the review. The revised maximum permitted income calculation is then based on Winston’s drawdown pension fund value and his age as at 10 September 2016. The revised income limit will, however, only apply from 1 November 2016 and the next three-yearly review will be due on 1 November 2019.

It is not possible to alter the end date of a drawdown pension year whilst a member is below the age of 75.  However, once an individual has attained age 75, it is possible to shorten or lengthen a drawdown year so that different tranches of drawdown benefits, each with different annual review dates, can be synchronised on the same date.

Death Benefits

Subject to scheme rules, the member’s residual drawdown pension fund on death can be used to provide:

• a lump sum;
• an annuity;
• flexi-access drawdown.

Where a member dies in capped drawdown it is not possible for their beneficiary to continue in capped drawdown. This means that if the beneficiary wishes to continue in some form of drawdown, then their only option is flexi-access drawdown. This will not disadvantage them in any way as there is no maximum income limit with flexi-access drawdown, and the MPAA will not be triggered by taking withdrawals as the pension is an inherited one and not one built-up in the beneficiary’s own name.

The benefits will be tax-free if the member died under age 75 and benefits commence within two years of the date when the scheme administrator was aware of, or should have been aware of, the death.

At age 75 or above, or if there is a delay of over two years, benefits will be taxed as income on the recipient under PAYE except when it is paid to a trust, in which case a 45% tax charge will apply.  The member’s death benefits will not be tested against the Lifetime Allowance as they were already tested when the member’s benefits were crystallised to provide the income withdrawals.  In normal circumstances there should be no inheritance tax payable.

The member can nominate who they wish to receive the death benefits, though the IHT exemption relies on the scheme administrator having final discretion in the choice of beneficiary.  If there are any surviving dependants of the member, flexi-access drawdown can only be paid to a non-dependant if they have been nominated by the member, but there is no such restriction on lump sums.

If the member has no dependants at the time of death and has nominated a charity to receive death benefits, these can be paid to the charity without any tax charge.

If a dependant or nominee dies while receiving flexi-access drawdown, the remaining fund may be passed down to a successor, and this process can continue indefinitely.  The tax position will depend on the age at death of the person who has just died.

Investments

There are no special investment restrictions placed on a member’s drawdown pension fund.  Crystallised funds providing income withdrawal benefits can be included in the value of benefits under a scheme to justify the level of a loan made by a SSAS or borrowing from a SSAS or a SIPP.

Taxation

Any income drawn by the member will be taxed under PAYE.

The member’s drawdown pension fund will continue to be invested in a tax privileged manner.

Further information

For further information, please click here.

Important information: This article is intended for informational purposes only and no action should be taken or refrained from being taken as a consequence of it without consulting a suitably qualified and regulated person. Opinions constitute our judgement as of this date and are subject to change without warning

Equerry Investment Management is a trade name of Raymond James Investment Services Limited utilised under exclusive licence. Raymond James Investment Services Limited is a member of the London Stock Exchange and is authorised and regulated by the Financial Conduct Authority. Registered in England and Wales No. 3779657. Registered Office: Broadwalk House, 5 Appold Street, London EC2A2AG.