From 6 April 2015 the rules relating to defined contribution pension arrangements relaxed, from age 55 an individual is given unlimited access to their defined contribution pension funds and can withdraw as much or as little as they like.

Any amounts withdrawn in excess of the tax-free Pension Commencement Lump Sum are subject to tax. The rate of tax payable will depend on the level of the individual's total income in that tax year including the amount withdrawn from the pension fund.

There will be three main formats of pension income withdrawal: 

  • Annuities: These will be potentially more flexible and more tax efficient
  • Flexi Access Drawdown (FAD): Ability to take tax-free cash only and not income (maintaining £40k annual contribution allowance)
  • Uncrystalized Fund Pension Lum Sum (UFPLS): Lump sums can be taken where both the tax-free element and the taxable element are taken together.

You can choose to:

  • Take the whole remaining fund as cash
  • Take a series of ad hoc lump sums
  • Take a regular income by drawdown – by drawing directly from the pension fund, which remains invested
  • Take a regular income by annuity – where the remaining fund is sold to an annuity provider in exchange for an agreed income for life or certain variations.

Any withdrawals in excess of the tax-free cash will be taxed as income at your marginal rate. This means that the pension withdrawal will be added to your income in the current tax year (April 6th to April 5th) and will be liable to basic rate tax, higher rate tax and/or additional rate tax if the total amount of earnings, including the pension withdrawal amount, when added together, take you into the higher tax thresholds.   If you want to take taxable lump sums from your pension you should calculate whether taking it in stages will be more tax efficient for you.

What are your options at retirement?

If you have  a “money purchase” pension (a pot of money), such as a Personal Pension, Stakeholder Pension, Self-Invested Personal Pension (SIPP) or an Additional Voluntary Contribution (AVC) you will need to make decisions on how you convert the fund into income or cash, which we describe below in more detail.

If you have a “defined benefit” pension or “scheme pension” also known as a “Final salary scheme” this will be based on a promise of benefits from your employer and you will not normally need to consider many options, other than those that are given by the scheme. The changes that the Government has made to pensions in the 2014 Budget do not apply to Defined benefit or scheme pensions.

Small Pot Lump Sum

Up to three small lump sums may be taken as a full cash withdrawal where 25% is tax-free and the remainder of the fund is taxed as income for that tax year.  Small lump sums can be taken irrespective of the value of other benefits and even where the member has no remaining lifetime allowance.  It will not trigger the reduced money purchase annual allowance of £10,000.

To receive a small lump sum:

  • The member must be at least 55 (formerly 60)
  • The lump sum must not exceed £10,000 when it is paid
  • The lump sum must come from uncrystalised funds.
  • The member must not have already received more than two small lump sums under these rules
  • All rights under the arrangement must be extinguished.

Lump sums can be taken from separate schemes, or from separate arrangements within a scheme. This allows a small pot to be taken from an arrangement within a scheme, even if total benefits across the scheme exceed £10,000.  The small lump sum rules apply to personal pensions, stakeholder pensions, FSAVCs and section 226 plans.

Triviality Commutation of all DB pension benefits

Triviality Commutation of pension benefits is only relevant to Defined Benefit pension schemes since the introduction of pensions freedoms as lump sums can now be accessed from all DC regardless of the amount.

Under triviality a Defined Benefit pension member may commute one or more pension arrangements as long as they comply with the following:

  • The member has reached the minimum retirement age of 55.
  • The lump sum extinguishes all entitlement to defined benefits under the pension scheme making the payment
  • All computations must take place within a 12 month period from the date of the first trivial commutation payment.
  • The value of all members’ rights should not exceed £30,000 on the nominated date which can be within 3 months of the start of the commutation period.
  • The member has available lifetime allowance

If the member has not previously drawn or become entitled to any other benefits under the registered pension scheme before the trivial commutation lump sum is paid, 25% of the lump sum is tax free and 75% of the lump sum is treated as taxable pension income for the tax year the payment is made, accountable through PAYE.

Lifetime annuity

This option is considered the safest option for those who want to have a guaranteed income for life.   A conventional lifetime annuity is the transfer of the fund value to an insurance company, in return for a guaranteed income for life.
This means that the insurance company retains the investment risk for the promise of the income that they make.

Insurance companies offer different annuity rates, which means that it is important to look for the best annuity provider for your circumstances.   The “Open Market Option” is a legal right that allows you to buy an annuity from any annuity provider, rather than the pension provider that you saved with. An open market option could mean an improved income of as much as 30% and will take into account your age, health and lifestyle.

Options when you set up an annuity

Most people are confused by the word annuity but it simply means an income. When you set up an annuity you have to make certain decisions which will make the income higher or lower at the outset such as:

  • Whether to approach an insurer who will take account of medical conditions or lifestyle.
  • Select an annuity that stops on your death.
  • Select an annuity that continues to pay an income to a spouse on your death, you can select any level of income to continue to be paid to your spouse.
  • Select an income which stays the same or which increases each year to keep pace with inflation.
  • Select an income which guarantees to pay for 5 or 10 years or even30 years if you die before then.
  • Select a protected annuity (money back option)

Death benefits for joint life annuities or for guaranteed periods paid to beneficiaries by way of annuity income will be free of tax if death occurs before age 75. If death occurs after age 75, income is taxed at the recipient's marginal income tax rate.  The Government has indicated it will be looking to set up a secondary market for the purchase of buying back purchased annuities so that policyholders can convert their annuities to a cash lump sum, however this has yet to be set into law and to be seen how competitive this market might be.

Fixed term annuities

  • Pay a fixed income for a set term rather than for life, and provide you with a maturity lump sum at the end of the term. You may then buy another fixed term annuity, a lifetime annuity or go into drawdown.
  • Short term annuities can delay making a long term decision which could be beneficial if annuity rates rise in future, or detrimental if annuity rates drop in future.
  • You usually need to decide at the start of a fixed term annuity what would happen on your death during the term, whether an income could continue to be paid or a lump sum paid.

Investment-linked annuities and variable annuities

Unlike conventional annuities which are secure, investment-linked annuities depend on the performance of an underlying investment. They are designed to allow a potentially increasing income but there is an element of investment risk as the investment will be reliant on stock market returns and there is a chance income could fall as well as rise.  These types of annuity can be complicated and are generally not very transparent.

Flexible Access Drawdown

Drawdown pension is a method of withdrawing benefits from your pension fund without purchasing a lifetime annuity.  Personal pension plan holders can defer taking their pension in the form of an annuity and instead make withdrawals directly from the pension fund.

Drawdown allows you to take the tax free cash and leave the rest of your fund invested from which you can elect to draw an income or not draw an income.   Therefore if you elect to take an average of 5% income per year from the fund you need to achieve a net average growth of 5% per year if you want the fund to remain the same.   Income drawdown is a higher risk option than an annuity because the remaining fund is your responsibility and the investment risk is yours. The fund can rise and fall and will need monitoring especially if income is being taken from the fund. If a high level of income is being taken from the fund and the fund performance is poor the fund value and the available future income is likely to reduce.

Drawdown enables the policy holder to buy an annuity at a time that is best suited to them and hopefully when annuity rates are more favourable or provides an opportunity to avoid purchasing an annuity altogether where appropriate.
The option enables investors to retain control over their pension investments and allows them to continue to be invested in the markets.  It enables any remaining pension fund on death to be paid to the policy holder's beneficiaries as a tax free lump sum where death occurs before age 75. For deaths after 75 the tax charge will be 45% in 2015/16 reducing to the beneficiary's marginal rate of tax from 2016/17.

Advantages of Flexi-access Drawdown

  • You want to take a substantial tax-free cash sum, but do not need any or all of the income which an annuity would provide.
  • If you and/or your spouse are relatively young, this makes annuity purchase relatively less attractive (because of the lower mortality factor), therefore you can take advantage of a longer timescale in which to take on the rewards and risks associated with equity-based investment.
  • Income withdrawals from the flexi-access drawdown fund are entirely flexible and can be altered to suit your circumstances.
  • If you believe that interest rates and therefore annuity rates are temporarily at low levels and might increase again.
  • You need a flexible income that might be relatively low to start with, but might need to be higher after a few years have elapsed.

Disadvantages of Flexi-access Drawdown

  • There are often relatively high charges levied by both the adviser and the pension provider for the considerable amount of administration and advice involved in running a drawdown pension arrangement.
  • By investing in safe investments like cash and fixed interest securities, you may receive a lower lifetime income than is available from an annuity, which has the advantage of the mortality factor.
  • Investing in assets that might provide the extra returns that could out-perform an annuity involves risk. The shorter the time-scale to intended annuity purchase, the higher is the risk.
  • The future income from your pension fund continues to be subject to investment risk.
  • Should you decide to take your tax free cash and defer taking any income from your fund, the income you eventually receive when you decide to draw an income will be smaller than if you had left the entire fund invested.

Death Benefits

If you die whilst in drawdown pension there are Important differences that occur if death occurs Before or After age 75 the following options are available to your beneficiaries.

If you die before age 75, your beneficiaries can:

  • Take the whole pension fund as a lump sum tax-free.
  • Continue with drawdown - income is taken tax-free.
  • Buy an annuity, which will be paid tax-free.

If you die after age 75, your beneficiaries have three options:

  • Take the whole pension fund as a lump sum be subject to 45% tax
  • (Although, it has been proposed this should be changed to the beneficiaries' marginal rate of income tax from 2016/17).
  • Continue with drawdown - income subject to income tax at your beneficiaries' marginal rate.
  • Take periodical lump sums: if you choose this, the lump sum payments will be treated as income, so subject to income tax at your beneficiary's or beneficiaries' marginal rate.
  • Buy an annuity, which will be paid taxable as earned.

What happens to your fund when death is before or after age 75

  UnCrystallised Funds                              

Crystallised Funds

Below Age 75

Can pass on completely tax free to any beneficiary as a lump sum or as a pension (up to the Lifetime Allowance)

Can pass on completely tax free to any beneficiary as a lump sum or as a pension.
No Lifetime Allowance test.

Above Age 75

Any beneficiary can draw down on it at their marginal rate

Any beneficiary can draw down on it at their marginal rate

Should you die with no living beneficiaries your remaining drawdown pension fund can be donated tax free to a charity.

There will normally be no Inheritance Tax due on drawdown pension funds on death at any age although there are still areas that could have Inheritance Tax implications, such as:

  • Making pension contributions whilst in ill-health
  • Transferring pension funds whilst in ill-heath
  • Assigning into trust whilst in ill-health

The only death benefits that are tested against the lifetime allowance are those payable from uncrystallised funds (ie. funds you haven't yet drawn on at all) either as lump sums or into flexi-access drawdown on death before age 75. If those benefits exceed your remaining lifetime allowance there will be a 55% tax charge on the excess.

Uncrystallised funds pension lump sum (UFPLS)

You can withdraw a single or series of lump sums from your pension without the need to move the funds into a drawdown plan first. 25% of each payment of UFPLS may be taken tax free with the balance taxed at your marginal rate of income tax. Some pension contracts may not allow this and therefore there may be a requirement to transfer the funds to a more flexible arrangement.

  • The payment must be payable from your uncrystallised rights held in a money purchase pension.
  • If you are aged under 75, you must have more lifetime allowance remaining than the lump sum required.
  • If aged over 75, you must have some lifetime allowance remaining.
  • If you have primary or enhanced protection with protected tax free cash or a lifetime allowance enhancement factor but the lump sum allowance is less than 25% you can’t take your benefits as a UFPLS.
  • Where scheme specific lump sum protection exists, the right to the higher TFC would have to be given up in order to use UFPLS.

With regard to the taxation of an UFPLS, only 75% of the lump sum will be taxable as pension income at your marginal rate of tax, the other 25% will be paid tax free.

The provider will make your payment through the PAYE system and it is likely that an emergency code will be used and you will probably therefore pay a higher rate of tax on receiving the cash lump sum and will need to reclaim the  tax through your self-assessment tax return or by way of a separate direct claim to HMRC.  

Changes to beneficiary rules where income or lump sum is first received after 6th April 2015

The restriction that income can only be paid to a ‘dependant’ has been removed, which affects both drawdown pensions and annuities. This means that any beneficiary can be the recipient of death benefits from 6 April 2015.

  • A beneficiary is someone who was married/civil partner or a child under age 23 (or anyone aged 23+ who was deemed dependant financially or due to physical/mental illness) at the members date of death or when the member became entitled.
  • A Nominee is anyone nominated other than a dependant to receive benefits on the member’s death.
  • A successor is anyone nominated by a dependant or nominee or a successor, to continue to receive income on their death.

There is a ‘two year window’ in which timeframe death benefits must be designated to an income producing contract or paid out as a lump sum. Otherwise a tax charge at the beneficiary’s marginal rate of tax.

  • If the previous recipient of the income is aged below age 75 at death and the funds are within the lifetime allowance no tax charge whether taken as income or lump sum
  • If the previous recipient of the income is aged over age 75 and the funds are within the lifetime allowance a tax charge at the beneficiary’s marginal rate of tax.
  • Dependants, Nominees or Successors can use pension funds to purchase a lifetime annuity but only on a single life with no further death benefits attached.
  • There is no limit to the number of times a flexi access drawdown fund can be passed on following the death of the previous holder. This makes it a useful ‘generational’ wealth planning tool.

Changes to the Annual Allowance

The amount an individual can contribute is between £3,600 and upto the amount of their earnings within the current tax year, but not more than £40,000 which is called the annual allowance.  However, if you make withdrawals from a defined contribution pension in excess of the tax-free cash, any future contributions to defined contribution plans will be restricted to a maximum of £10,000 per tax year.  Once you enter flexible access drawdown and take an income you must, within 91 days, any pension provider to which contributions are subsequently paid, or face a £300 fine.
The new £10,000 annual allowance limit does not apply to any benefits you are building up in a final salary pension.

State pensions

The full state pension for tax year 2014/15 is £115.95 per week. If you have been employed and contracted into the State Second Pension (S2P) or the State Earnings Related Pension Scheme (SERPS) you will receive an Additional State Pension.   After 6 April 2016 you will receive the new proposed single tier, flat rate pension, which is expected to be about £150 per week.  You can find out more about your state pension by contacting the Department for Work and Pensions on 0345 606 0265.

Final Salary Schemes

Final salary schemes - and other types of defined benefit pension - provide you with a guaranteed income for life based on set criteria, for example 1/60th of your salary for every year you have worked for a company. This means people are not dependent on the stock market's performance, or annuity rates, and in the majority of cases a defined benefit pension ends up providing a higher income that is much more secure. The key difference between defined benefit and defined contribution is that with the former you know in advance what you will get out, while with the latter you only know what you are putting in.

The new rules do not affect these schemes. 

Those with final salary pensions can also take up to 25 per cent of what their pot is judged to be worth as a tax-free lump sum, although they will then get a lower retirement income to reflect this.  Because of the reforms, there has been a surge of interest in transferring the value of their defined benefit pension pot into a defined contribution scheme, which will then enable them to control when they take income.  The new regime permits transfers for private sector workers with final salary pension arrangements provided they take independent financial advice. But many advise against it because of the valuable guarantees a final salary member could be sacrificing, such as inflation-protected income and guarantees to pay a spouse a regular income if the scheme member dies.  Public sector workers are not allowed to transfer their deluxe defined benefit pensions.


If you intend to draw all your pension fund as a lump sum you need to consider how much tax will be payable and whether drawing income over several tax years would be more tax efficient.  You also need to consider that your retirement could last decades and your income in retirement will be less if you spend your pension fund rather than taking it as income from your pension or re-investing it elsewhere for an equitable income.

The lifetime allowance

The value of all your pension savings are subject to a lifetime allowance of £1.25M (2015/16) reducing to £1.0M in April 2016.  The lifetime allowance will then be indexed in line with CPI from 6 April 2018.  Any funds over this amount could be subject to a 55% tax charge.

To value your pension funds:

  • For defined contribution pensions use the current fund value.
  • For defined benefit, final salary schemes, multiply the current accrued annual pension, not yet in payment, by X20 plus any additional tax-free cash entitlement.
  • Any pensions in payment before 6th April 2006 multiply the annual income by X25.
State benefits are not included in the calculation.

Risk Warnings for Pension Withdrawal

  • Past performance is not a guide to future performance.
  • Investment returns may be less than shown in illustrations.
  • Investments can fall as well as rise and you could get back less than you invested.
  • Benefits from an annuity or drawdown plan can reduce some means-tested benefits.
  • Pension and tax legislation is subject to government changes.
  • Once an annuity is set up you cannot normally cancel it.
  • Annuity rates may reduce during the purchase period.
  • Income Drawdown - high income withdrawals may not be sustainable, withdrawals may erode the capital value of the pension fund, especially if investment returns are poor which could result in a lower income if an annuity is ultimately purchased.
  • Future contribution allowances may be reduced

Our Independent Financial Advisers are always happy to meet at our clients' preferred location and time and to have detailed initial discussions with no obligation.

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