The main purpose of a pension plan is to provide you with an income when you reach a certain age and would like your retirement benefits.
- The normal minimum pension age is 55.
- It is proposed that from 6 April 2028 the normal minimum pension age will increase to 57.
- It is possible in certain circumstances to retire before age 55.
- It may be possible, depending on the type of plan, to phase benefits.
- Income from a pension is taxed as earned income.
- Income can be paid in one or a combination of ways:
- secured pension
- income drawdown
- partial uncrystallised funds pension lump sum
The options on how the benefits can be provided depends on the type of pension plan that is being used to provide the benefits.
The following article explains the range of options that are possible under the current legislation, though this may be different to what is offered by a specific pension plan.
When can benefits be taken?
The current normal minimum pension age is 55 and has been since 6 April 2010. It is proposed that from 6 April 2028 the normal minimum pension age will increased to 57.
This applies to all pension schemes, including those set up for people who traditionally had been allowed low normal retirement ages for example, professional sports people. There are however transitional arrangements for those with pre 6 April 2006 (A-Day) benefits with low retirement ages.
Depending on the type of pension plan, it may be possible to take pension benefits in stages.
Who can take their benefits before age 55?
Before 6 April 2006 there were a number of occupations where an individual could take their benefits from a personal pension or retirement annuity contracts before the age of 50. Fifty was the normal minimum pension age at that time for these types of plans.
Details of these occupations can be found in HM Revenue & Customs pension tax manual. There are still occupational pension schemes that have a normal retirement age below age 55, these schemes relate to the Armed Forces, Police and Fire Brigade. Certain conditions do apply.
Any current or deferred individual in an occupational pension scheme, including section 32 buyout plans (s32), who is contractually entitled to take their benefits from age 50 under their scheme, retains that right provided the contract was in place before 10 December 2003, they take all their benefits at the same time and the right is unqualified (in that nobody else's consent is required before the benefits can be paid).
Individuals taking their benefits due to ill health, severe ill-health and serious ill-health can do this before they reach age 55 or 57 from 6 April 2028, but there are conditions for doing so.
What benefits can be provided?
Lump sum benefits
There are a few different ways lump sum benefits can be paid.
Tax-free cash lump sum
In general, this is normally 25% of the benefits value subject to an overall maximum of 25% of the lifetime allowance.
Current or previous members of an occupational pension scheme including those who have s32 buyout plans may have a right to more than 25% of their pre 6 April 2006 benefits as a tax-free lump sum. However, some restrictions apply which are detailed in the Are there any restrictions? section below.
We have produced two articles - Primary and enhanced protection and Scheme specific tax-free cash which give full details regarding TFC and protection.
It may also be possible to take 25% TFC from any additional voluntary contribution (including free standing additional voluntary contribution) funds.
Small Lump Sums
There are a number of scenarios, for all scheme types, where it is possible to take benefits under the small lump sum rules if the plan value is below £10,000.
Since 6 April 2015 the option to take benefits under triviality is only available to defined benefits schemes. For defined contribution schemes see the section below on Uncrystallised funds pension lump sums (UFPLS).
When an individual reaches the age of 55, if the combined value of all of their registered pension scheme benefits is less than £30,000, they can take all of their defined benefits as a taxable lump sum. This must include the value of any pensions in payment. There are other conditions that must be satisfied which are detailed in our triviality article.
Uncrystallised funds pension lump sums
Since 6 April 2015 the option to take benefits under triviality from a defined contribution plan has been removed and replaced with an uncrystallised funds pension lump sum (UFPLS).
Unlike triviality there is no maximum value of benefits that can be taken. Nor is there any time period that benefits have to be taken, so it is possible to phase benefits.
To use this option the individual must be over age 55 (or eligible for early retirement due to ill-health or has a protected pension age), not have primary or enhanced protection with protected tax-free cash over 25% and have available lifetime allowance:
- Those under 75 can only have an UFPLS up to their available lifetime allowance. Any excess over the lifetime allowance would be treated as a lifetime allowance excess lump sum.
- Those age 75 and over can have an UFPLS where only part of the UFPLS is within their remaining lifetime allowance.
- That part of the lump sum equal to 25% of the individual’s available lifetime allowance at the time it is paid is not liable to tax, so it is paid tax-free.
- The rest of the lump sum is taxed as pension income in the same way as a pension paid under a registered pension scheme. This means the payer of the lump sum will deduct and account for income tax under the requirements of the PAYE regulations.
It is only available from uncrystallised funds, so it isn't possible to pay an UFPLS from drawdown funds.
Taking this option will trigger the money purchase annual allowance (MPAA).
75% of the value of the UFPLS will be added to the individual's taxable income in that year and be taxed at their marginal rate. If the plan allows, it is possible to phase benefits by using partial UFPLSs that would allow them to manage their income tax liability.
HMRC Pensions Tax Manual - PTM063300: Member benefits: lump sums: uncrystallised funds pension lump sum (UFPLS)
The remaining fund after any tax-free cash has been paid must be taken as an income. Pension income is taxed as earned income.
The income can be taken in one or a combination of two ways:
The scheme trustees of a defined benefit scheme can pay a pension for life out of the scheme assets (a scheme pension) or buy an annuity, using the scheme assets. The trustees can't offer the member an open market option.
Under a money purchase plan after the payment of any tax-free cash the value of the individual's fund is used to buy a scheme pension or a lifetime annuity.
- Scheme pension - This can be paid directly from the scheme assets or secured through an insurance company.
- Lifetime annuity - This can be bought from an insurance company and is not restricted to the company providing the pension plan. This is known as an open market option.
Individuals can select either an annuity guarantee period or annuity protection.
Annuity protection allows a lump sum to be paid out on death. This is based on the difference between the annuity purchase price less income payments already paid. If the individual was 75 or older at their date of death this lump sum is subject to a tax charge at the recipient's marginal rate of tax. If the lump sum is paid to a trust the tax charge is 45%. If they are under 75 at their date of death the lump sum is paid tax-free. This lump sum will either be paid to the deceased's estate or directly to the beneficiaries.
It is also possible to provide a survivor's annuity that will be paid on the death of the individual.
Income can be paid in three ways. Either by:
Short-term annuities allow an individual to purchase an annuity from an insurance company (on the open market, if required), or a series of annuities with all or part of their benefits. The annuity payable can't be paid for more than 5 years.
Since 6 April 2015 the money purchase annual allowance will be triggered as soon as income is taken.
All new drawdown plans set up after 6 April 2015 will be flexi-access drawdown plans. All existing flexible drawdown plans automatically converted to flexi-access drawdown plans on 6 April 2015.
A tax-free lump sum of up to 25% of the crystallised fund (tax-free cash) is payable (if required) each time crystallisation takes place. The remaining 75% will be designated to provide drawdown, which may be taken as a regular income, as a single lump sum or on an ad hoc basis as required. The amount that can be withdrawn is not subject to income limits; however any amounts withdrawn will be added to the individual’s taxable income in that year.
There is no minimum income requirement. Individuals in flexi-access drawdown may continue to make contributions; however, if they take any income any further contributions they pay will be subject to the money purchase annual allowance.
Since 6 April 2015 it's no longer possible to set up any new capped drawdown plans. Existing capped drawdown plans can continue as long as the income doesn't exceed the applicable GAD limits.
Capped drawdown replaced what was previously known as unsecured pension and alternatively secured pension.
There is no minimum level of income and the current maximum income is based on 150% of the relevant Government Actuary's Department (GAD) rate with no guarantee.
It is possible for an individual to take tax-free cash from their pension without the requirement to take income at the same time.
Reviews of maximum income are required every three years if the individual is under age 75, and every year for those who are age 75 or over. It is also possible to request a review at the end of each pension year. The scheme administrator can grant or refuse this request at their discretion.
Individuals can crystallise any proportion of their fund depending on the income they need. Where they choose to crystallise less than 100% of the fund, the plan will hold both uncrystallised and crystallised monies; this is called phased income drawdown. The level of income they can receive is determined by the value of funds designated and the GAD limits.
Additional fund designations to existing capped drawdown plans will still be possible and the annual allowance of £60,000 can be maintained provided the income doesn’t exceed the applicable GAD limits. Though care should be taken if the tapered annual allowance applies.
If the GAD limits are breached the plan will be converted to a flexi-access plan and the annual allowance reduces to the MPAA of £10,000.
Should the individual die below the age of 75 under income drawdown any remaining fund can be paid completely tax-free to any named beneficiary as a lump sum or as a drawdown pension.
If they die above the age of 75 any named beneficiary can draw down on the remaining funds or have the benefits paid as a lump sum. Both would be taxed at the recipient's marginal rate of tax.
If the lump sum is paid to a trust the tax charge would be 45%. In all cases this applies to crystallised and uncrystallised funds.
More detail can be found in our article Death benefits from April 2015.
What is the difference between drawdown and phased drawdown?
Phased drawdown can work with both capped and flexi-access drawdown.
Drawdown allows an individual to take tax-free cash of up to 25% (or higher amount if tax-free cash is protected) of the benefits and delay buying an annuity. If the plan has greater than 25% tax-free cash, all of the benefits under the scheme have to be taken at the same time, otherwise the higher tax-free cash will be lost. There is no requirement to take an income from the fund, however, income can be taken up to the maximum levels prescribed by the Government Actuary's Department under capped drawdown. There is no limit on the amount of income that can be taken under flexi-access drawdown.
Phased drawdown is when a combination of tax-free cash and income is used each year to provide the required income. Only the amount needed to provide the income is moved into income drawdown, the balance remains uncrystallised. Assuming that the individual doesn't require the maximum permitted tax-free cash at the start, this combination provides maximum flexibility.
Phased uncrystallised funds pension lump sum although this is not income drawdown it can achieve a similar result as phased income drawdown. The individual crystallises the amount required each year, which would be a mixture of tax-free cash and taxed income. Not all plans allow phased UFPLS.
If benefits are taken by either phased drawdown or UFPLS any protected tax-free cash would be lost.
Are there any restrictions?
There is no limit on the value of pension saving that can be built up by an individual. However, if they exceed the lifetime allowance when they are taken, the amount in excess of the lifetime allowance will be subject to income tax at the individual's marginal rate.
It is possible for individuals in pension schemes set up before 6 April 2006 to protect the benefits they already had on 5 April 2006. There are 2 types of protection - primary protection and enhanced protection. Individuals had until 5 April 2009 to apply for primary or enhanced protection.
When the lifetime allowance reduced in 2012, 2014 and 2016 the government introduced new protections which allowed individuals to protect their benefits against the lifetime allowance charge. More information on these new protections can be found in our articles fixed protection and individual protection.
The lifetime allowance is reduced when benefits are taken from a scheme that is able to pay benefits before normal minimum pension age.
Some occupational pension scheme benefits contain GMP or Section 9(2B) rights which may restrict the amount of tax-free cash that can be paid and will also restrict the type of annuity that has to be provided.
The information provided is based on our current understanding of the relevant legislation and regulations and may be subject to alteration as a result of changes in legislation or practice. Also it may not reflect the options available under a specific product which may not be as wide as legislations and regulations allow.
All references to taxation are based on our understanding of current taxation law and practice and may be affected by future changes in legislation and the individual circumstances of the investor.