HM Revenue & Customs (HMRC) published its draft Taxation of Pensions Bill on August 6, 2014, covering the new pension freedom that comes into effect on April 6, 2015. Pension scheme members aged over 55 taking benefits for the first time will have four options from April:
1. Flexi-access drawdown. This new form of income drawdown has no upper limit on how much members can take.
2. Uncrystallised funds pension lump sum (UFPLS). This allows members to take a lump sum, or a series of lump sums, from uncrystallised pension funds.
3. Lifetime annuity.
4. Scheme pension.
The uncrystallised fund pension lump sum is a new addition to the “pensions freedom” reforms. “Uncrystallised” means that no pension benefits, whether in the form of a lump sum or income, have been drawn yet from the pension plan.
Normally, when you take a pension commencement lump sum (tax free cash), you have six months to decide how to use the balance of the fund (drawdown or annuity), otherwise the sum becomes taxable. With this new UFPLS, this requirement to make a decision within six months is removed.
This new type of lump sum could therefore be an interesting option for individuals to consider, depending on their circumstances and objectives.
There are, however, two key points to consider: only 25% of the withdrawal will normally be tax free. The remaining 75% will be taxed at the individual’s marginal rate of income tax. Those using UFPLS will not be able to access their tax free cash and leave the rest of their pension invested; each withdrawal will be treated as 25% tax free cash and 75% taxable income.
Therefore, individuals who take an ad hoc lump sum without moving into drawdown or buying an annuity could end up paying more tax than expected.
Also, when an UFPLS is taken, the individual’s annual allowance for ongoing contributions is reduced from £40,000 to £10,000.
These tax rates are as applied under the UK taxation. Non-UK residents also have to consider the tax rules in their country of residence. Specialist advice is needed to ensure there are no unexpected tax consequences.
Note also that accessing funds through UFPLS is not yet regulated by the Financial Conduct Authority (FCA) or Pensions Regulator. This leaves anyone who takes this option unprotected.
There is a risk that individuals could deplete their pension pots without realising it. This is in contrast to the income drawdown process where the FCA has established strict rules on providing advice to ensure everyone understands the risks.
You should ensure that your pension adviser is authorised by the FCA, even if you live overseas.
Temporary rules for pension commencement lump sums
With the full “pensions freedom” not starting until April 2015, temporary rules have been introduced so that money purchase scheme members can take their tax free lump sum now and defer the associated pension until after April.
In other words, the six month period mentioned above will not start until April 6, 2015, so the associated pension can be deferred to October 5.
This rule came into effect after the Budget on March 19, but also affects those who took a lump sum from September 19, 2013 onwards if they had not become entitled to their pension.
This temporary measure enables members to wait to take their pension under the flexible rules starting in April – if their pension scheme allows this.
The deferred scheme is considered uncrystallised, so if the individual dies between taking the lump sum and taking the pension, the balance of the fund can be paid out as an uncrystallised lump sum death benefit. However if the October 5 deadline passes and the pension is still not in payment, the lump sum paid can no longer be considered a pension commencement lump sum and will be subject to tax charges.
The pension reforms are welcome for UK residents and expatriates alike, but it is essential to understand the short and long-term implications of the new options, both from a tax point of view and your long-term financial security, so that you can determine what the best route is for you. Seek specialist and regulated advice.
Tax rates, scope and reliefs may change. Any statements concerning taxation are based upon our understanding of current taxation laws and practices, which are subject to change. Tax information has been summarised; an individual is advised to seek personalised advice.
By Gavin Scott
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Gavin Scott, Senior Partner of Blevins Franks, has been advising expatriates on all aspects of their financial planning for more than 20 years. He has represented Blevins Franks in the Algarve since 2000. Gavin holds the Diploma for Financial Advisers. | www.blevinsfranks.com