I believe the answer is that flexi-access drawdown (FAD) is essential for the delivery of maximum possible flexibility to clients who are looking to withdraw money from their pensions.
Uncrystallised Funds Pension Lump Sum (UFPLS) is administratively easier to deliver but doesn’t offer the same range of client options as FAD.
There are two areas where FAD is more flexible:
UFPLS is, by definition, paid as a lump sum so it can deliver an upfront payment. The downside is that 75% of each payment taken under this route will be subject to a tax charge at the time the payment is made.
In comparison a FAD policy can pay up to 25% of the whole pension fund tax-free before any income is paid. So if a lump sum is the primary objective it makes sense to take as much as possible using the Pension Commencement Lump Sum. If the lump sum required is more than the 25% tax-free cash, taxable income can be taken to make up the shortfall.
If a client chooses to crystallise their full fund FAD offers another tax advantage in that the client can then select exactly how much taxable income they withdraw each year, and change the amount as often as they wish.
This allows them to plan for specific events and avoid taking income that would take them into a higher tax bracket.
Under UFPLS even though it is paid as a lump sum 75% of each lump sum is treated as income for tax purposes and the client cannot choose not to take the full income.
Ongoing payments look to be more tax-efficient under UFPLS as each will contain an element of tax-free cash.
That’s not the end of the argument however, since the same result can be achieved by phasing crystallisation under FAD where a lump sum is not required up front.. The most suitable route in these circumstances will be the one which delivers the most flexibility in terms of the frequency of withdrawals in the most cost-effective manner.
The same thing applies to any ad hoc lump sum withdrawals. Conceptually UFPLS seems more aligned to the payment of lump sums however partial crystallisation under FAD will deliver the same result.
I'm inclined to believe that FAD can do anything UFPLS can do however UFPLS cannot offer everything that FAD is able to.
A FAD option will therefore deliver maximum flexibility and choice, However it is important to check whether the options chosen will result in extra charges under each solution.
|Lump sum up front with little/no income|
|Ability to select precise income amounts|
|Tax-efficient income utilising tax-free cash over time|
|Ad hoc payments|
The ideal scenario would be for every client to have the choice of both options at retirement, however this is unlikely to be the case in practice.
Providers who are active in the pension market will no doubt offer both with their current products but it is unlikely they will go the expense of creating systems to deliver FAD for legacy products which they no longer sell.
One-off or infrequent UFPLS payments would be easier to offer so this is probably going to be the only option for many legacy products and even then regular payments could still prove a challenge.
The most likely scenario is therefore that clients in legacy products will have to switch to another policy if they want to access regular withdrawals.
Read details on how our pension products will change following the legislation changes this coming April.
Fiona joined the life and pensions industry in 1989. She is a Fellow of the Personal Finance Society, an Associate of the Chartered Insurance Institute and is currently Vice-President of The Insurance Society of Edinburgh. Fiona specialises in the areas of at retirement planning and pensions and divorce.