Chapter 6 – Drawing Pension Benefits (9 marks, 5 muliti choice) Flashcards
Back ground -
We often hear people talking about their retirement. The long, happy days when work is only a memory and you take the benefits from your employer or individual pension plan.
You might take a cruise or live in Spain through the winter months, whatever takes your fancy.
The reality is that ‘Retirement’ is often not a transition from working five days a week, to not working at all, that happens on a particular, set day. It is often phased in, or people retire from their ‘main’ job and take part-time employment to supplement their income and stop themselves being bored.
As the reliance on state provision has decreased over the years (for certain individuals), the old concept of ‘retirement’ seems somewhat outdated.
Recognising this trend, in 2006 rules changed, meaning that members of occupational schemes no longer need to ‘retire’ to draw pension benefits.
This allows for the phasing of retirement benefits, which we shall explore later in this chapter.
We looked at ‘crystallisation’ in Chapter 2. Whilst you are far more likely to hear your customer talking about ‘drawing my pension’ than ‘crystallising my pension’, the reality is that they are one and the same.
Recognising the need for greater choice at retirement lead to the TOPA 2014, and the introduction of more options through pension freedoms.
The bulk of the pension freedom changes do not apply to DB scheme benefits but DC funds only.
There are many ways an individual can currently draw benefits.
Scheme Pension
Lifetime Annuity
UFPLS
Capped Drawdown
Flexi-Access Drawdown
Triviality
Triviality
Funds of up to £30,000 can be taken as cash under rules for DB scheme members, and funds of up to £10,000 each, under ‘small pots’ rules, for both DB and DC schemes.
The flexible pension rules, allowing access to all pension funds, made this concept redundant, in many cases. In fact, as from 6th April 2015, standard triviality is now not needed in DC schemes, only in DB schemes
These are where a beneficiary, on death of the DC member, can:
Commute a pension they are receiving.
Commute a lifetime annuity guaranteed period income.
Both a nominee and/or a dependant can use these triviality types, however they must extinguish all pension scheme rights completely. These forms of commutation are not RBCEs.
With both of the above, the maximum triviality commutation amount is £30,000. Any amount above this will be treated as an unauthorised payment subject to the relevant unauthorised payment taxation.
Normal minimum pension age (NMPA)
When the state pension age (SPA) increases to 67, NMPA will change to 57. This will come into force from April 2028. If an individual draws pension benefits earlier than NMPA, unless they are in ill-health or serious ill-health or have an HMRC concession, there will be an unauthorised tax charge levied.
Going forward, the minimum pension age will always be 10 years less than SPA. So, as SPA rises to 68, NMPA will rise to 58, and so on (excluding the rise to 66, as NMPA has remained at 55 until 2028 - as always nice and simple!)
This NMPA will apply to any RPS that receives tax relief and concessions, as previously covered.
There will be some exceptions.
Payment of PCLS
What are the arguments for and against taking a full PCLS? (SEE Info box in 6.2)
When an individual crystallises their pension, be it DB or DC, they have the right to take maximum PCLS, and usually do.
This 25% rule applies to all types of RPS, including DC and DB schemes. This PCLS must be paid within a set timeframe: up to six months before, and up to twelve months after, the member became entitled.
Otherwise, it will be treated as an unauthorised payment.
6.3: Secured income
Scheme pension and lifetime annuity.
Tell me similarities and differences between both
LOOK AT ALL DIFFERENCES
DO 6.2
These are the two secured income options potentially available to an individual.
UFPLS and Drawdown pension are not secured income!
Certain criteria must be met for income payments to qualify as a scheme pension (if that is the option chosen):
What are they?
Instances where a scheme pension can be reduced or stopped after being secured are noted below.
As you can see from the list, specific circumstances must apply:
where a member retired early due to ill-health but recovered sufficiently to be able to work again.
the scheme reduces all members benefits, for financial reasons, or on scheme wind-up.
the pension was temporarily set higher to bridge the gap until state pension benefits become available (bridging pension payments or an integrated scheme).
the court orders a reduction, most commonly through a pension sharing order following a divorce.
certain re-employment circumstances (often public not private sector).
in cases of fraud that come to light once income has commenced.
In many cases, the income remains the same, or increases due to escalation chosen by the member or featuring within the scheme, until death of the member.
Lump sum payment on death
The option to take a deceased member’s pension as a lump sum probably carries the most complicated qualifying rules of the options available.
Whereas a guaranteed period or a dependant’s pension is fairly straightforward to arrange and understand, this option depends on a number of factors.
The first consideration is the type of pension scheme that the deceased saved into, defined benefit or defined contribution. Once this is established, the other factor is the age of the member at their death (before or from age 75) which leads to different rules being applied.
RWAD 6.3!!!!
key points in the rules we have just covered are:
the pension schemes were DB, providing a lump sum option.
the age at death was one key factor regarding any LSDBA charge issues, as this affected whether the payment was an RBCE or not….pre-75 it was, from 75 it was not. (if it is a RBCE it is calcuated against the LSDBA/LSA. For those agad over 75 the whole lump sum is taxable so it is not tested against these allowances)
The other key factor was whether the funds at the time of death were: uncrystallised (RBCE) / crystallised from 6th April 2024 (RBCE) / crystallised before 6th April 2024 (NOT RBCE).
the scheme rules had to include a lump sum death payment as an option.
Important to understand!
Whether a lump sum death benefit is a RBCE or Not, and therefore, whether tested against the LSDBA.
- Death pre 75, with uncrystallised funds or funds crystallised from 6th April 2024, left as a lump sum, is a RBCE, and therefore the LSDBA is used, meaning tax could be chargeable on any excess above the LSDBA. If no excess, no tax is chargeable. However, It must be distributed within 2 years or it will be taxed.
- If the lump sum came from funds crystallised before 6th April 2024, or death is when they are 75 or more, it is NOT a RBCE. Therefore the full amount is taxable at beneficiaries’ marginal rate of income tax.
Why is that low rates also cause annuity rates to be low.
Annuity providers guarantee the income by buying long dated bonds using your pension funds
SEE END OF 6.3 FOR FULL EXPLANATION
the general returns on annuities are affected by longevity and long-term bond yields, but they are not the only factors that matter.
Do you remember the difference between a dependant and a nominee?
A dependant: someone satisfying HMRC rules, such as a spouse, civil partner, or child up to age 23.
A nominee: an individual who does not satisfy this definition.
This is any individual nominated by the annuitant, so could be someone that is non-dependent such as a close friend, business partner or older child.
Income paid to a dependant that is not a child can cease if the individual dies or remarries.
As mentioned previously, the older an individual is, the more likely their spouse / RCP will have pre-deceased them, and their children are classed as non-dependent under HMRC rules.
As a reminder: lump sums
A lump sum paid before age 75 from funds crystallised before 6th April 2024 – not an RBCE, and not tested against the LSDBA. All paid tax-free.
A lump sum paid before age 75 from funds crystallised from 6th April 2024 – an RBCE, and tested against the deceased’s LSDBA. Funds within the LSDBA will be paid tax-free and any excess will be taxed at the recipient’s marginal rate.
A lump sum paid from age 75 – not an RBCE. All taxable at the recipient’s marginal rate.
Also, remember
the 2 year rule for distribution of the lump sum – otherwise, it will all be liable to tax.
If paid to a charity – tax free.
If paid to a trustee / personal representative – taxed at 45%
As reminder: Income
The income, however, that can be paid from joint life annuities has some key differences to income from a scheme pension following the changes introduced by pension freedoms legislation.
As already mentioned, it can be paid to either a dependant or a nominee.
Taxation of this income, as already mentioned, varies depending on the age of the annuitant at death.
Tell me about the option to take Uncrystallised funds pension lump sums (UFPLS)
UFPLS = Lump sums only
This is another flexible pension option, introduced from April 2015. It allows the member to draw a cash lump sum from uncrystallised funds, without having to designate them to drawdown first.
25% of the cash withdrawn will be tax-free (subject to having sufficient LSA) and the remainder will be taxable as the individual’s pension income via PAYE. The 25% cannot be called PCLS, as there is no income commencing.
As discussed in Chapter 2 of this study guide, if an individual uses UFPLS it will trigger the MPAA. This is to prevent an individual taking a cash sum and then recycling it, with tax relief, back into a DC RPS.
The rules for UFPLS are now the same for payment before and after reaching age 75: SEE RULES IN 6.4
Do remember, subject to the member have sufficient LSA remaining, any UFPLS payment is always split into 25% tax-free and 75% taxable. Let’s look at one more example to illustrate this point.
How to calculate GAD rate and use GAD rate in practise for capped drawdowns. Using GAD rates is called capped drawndown. Anything over GAD is flexi access drawdown
if an individual was using capped drawdown as at 6th April 2015 they may continue to do so.
Take the age of the individual in complete years.
Take the applicable gilt yield from the 15th of the previous month.
Round this down to the nearest 0.25% if required, so 3.85% would become 3.75%.
Use the age and yield to identify the GAD rate. This is the £ per £1,000 allowable, so if the table shows £64 then the GAD rate is £64 ÷ £1000 x the pension fund available after PCLS taken.
This gives 100% GAD withdrawals.
The withdrawal maximum is 150% of the GAD rate.
Before we move on to look at flexi-access drawdown let’s look at another style of GAD calculation question which is very popular with R04 examiners.
This is where you are given a certain DC fund size and the applicable GAD rate, and are asked how much of the fund must be crystallised to provide a certain net income target.
If you have not had a practice at one of these beforehand it can be very tricky to work out an answer!
(see examole
FAD follows the same principles as capped, in that: funds are crystallised, PCLS taken, and monies remain invested and potentially growing, however an individual has no cap applied to withdrawals taken from FAD.
FAD withdrawals are limited only by the DC fund size.
Remember, any individual in capped drawdown that exceeds 150% GAD in terms of withdrawals will also have their plan converted into FAD.
HMRC need to be informed of the intention to access FAD and will require information from the scheme or individual. The information required will include:
full name and address of the individual.
their National Insurance Number.
The SA must notify the member that they have accessed flexible benefits within 31 days, and the member has 3 months to notify any other schemes they have, that they accessed flexible benefits.
6.5.3: Short-term annuities
Short-term annuities are temporary arrangements, that can be used in conjunction with both capped and flexi-access arrangements. They provide a fixed income, for a fixed time, and the income is taxed as earned income at the recipient’s marginal rate.
Explain this further
OMO is not compulsory on short-term annuity purchases. It is still recommended, since, as mentioned previously, it allows the individual to shop around for the best annuity for their personal circumstances.
Income from a short-term annuity can now be ‘flexible’ in that it can go down as well as up. This is, of course, dependent on this being offered by the relevant provider.
The annuities can be max 5 years
See example for problem with short term annutities in relation to GAD rates
Why would someone use short-term annuity purchase?
There are a variety of reasons, which include:
the need for some guaranteed income (albeit short-term).
wanting to keep costs down (premiums will be lower as this income is only paid for 5 years).
the opportunity for their remaining pension fund to grow.
not wanting to make all annuity decisions at one point in time as annuity rates may improve (they are comparatively low currently) or an individual’s personal circumstances may become clearer (perhaps a spouse is unwell).
Provider reviews are not an issue for FAD, as there are no limits to the amount you can withdraw, but they still apply to capped drawdown plans. As alluded-to already, the regularity of reviews carried out in relation to capped drawdown plans is largely based on your age:
Every 3 years for under 75s
annully if 75 or older
Why are reviews carried out for capped drawdown and not FAD?
The scheme administrator within the provider is responsible for the recalculation, which is done on a ‘nominated date’. The nominated date must be conducted within a 60-day window, no later than the new reference date. This date is selected by the scheme administrator, not the member.
There are some new terms here, so let’s just make sure you understand these.
Reference period
The reference period is the length of time, at the end of which, capped drawdown maximums must be recalculated. So, up to age 75, this reference period will last for three years, from 75 onwards it will last for one year.
Reference date
This is the day that the reference period ends on. The new income levels must be recalculated within a 60-day window of this date.
Nominated date
The date selected to carry out the new income calculation review. This day is unlikely to be the same as the reference date, but more likely to be within the 60-day window preceding it.
Pension year
A pension year for an arrangement, runs for 12 months from the date the member first designates funds to provide capped drawdown income under the arrangement. Each subsequent pension year follows this date. Once set, the member cannot change a pension year before they are 75. In limited circumstances, a pension year can be changed after reaching age 75.
Some individuals have drawdown arrangements from a variety of sources, different capped drawdown pensions, short-term annuities, etc. and these will all have their own separate review arrangements.
There isn’t anything you can do about this when you are under 75 unless you successfully plead to the scheme administrator for assistance, but you can align them all when you reach 75.
Choosing your nominated date, the first time you review after 75 allows you to pick the same dates for all of them.
Remember, provider reviews only apply to capped drawdown or short-term annuities purchased using capped drawdown funds. They are not relevant to FAD as there are no restrictions on withdrawals.
There are other occurrences that can trigger a recalculation. These are:
Remember, provider reviews only apply to capped drawdown or short-term annuities purchased using capped drawdown funds. They are not relevant to FAD as there are no restrictions on withdrawals.
