Technical terms such as ufpls and FAD
The pension industry likes to confuse people with technical terms such as UFPLS and FAD.
These two retirement options are easily confused as they are very similar. Pension Freedoms allow us to decide exactly how we take income in retirement. Understanding the difference between Flexi-Access Drawdown (FAD) and Uncrystallised Funds Pension Lump Sum (UFPLS) is essential when deciding your retirement options.
As you are most likely aware, a portion of your pension fund is available to you without income tax cash,also know as a pension commencement lump sum(PCLS). This is generally 25% but can be higher or lower in certain circumstances. This article will assume that the permitted PCLS cash is 25%.
When we compare flexible drawdown vs ufpls, the most significant difference is when the PCLS is taken. UFPLS means you take a portion of your pension once or in a series of lump sums.
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Understanding Flexi-Access Drawdown (FAD)
Flexi-Access Drawdown (FAD) is a flexible way to access your pension savings, allowing you to take a tax-free lump sum and income payments from your pension pot. With FAD, you can crystallise your pension fund and take up to 25% of the fund as a Pension Commencement Lump Sum (PCLS). The remaining 75% of the fund is invested and can be drawn down as income, which is subject to income tax at your marginal rate. FAD provides a high degree of flexibility in drawing pension income, allowing you to choose when and how much income to take.
Understanding Uncrystallised Funds Pension Lump Sum (UFPLS)
Uncrystallised Funds Pension Lump Sum (UFPLS) is a way to access your pension pot without taking a regular income via drawdown or buying an annuity. With UFPLS, you can take lump sums from your pension pot, with 25% of the lump sum as PCSL and the remaining 75% being taxed as ordinary income.
UFPLS is available if your pension company offers it, and advice on an alternative scheme is required if not. UFPLS (Uncrystallised Funds Pension Lump Sum) is often used by individuals who require large lump sums from their pension pot, such as to pay off a mortgage or buy a house.
Key Differences Between FAD and UFPLS
The key differences between Flexi-Access Drawdown (FAD) and Uncrystallised Funds Pension Lump Sum (UFPLS) are:
FAD allows you to crystallise your pension fund and take a tax-free lump sum, while UFPLS allows you to take a lump sum from your pension pot without crystallising the fund.
FAD provides a high degree of flexibility in drawing pension income, while UFPLS is a more straightforward way to access your pension pot.
FAD is generally preferred over UFPLS in most situations, as it allows for more flexibility and tax efficiency.
Tax Implications of FAD and UFPLS
The tax implications of FAD and UFPLS are:
With FAD, the lump sums are limited to 25% of the pension fund, and the remaining 75% is taxed as ordinary income.
With UFPLS, 25% of the lump sum is free of tax, and the remaining 75% is taxed as ordinary income.
Both FAD and UFPLS can trigger the Money Purchase Annual Allowance (MPAA), which reduces the amount you can contribute to your pension pot each year.
It’s essential to consider the tax implications of both FAD and UFPLS before making a decision.
Flexi-Access Drawdown (FAD)
With Flexible Access Drawdown, your tax-free cash is taken upfront and in full. The remainder of your pension pot is designated into a drawdown account and is considered ‘crystallised’. This means the funds have been accessed, and you have decided which route you would like those funds to go down. Once your pension pot is crystallised, you can withdraw funds as needed, providing flexibility to manage your retirement income according to your changing circumstances. It’s important to understand that while you can take out the cash as required, the remaining funds will still be invested, which could potentially grow over time. For those seeking a deeper understanding of this process, a drawdown pension explained can clarify how it works and the implications for your long-term financial planning. It’s crucial to recognize that with the flexibility this option provides, there are also responsibilities and potential risks involved. Managing your investments wisely becomes essential to ensure that your retirement funds last throughout your lifetime. For a more comprehensive overview of the various aspects of this retirement strategy, a detailed resource on ‘pension drawdown explained‘ can be invaluable in guiding you through the nuances and best practices for effective management of your drawdown account.
This could involve allocating them to FAD or choosing a guaranteed income by buying an Annuity. If you choose to assign them to Flexi access drawdown, you can leave the rest of the funds invested.
If you are considering withdrawing money for income from your Flexi-Access Drawdown, you may arrange a regular income or make ad-hoc withdrawals.
Any money taken from your FAD account is then taxed at your marginal rate. This is because you have already taken your total tax-free cash initially.
Example – £400,000 pension pot
The charts below show how Flexi-Access Drawdown (FAD) works, assuming you have a pension pot of £400,000 and choose to use FAD to take your pension benefits. The Flexi-Access Drawdown approach allows you to withdraw money from your pension while keeping the rest invested, providing both flexibility and potential for growth. With a pension pot of £400,000, you can take an initial tax-free lump sum of 25%, or £100,000, leaving the remaining £300,000 to be drawn upon as needed. By utilizing this strategy, you can enjoy various pension flexi access benefits, such as controlling your income and adapting your withdrawals based on your financial needs and goals.
Initially, you take the Pension Commencement Lump Sum (PCLS). This would be £100,000 as it is 25% of your pension fund.
The remaining £300,000 (75% of your pension fund) is designated to FAD. You decide to take a yearly income of £20,000 from these funds, which is taxable at your marginal rate. You may increase, reduce or stop this income at any time.
In this scenario, your pot can be summarised at each stage by:
Before taking any benefits
Pension balance = £400,000
Uncrystallised funds = £400,000 (100%)
Crystallised funds (designated to FAD) = £0 (0%)
Taxable income taken from FAD = £0 (0%)
Tax-free cash (PCLS) taken = £0 (0%)
After commencing FAD
Pension balance = £300,000
Uncrystallised funds = £0
Crystallised Benefits (designated to FAD) = £300,000
Total taxable income taken from FAD = £0
Total (PCLS) taken = £100,000 (25%)
After 1 year
Pension balance = £280,000
Uncrystallised funds = £0
Crystallised Benefits (designated to FAD) = £280,000
Total taxable income taken from FAD = £20,000
Total (PCLS) taken = £100,000 (25%)
After 2 years
Pension balance = £260,000
Uncrystallised funds = £0
Crystallised Benefits (designated to FAD) = £260,000
Total taxable income taken from FAD = £40,000
Total (PCLS) taken = £100,000 (25%)
This process can continue until your funds in the drawdown run out or the income changes. You can still transfer uncrystallised and crystallised pension funds to another provider even after designating funds to FAD.
Please note that the above does not account for the effect of your funds being invested. The value of investments can go up and down.
Side note: Phased Drawdown
You are also able to designate funds to FAD in stages, and this is known as Phased Drawdown. When using Phased Drawdown, 25% of each amount you crystallise is paid to you as a PCLS (non taxable), with the remaining 75% allocated to FAD. In this case, you will have some funds uncrystallised, crystallised, and some free of tax.
Example
You have the same £400,000 pension fund, but this time, you allocate only £60,000 to FAD and leave the remaining £340,000 uncrystallised.
You are paid £15,000 in pension lump sum (tax-free cash) £ (25% of £60,000), with £45,000 allocated to FAD.
If you take income from the £45,000, it will all be taxable at your marginal tax rate.
You still have £340,000 uncrystallised, which you can use by purchasing an Annuity, allocating more to FAD, or taking UFPLS.
Advantages and Disadvantages of UFPLS and Tax Free Lump Sum
In contrast, under the UFPLS rules, you choose how much you would like to withdraw, and 25% of each withdrawal is paid tax-free, whilst the remaining 75% is taxed at your marginal rate. When you withdraw funds using UFPLS, you will pay income tax on the remaining 75% of each withdrawal at your marginal rate.
This means you don’t necessarily use your total tax-free allowance in one go (unless you decide to take a UFPLS of your whole pension pot). It’s important to understand that you may pay tax on your total income, including any UFPLS withdrawals, which could impact your overall tax liability.
Similar to FAD, you have complete control over how much you withdraw and when:
That is possible if you would like ad-hoc withdrawals, with 25% of each tax-free.
You can also set up regular income payments, with 25% of each tax-free.
Example – £400,000 pension pot
This time, assume you have the same £400,000 pension fund as in the FAD example. You decide to take your retirement benefits using UFPLS. This may be because you do not need your tax-free cash and would rather receive tax-efficient income yearly.
You still decide to take £20,000 per year as retirement income. Under UFPLS, 25% of every withdrawal you make is paid tax-free, and the remaining 75% is subject to income tax at your marginal tax rate.
The charts below show how this would look after one year and then in subsequent years.
In this scenario, your pot can be summarised at each stage by:
Before taking any benefits
Pension Funds = £400,000
Uncrystallised funds = £400,000
Crystallised Benefits = £0
Annual UFPLS taken = £0
Taxable portion of UFPLS = £0
Tax-free portion of UFPLS = £0
Total funds withdrawn to date = £0
1st year of taking benefits
Pension balance = £380,000
Uncrystallised funds = £380,000
Crystallised Benefits = £0
Annual UFPLS taken = £20,000
Taxable portion of UFPLS = £15,000 (75% of UFPLS)
Tax-free portion of UFPLS = £5,000 (25% of UFPLS)
Total funds withdrawn to date = £20,000
2nd year of taking benefits
Pension balance = £360,000
Uncrystallised funds = £360,000
Crystallised Benefits = £0
Annual UFPLS taken = £20,000
Taxable portion of UFPLS = £15,000 (75% of UFPLS)
PCLS portion of UFPLS = £5,000 (25% of UFPLS)
Total funds withdrawn to date = £40,000
3rd year of taking benefits
Pension balance = £340,000
Uncrystallised funds = £340,000
Crystallised Benefits = £0
Annual UFPLS taken = £20,000
Taxable portion of UFPLS = £15,000 (75% of UFPLS)
Tax-free portion of UFPLS = £5,000 (25% of UFPLS)
Total funds withdrawn to date = £60,000
Using UFPLS, you draw your retirement income directly from uncrystallised funds, which are paid to you without initially crystallising the pot. This method continues until you adjust your income or deplete your uncrystallised funds, at which point the option for tax-free cash ceases. Nonetheless, you can transfer uncrystallised funds to another provider even after UFPLS withdrawals. Note that this does not consider the potential fluctuations in the value of your investments.The value of investments can go up as well as down.
Eligibility for UFPLS
To be eligible for Uncrystallised Funds Pension Lump Sum (UFPLS), you must:
Be over the retirement age of 55 (or eligible for early retirement due to ill health or protected pension age) It’s essential to consider various factors that may impact your retirement plans, such as financial stability, health care needs, and lifestyle choices. One critical aspect to delve into is understanding retirement longevity risks, as living longer than expected can strain your resources. By planning ahead and potentially seeking financial advice, you can better prepare yourself for a comfortable retirement that accommodates your needs well into your later years. Additionally, it’s wise to regularly reassess your retirement strategy, as market conditions and personal circumstances can change over time. Staying informed about retirement planning tips can help you make necessary adjustments to your savings and investment strategies, ensuring that you remain on track to meet your goals. Engaging with a financial advisor can also provide valuable insights, helping you navigate the complexities of retirement savings and investment options effectively.
Have a pension pot that is not already crystallised
Have available lump sum allowance and lump sum and death benefit allowance
Not have enhanced protection but no entitlement to greater than 25% tax-free cash
Not have already taken a 25% tax-free lump sum from your pension account
It’s essential to check with your pension provider to see if they offer UFPLS and to consider seeking advice from a financial adviser before making a decision.
What is the Money Purchase Annual Allowance (MPAA)?
When you contribute to your pension, you benefit from a tax deduction. Any future pension contributions you make is ‘grossed up’ (increased) by the amount of your marginal tax rate.
However, most people cannot get this relief on pension contributions of over £60,000 annually, which is known as their Annual Allowance (AA). High earners may have their AA tapered to below £60,000.
Once activated, the Money Purchase Annual Allowance (MPAA) reduces your Annual Allowance to £10,000. If you contribute more than £10,000 to your pensions in a tax year after activating the MPAA, you must pay back the tax relief received.
Flexi-Access Drawdown (FAD), UFPLS and the MPAA
When you choose to use Flexi-Access Drawdown, the MPAA is not triggered when you crystallise your funds and receive the PCLS. It is only triggered after you first withdraw from the crystallised funds, i.e., those designated to FAD.
Example
You have a £400,000 pension account allocated entirely to Flexi-Access Drawdown, receiving 25% tax-free (£100,000), with the remaining £300,000 designated to FAD.
Initially, the MPAA is not triggered, allowing contributions up to the standard Annual Allowance (generally £60,000) with tax relief. However, once you withdraw income from your FAD, the MPAA is triggered, limiting relief on contributions to £10,000 annually in future tax years.
With UFPLS, the MPAA (Money Purchase Annual Allowance) is triggered immediately upon taking your first lump sum, also capping future contributions with tax relief to £10,000 per year.
Which Pension is the Best Option for Me?
The answer to this question depends entirely on your personal circumstances and requirements. You can read ‘How much money do I need to retire’ here. As previously mentioned, FAD is popular for those people who want to pay off their mortgage using the tax-free lump sum because they can reduce their monthly outgoings in retirement. For some, the benefit of lowering monthly expenditure outweighs the fact that all pension benefits will be taxable after that point. Moreover, it’s crucial to consider how your retirement income will be structured after making withdrawals, especially when evaluating a million-pound pension. Balancing immediate financial needs with long-term sustainability is essential for a secure retirement. Ultimately, consulting with a financial advisor can provide tailored strategies that take into account your unique situation and help you make informed decisions.
Still Unsure
Many other retirees will have no reason to take the untaxed cash in one lump sum and would instead
ensure their yearly income is as tax-efficient as possible. In this case, an annuity or UFPLS may be a better option. If you have reached age 75, you should obtain advice as the tax rules differ.
If you are unsure which route suits you, our Retirement Planning Service can help you. We provide annual Income Sustainability Reviews, and we do this to help ensure your income is tax-efficient and that you do not run out of money. The value of your retirement savings can rise and fall, and our cash flow forecasts are based on your current situation. Our team of experts will work closely with you to create a personalized strategy that considers your goals, lifestyle, and future needs. Through our comprehensive approach to income planning for retirement, we ensure that your financial plans align with your long-term aspirations. With regular reviews and adjustments, we aim to provide peace of mind that your financial future is secure and sustainable.
Contact us today for more information or to book your free initial consultation meeting.