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Unpicking the Uncrystallised Funds Pension Lump Sum (UFPLS)

So, drawdown [1] or annuity [2]? For 20 years, that has been the choice facing retirees. But at least there was a choice – prior to 1995, buying an annuity was pretty much your lot.

Wind the clock forward to April 2015, however, and a bold new era of pension freedoms [3] has begun.

Our pension, we are told, has become as flexible as a bank account.

That said, some pension providers aren’t yet offering [4] the full range of new pension freedoms – and it’s not difficult to see why. Certain aspects of the new freedoms are fiendishly complicated, imposing a hefty administrative and compliance burden.

And that can be a double-edged sword. Because it’s a reasonable bet that anything that imposes a hefty administrative and compliance burden on providers will also be complicated for retirees to figure out, as well.

Important decisions

That isn’t a problem if you’ve got an ever-helpful financial adviser at hand to help out, of course.

Though we all know what bastions of probity these have often proved to be [5] in the past.

So for those of us a little leery of Mercedes-driving gentlemen in flashy fur coats, it might be handy to get some of that complexity demystified, before making potentially irreversible decisions regarding the disposition of our own individual pension savings.

Which is why I thought I’d have a bash at it myself, on behalf of Monevator readers.

Be warned: I’m not a financial industry insider, just an ordinary investor like you.

Please feel free to use the comment box below to amplify (or even correct) what I say if you know better.

Your Lamborghini beckons

Most of the complexity, it seems, comes from the emergence of the new Uncrystallised Funds Pension Lump Sum (UFPLS) route to taking pension benefits.

The phrase is quite a mouthful, and far less memorable than former pensions minister Steve Webb’s oft-quoted remark about the new pension freedoms [6] enabling retirees to spend the lot on a Lamborghini if they so wished.

Nevertheless, if you do want to go down the Lamborghini route [7], it’s UFPLS that will take you there.

Also, it’s fair to say UFPLS is the route to a great deal many more interesting possibilities besides.

Because it’s UFPLS that really lies at the heart of the new freedoms.

Simply put, apart from UFPLS, there’s not a lot that’s really new, apart from tinkering at the edges – such as removing GAD [8] limits to drawdown, for instance.

So you really do need to get your head around UFPLS, and understand why you might want to go down the UFPLS route – and why you might not.

Crystal clear

The key is the word uncrystallised.

Fairly obviously, a conventional annuity crystallises your pension:

Here’s your pot [9]; here’s your 25% tax-free sum (should you wish to take it); and here’s your regular annuity income.

Likewise, drawdown also crystallises your pension – although rather less so, now that GAD withdrawal rates are a thing of the past:

Here’s your pot, here’s your 25% tax-free sum (should you wish to take it); and here’s your resulting drawdown income—which can be regular, irregular, or deferred, as you wish.

(Why would you elect for drawdown, and yet defer the resulting income? To get your hands on the 25% tax-free sum, of course.)

In contrast, UFPLS, as the name makes clear, does not crystallise your pension.

Making a withdrawal crystallises only the amount that is being withdrawn – leaving the remainder invested to (hopefully) continue growing.

The retiree can take the 25% tax-free sum each and every time they make such a withdrawal, with the remainder of the withdrawn amount subject to tax at the retiree’s highest marginal rate [10].

As a result, UFPLS offers the prospect of giving retirees a larger amount of tax-free cash than is possible with conventional drawdown, because the sum remaining invested [11] (hopefully) continues to grow [12] – and 25% of a larger amount is, er, a larger amount.

To UFPLS or not?

So should we all opt for UFPLS?

According to pension experts such as Tom McPhail at Hargreaves Lansdown [13], UFPLS is a decision requiring careful thought.

Not least because conventional drawdown offers two distinct advantages over UFPLS.

First, because of its administrative overhead (read: ‘form filling’), UFPLS is better regarded as a vehicle for irregular (and perhaps sizeable) withdrawals.

For a monthly income, drawdown is going to be an easier route.

Second, with UFPLS the government has taken the opportunity to clamp down on allowance ‘recycling’ – the dodge where investors took out the 25% tax-free sum and re-invested it their pension, thereby getting a double-dollop of tax relief.

Or, as we Northerners say, ‘free money’.

This clampdown takes the form of a £10,000 annual Money Purchase Annual Allowance [14], coupled to making post-UFPLS pension savings ineligible for the sometimes-handy ‘Carry Forward’ rules, whereby earnings in one tax year can be used to gain tax relief in another tax year.

So in a post-UFPLS situation, if one were to, say, sell a business or benefit from a large inheritance, you couldn’t tuck the money inside your pension in handy £40,000 dollops, gaining tax relief each time.

In contrast, investors simply taking the 25% tax-free sum through the drawdown route will not be deemed to have used the new pension freedoms, and so retain their ability to benefit from the £40,000 tax relief allowance.

(Don’t take income, though – otherwise the £40,000 tax allowance will be lost.)

The bottom line

So there we have it. Lots of things to weigh up, and various calculations to perform.

From what I can make of it, three ‘golden rules’ seem to apply:

Note: Do you know all about UFPLS? We’d love to hear from you below. And do read The Greybeard’s other articles on deaccumulation [15] and the changing landscape for pensions.