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.
UFPLS VS Drawdown
As you are most likely aware, a portion of your pension fund is available to you as tax-free cash. This is generally 25% but can be higher or lower in certain circumstances. This article will assume that the permitted tax-free cash is 25%.
When we compare flexible drawdown vs ufpls, the most significant difference is when the tax-free cash is taken. UFPLS means you take a portion of your pension once or in a series of events.
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.
This could involve allocating them to FAD or buying an Annuity. If you choose to assign them to Flexi access drawdown, you can leave the rest of the funds invested.
The tax-free cash in this scenario is called a Pension Commencement Lump Sum (PCLS) and is paid directly to you. Some will use it to pay off their mortgage. Others may upgrade their home or purchase a new car. It is entirely up to you.
If you have no use for it, perhaps FAD is not suitable for you at this stage.
When you want to access your pension savings 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.
Initially, you take your tax-free cash – the Pension Commencement Lump Sum (PCLS). This would be £100,000 as it is 25% of your pension pot.
The remaining £300,000 (75% of your pension pot) 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 funds (designated to FAD) = £300,000
Total taxable income taken from FAD = £0
Total tax-free cash (PCLS) taken = £100,000 (25%)
After 1 year
Pension balance = £280,000
- Uncrystallised funds = £0
- Crystallised funds (designated to FAD) = £280,000
Total taxable income taken from FAD = £20,000
Total tax-free cash (PCLS) taken = £100,000 (25%)
After 2 years
Pension balance = £260,000
- Uncrystallised funds = £0
- Crystallised funds (designated to FAD) = £260,000
Total taxable income taken from FAD = £40,000
Total tax-free cash (PCLS) taken = £100,000 (25%)
This process can continue until you decide to change the income you are taking or your funds in FAD run out. You can still transfer uncrystallised and crystallised funds to another provider even after designating funds to FAD.
Please note that the above does not account for the effect of your crystallised 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 (tax-free cash), with the remaining 75% allocated to FAD. In this case, you will have some funds uncrystallised, crystallised, and tax-free cash paid.
Example
- You have the same £400,000 pension pot, but this time, you allocate only £60,000 to FAD and leave the remaining £340,000 uncrystallised.
- You are paid £ 15,000 in PCLS (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 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
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.
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).
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 pot 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 taxable 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 balance = £400,000
- Uncrystallised funds = £400,000
- Crystallised funds = £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 funds = £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 funds = £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 = £40,000
3rd year of taking benefits
Pension balance = £340,000
- Uncrystallised funds = £340,000
- Crystallised funds = £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
As you can see, you do not have any crystallised funds when using UFPLS to take your retirement income. Funds are taken straight from your uncrystallised pot and paid to you directly.
This process can continue until you decide to change the income you are taking or your uncrystallised funds run out. You can still transfer uncrystallised funds to another provider even after making withdrawals as UFPLS.
Please note that the above does not account for the effect of your uncrystallised funds being invested. The value of investments can go up as well as down.
What is the Money Purchase Annual Allowance (MPAA)?
When you contribute to your pension, you benefit from tax relief. Any contribution you make is ‘grossed up’ (increased) by the amount of your marginal tax rate.
However, most people cannot get tax relief on pension contributions over £40,000 annually, known as their Annual Allowance (AA). High earners may have their AA tapered to below £40,000.
Once activated, the Money Purchase Annual Allowance (MPAA) reduces your Annual Allowance to £4,000. If you contribute more than £4,000 to your pensions in a tax year after activating the MPAA, you must pay back the tax relief received. Please note that the MPAA only applies to contributions made to defined contribution pension schemes.
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 (tax-free cash). It is only triggered after you first withdraw from the crystallised funds, i.e., those designated to FAD.
Example
You have the same £400,000 pension pot and allocate it all to Flexi-Access Drawdown. You receive 25% tax-free cash of £100,000; the remaining £300,000 is designated as FAD.
You have not yet triggered the MPAA at this stage, but you can contribute to your pensions up to your standard Annual Allowance (generally £40,000) and receive tax relief on all contributions.
Once you decide to take income from your crystallised funds in FAD (as after year 1 in the FAD example on this page), then your MPAA is triggered. For the rest of that tax year and in all future tax years, you can only receive tax relief on contributions up to £4,000 per year.
Unlike with FAD, you trigger the MPAA when you access your pension using UFPLS. Your MPAA is triggered once your first lump sum has been taken from your uncrystallised funds and paid to you as a UFPLS. For the rest of that tax year and in all future tax years, you can only receive tax relief on contributions up to £4,000 per year.
Which is the best option for me?
The answer to this question depends entirely on your situation 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.
Many other retirees will have no reason to take the tax-free cash in one lump sum and would instead ensure their yearly income is as tax-efficient as possible. In this case, 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 they 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.
Contact us today for more information or to book your free initial consultation meeting.
