Freedom and choice
You no longer have to purchase an annuity with your defined contribution pension. There are other options available to you and free impartial guidance from Pension Wise to help you decide what to do.
In April 2015, the tax rules were changed to give people greater access to their pensions. Drawdown of pension income is taxed at marginal income tax rates rather than the previous rate of 55% for full withdrawals. The tax-free lump sum continues to be available. In order to support their decisions, individuals have access to free and impartial guidance via the phone or face-to-face, Pension Wise, to help them make the choices that reflect their needs in retirement. There are six options available including, leaving the pension pot untouched, purchasing an annuity, getting an adjustable income (Flexi Access Drawdown), taking cash in chunks (Uncrystallised Funds Pension Lump Sum), cashing in the whole pot in one go and mixing any of the options.
To find out more about the options available, you can read the below information and read our dedicated spotlight 'What are my options after April 2015?'.
There are now six retirement options that you should consider.
- Option 1 - Leave your pension pot untouched for now and take the money later.
It’s up to you when you take your money; you might have reached the normal retirement date under the scheme or got a pack from your pension provider but that doesn’t mean you have to take the money now. If you do not take your money, you should check the investments and charges under the contract.
- Option 2 - Get a guaranteed income (annuity)
You can use your whole or part of your pension pot to buy an annuity. It typically gives you a regular and guaranteed income. There are different types of annuity available.
- Option 3 - Get an adjustable income (drawdown)
You can usually take up to 25% as a tax-free cash sum. The rest of your pot is invested to give you a regular (taxable) income in retirement
- Option 4 - Take cash in chunks (drawdown)
- How much and when you take your money is up to you. 25%, of every chunk, you take is usually tax-free, the rest is taxable.
- Option 5 - Cash in your whole pot in one go
You can do this but there are certain things you need to think about. You have to consider how much tax you pay on the amount your take out and you have to think about what you’ll live on in retirement.
- Option 6 - Mix your options
You don’t have to choose one option you can mix them over time or over your total pot.
Option 2 - Different types of annuity
There are many different types of annuities. The amount of annuity that you will get will depend on how much you have in your pot and when you buy it, your age, your health and lifestyle and the type of annuity (anything ‘extra’ will mean that you get a lower rate at first). You don’t have to use your whole pot after the tax-free lump sum to buy an annuity, it’s up to you how much you use.
- If you decide that you wish to buy an annuity, it is really important that you shop around. It might be possible to get a better rate if your health is poor or you smoke.
Options 3 and 4 - Drawdown
There are two types of drawdown; flexi-access drawdown and uncrystallised funds pension lump sum.
Everyone has a 25% tax-free allowance for their pension pot, which can be taken in different ways. If you want to take a flexible income when you retire, you have two ways of doing this. Both allow you to take 25% tax-free cash, but the difference is when you take it:
- if you take flexi-access drawdown, you take the tax-free chunk all in one go
- if you take smaller sums of cash from your pension pot (this option is also known as 'Uncrystallised Fund Pension Lump Sum' (UFPLS)), you take the tax-free amount as part of each separate withdrawal.
Please note: The Money Purchase Annual Allowance was introduced on 6th April 2015 and was set at £10,000 gross p.a. The government has now reduced the MPAA to £4,000 gross p.a. which applies to contributions made from 6th April 2017.
For both, part of your pension pot is still invested, and you will have to be careful to manage this money. As with all investments the remaining pot might rise or fall in value (depending on the investments you have chosen) and this will affect what you can take out in the future. You also need be aware of the charges that might apply to each of the options. The way these are taxed and how remaining pots can be paid out when you die are the same under both options. Not all pensions offer these options and it is important that you check with your provider to see what is available. As always you have the right to shop around to find another pension that can provide the option you want. If you intend to use these options you may want to seek the help of a financial adviser.
- Option 3 - Flexi-access drawdown fund
You can take up to 25% tax free cash from your pot and the remaining 75% needs to be invested so that it generates an income for you. It is important that you get help on how much you can take out to make the fund last as long as possible (people who are 55 now live on average to their mid to late 80s but you might live longer). The income you get from what’s in your flexi-access fund is taxable. It’s added to any other income you might have for the year if and how much tax you pay depends on your overall income for the year. If you take a lot of income it could mean that you get bumped into a higher tax rate. If you don’t have a P45, it’s possible that you’ll be put on an emergency tax code until HMRC issues a new tax code to your provider. At the end of the tax year HMRC will check you've paid the right amount of tax. If you owe tax or have underpaid, they'll send you a tax calculation and a new tax code to your provider. They'll use this to work out how much tax to take from your pension payments for that tax year. However, if you have overpaid tax you do not need to wait until the end of the tax year to reclaim the overpayment. If you still want to pay into a defined contribution pension fund, you only get tax relief on £4,000 a year. This is called the Money Purchase Annual Allowance (MPAA).
If you are on benefits: you should know that any money you take from your pension pot will be counted towards the income that’s assessed when checking your eligibility. If you have any larger debts, creditors may be able to access income you get from flexi-access drawdown.
- Option 4 - Uncrystallised Funds Pension Lump Sum (UFPLS)
If you’re a member of a defined contribution scheme, you may be able to access your pension fund, in full, or a series of lump sums as you go along, without the need to purchase either an annuity or putting your money into income drawdown. This is known as an Uncrystallised Funds Pension Lump Sum (UFPLS). UFPLS may be available if you are aged at least 55, or earlier if you’re in poor health.
25% of each cash amount you take out is tax free but the remaining 75% is taxable. As with flexi-access drawdown, it is important that you consider seeking regulated financial advice on how much you can take out to make the fund last as long as possible (people who are 55 now live on average to their mid to late 80s but you might live longer).
It’s a bit like a savings account although the pension provider might limit how much you can take out and how often you can take money out and some providers might charge every time you take money out and like with all investments the value of your fund could go down.
Of the amount that you withdraw, 75% of the lump sum is taxable. It’s added to any other income you might have for the year and if and how much tax you pay depends on your overall income for the year. If you take a lot of income it could mean that you get bumped into a higher tax rate. If you don’t have a P45, it’s possible that you’ll be put on an emergency tax code until HMRC issues a new tax code to your provider. At the end of the tax year HMRC will check you've paid the right amount of tax. If you owe tax or have underpaid, they'll send you a tax calculation and a new tax code to your provider. They'll use this to work out how much tax to take from your pension payments for that tax year. However, if you have overpaid tax you do not need to wait until the end of the tax year to reclaim the overpayment. If you still want to pay into a defined contribution pension fund, you only get tax relief on £4,000 a year. This is called the Money Purchase Annual Allowance (MPAA).*
If you are on benefits: you should know that any money you take from your pension pot will be count towards the income that’s assessed when checking your eligibility. If you have any larger debts, creditors may be able to access income you get from flexi-access drawdown.
To find out more about the above, you can read our 'Income Drawdown' spotlight, providing more detailed information.
Scheme rules override
As many pension scheme rules will not permit either an UFPLS or flexi-access drawdown, the government has introduced a ‘scheme rules override.’ This override is intended to allow pension providers to make these payments without having to amend their scheme rules. There is no obligation on any pension provider to offer an UFPLS and/or flexi-access drawdown.
Minimum pension age increased to 57
In a consultation document from 2014, the government proposed that the normal minimum pension age (the earliest age you may be able to take your pension benefits) should increase from age 55 to age 57 in 2028. It would increase at the same rate as the increase in the State Pension age from then on. This means that the minimum pension age would remain ten years below State Pension age.
However, there is currently nothing in the legislation to state that the normal minimum pension age will increase in 2028.
Future annual allowance
If you have taken benefits under flexi-access drawdown or ‘Uncrystallised Funds Pension Lump Sum (UFPLS)’ and you want to continue paying contributions to a defined contribution pension scheme, you will have a reduced annual allowance of £4,000 towards your defined contribution benefits. This is known as the ‘money purchase annual allowance’ (MPAA) and includes both your own contribution and any other contribution paid on your behalf, such as an employer or a third party. You cannot bring forward any unused annual allowances from the previous three tax years, to warrant a higher contribution of £4,000 towards your defined contribution benefits.
The Money Purchase Annual Allowance was introduced on 6th April 2015 and was set at £10,000 gross p.a. The government has now reduced the MPAA to £4,000 gross p.a. which applies to contributions made from 6th April 2017.
The money purchase annual allowance will only start to apply from the day after you have taken flexible benefits and so any previous savings are not affected. When you first flexibly access your pot, the scheme administrator must issue a statement to you within 31 days explaining the reduced money purchase annual allowance. You then have 91 days to inform all schemes of which you are a member and building up benefits with that you are now subject to the money purchase annual allowance. Once the member is subject to the money purchase annual allowance, their position is monitored after each tax year and the member is provided with an annual allowance pension savings statement in any tax year where the £4,000 limit is breached.
The money purchase annual allowance will not apply if you have taken a small pot under the trivial rules.
Passing on your pension pot on death
If you die in drawdown, pension death benefits can be paid to dependants (normally a partner or a child under the age of 23, or older, if the child is mentally or physically impaired) and a ‘nominee’ or a ‘successor’ may also be able to inherit a drawdown fund.
A nominee can be anyone who has been nominated by the member other than a dependant. If the deceased has made no nomination and there are no dependants, the scheme administrator can nominate an individual to become entitled to the funds.
A successor can be anyone nominated by the previous beneficiary, or, if no nomination has been made by the beneficiary, by the scheme administrator.
If you die under age 75, the remaining fund can be paid out as a lump sum or as an income to beneficiaries free of any tax. The remaining fund can also be used by beneficiaries to buy an annuity where the annuity income will be free of any tax. The tax exemptions only apply if benefits are either paid out as a lump sum or as income within two years starting with the earlier of the member’s death or when the scheme administrator could reasonably have known of the death. If not, the tax treatment reverts to the tax implications for post 75 deaths (see below). This applies to deaths before and on or after 6 April 2015.
If you die over age 75 when in drawdown and income is taken, either thorough continued drawdown or buying an annuity, the income will be liable to income tax at the recipient’s marginal rate of tax. As of April 2016, any payment of lump sum, in these circumstances, will also be liable to income tax at the recipient’s marginal rate of tax.
To find out more information about passing on your pension pot on death you can read our dedicated spotlight here.
The trivial commutation rule will only apply to defined benefit schemes. This is because defined contribution benefits may be taken as an ‘Uncrystallised Funds Pension Lump Sum (UFPLS). You have to add all the benefit values of all types of pension (company pensions/personal pensions/stakeholder pensions/retirement annuities/buy-out plans, but not any state pension) together. If they do not exceed £30,000 trivial commutation may be a possibility. In addition, trivial commutation can apply from age 55, or earlier, if in ill-health.
Small pots can apply from age 55, or, earlier if in ill-health.
Defined benefit transfers to a defined contribution scheme
Transfers from defined benefit (DB) schemes to defined contribution (DC) schemes continue to be allowed (but exclude pensions that are already in payment). However, transfers from DB schemes to DC schemes are restricted for members of unfunded public sector schemes (such as the Teachers’ scheme; NHS; Civil Service etc.), although you may be allowed to transfer in very limited circumstances.
There are also some safeguards in place, to help ensure that you and your pension benefits are protected. These include getting advice from a regulated adviser before you can transfer your benefits. Advice is not required where the transfer value is no more than £30,000. You will have to pay for the advice and provide documentary evidence to the scheme trustees that you had received such advice. If the transfer is to a connected employer scheme, or it is an 'incentivised transfer', your employer should pay for the advice if it is part of a company wide exercise.
To find out more information about the options available to those with a defined benefit pension, including information about transferring, you can read our dedicated spotlight here.
Part of the changes included the Government’s promise that all individuals with a defined contribution pension approaching retirement would have access to good quality, free and impartial advice through the service: Pension Wise.
The Pension Wise service is designed for those over the age of 50 with defined contribution pensions.
You can book an appointment – a 45-minute conversation between you and a Pension Wise guidance specialist. You’ll get personal guidance on:
- your pension options
- which options might be suitable for you
- what you can do next
You can find out more about Pension Wise and how to book an appointment by clicking here.
Where can I find out more?
If you need more information, please contact us. A pension specialist from our team will be happy to help with whatever pensions-related question you have. Our help is always free.