If you’re looking to help a child with a house deposit, pay off a mortgage or purchase a new car, your pension savings could be a useful source of funds via what’s known as a “UFPLS”.
As a result of the 2015 Pension Freedoms, people are able to take an uncrystallised funds pension lump sum (UFPLS) from their pension if in need of a cash injection. Careful though: while 25% of the UFPLS can be taken tax-free, the remaining 75% is added to an individual’s income and taxed at their marginal rate. People have the choice of taking their entire pension as one single UFPLS, or a bit at a time. Anything that is not withdrawn can remain invested.
Many, including Courtiers with its SIPP (Self-Invested Pension Plan), but not all pension providers, offer UFPLS as an option. However, before going down the UFPLS route, it’s important to understand more about them; when a UFPLS can and can’t be taken, as well as being aware of the limitations and drawbacks, especially when it comes to tax.
When a UFPLS can be taken
An individual must be age 55 or over (57 from 6 April 2028), or eligible for early retirement due to ill health or have a protected pension age.
The funds must be held in a money purchase or DC (defined contribution) scheme and must be uncrystallised i.e.: they have not yet been accessed.
All or part of the pension scheme member’s LTA (lifetime allowance) must be available. The LTA is the maximum amount that an individual can contribute to their pension or pensions without incurring a tax charge. The current LTA is £1,073,100, a figure that has been frozen until 2025/26.
Where a UFPLS can’t be taken
A UFPLS cannot be paid where an individual has already crystallised their pension pot, by taking tax-free cash, buying an annuity, or taken an income from their fund.
An individual isn’t eligible for a UFPLS if they have either primary or enhanced protection and where the tax-free lump sum entitlement exceeded £375,000 on 5 April 2006. Or if they are entitled to a tax-free lump sum, which is more than 25% of their total lump sum.
A UFPLS is not the same as a Pension Commencement Lump Sum PCLS, (tax-free cash), which is only payable out of funds held in pension drawdown or as an annuity.
Under 75: For a lump sum payment to qualify as a UFPLS payment it must not be greater than an individual’s remaining lifetime allowance (LTA).
75 and over: There must be some LTA available. While the whole lump sum can be paid as a UFPLS, the tax-free portion of the UFPLS is restricted to 25% of the remaining LTA.
The big drawback of a UFPLS is that 75% of the payment is added to the person’s income and is taxed at their marginal rate. Because of this, Graeme Clark, Head of Private Clients at Courtiers, says especially when a UFPLS “is a big chunk of money” that takes an individual income into a higher tax bracket, they can be very tax inefficient.
From a tax efficiency perspective, using a UFPLS to take small sums when your income is low, or taking smaller amounts over several years is likely to prove a better option.
By way of contrast, moving pension funds into pension drawdown allows an individual to take the 25% tax-free element upfront, while giving them the flexibility to keep the rest invested and to take the taxable element as income at a time of their choosing.
Depending on an individual’s circumstances, alternative ways to raise a lump sum for example, by re-mortgaging a property might be better.
The part of a payment that exceeds the LTA of £1,073,100 must be paid as a lifetime allowance excess lump sum and is subject to a 55% charge.
Taking a UFPLS triggers the MPAA (Money Purchase Annual Allowance), which limits future pension contributions to £4,000 a year. In contrast, when pension savings are moved into pension drawdown, the MPAA is only triggered when income is taken.
Passing it on
If you’re under 75 when you die, lump-sums passed on to a beneficiary will usually be paid tax-free
If you’re 75 or over, any lump sum passed to a beneficiary will be added to their income and taxed in the normal way.
Any money that an individual withdraws from their pension savings that is not spent counts as part of their estate for inheritance tax (IHT) purposes.
It is likely that emergency tax will be applied to a UFPLS payment. This can be reclaimed from HMRC using form P55 or using its online service.
In some circumstances, for example, if somebody has just retired and is on a lower income than previously, or where a pension pot is so small it isn’t worthwhile setting up a drawdown scheme or buying an annuity, a UFPLS could be a useful way to withdraw funds from pension savings. However, anyone considering a UFPLS should investigate alternatives, and pay particular attention to the tax implications. And of course, they should also consider the risk of withdrawing too much, thereby reducing their retirement income in the future and potentially even running out. For these reasons, before going down the UFPLS route it may be worthwhile contacting your Financial Adviser.