I am wondering if I have misunderstood how the UFPLS (uncrystallised funds pension lump sum) withdrawal arrangement works and how much tax-free element would be available to me over the lifetime of my pension and its overall withdrawal. 

I understand there is a lump sum allowance for tax free withdrawal. I have opted for a regular annual UFPLS. From the point I start taking regular UFPLS, I’m allowed 25% tax free I believe. As the RBCE (relevant benefit crystallisation event) is fixed so to speak at that date, does this mean my overall 25% tax free sum is fixed at the Lump Sum Allowance level (circa £268,000) or 25% of the value of all my pension pots at the point of first withdrawal in time, as the difference could be substantial (now versus say 20 years time) if the SIPP is allowed to invest and accumulate over time.

Matthew

Rachel Vahey, AJ Bell Head of Public Policy, says:

On 6 April, we marked the 10th anniversary of pension freedoms. These rules revolutionised how savers access their pensions, allowing them to tailor a strategy to meet their retirement needs.

Pension freedoms introduced new ways to take income. After taking up to 25% of their pension fund as tax-free cash (known as a pension commencement lump sum or PCLS for short), pension savers can either buy an annuity or move into drawdown taking as much or as little taxable income as they want from their pension pot whenever they want. (They can also cash it in totally and take it all as a taxed lump sum.)

Many people when they first access their pension choose to take all their tax-free cash in one go, moving the remainder of the pot into drawdown. But if they opt to do that, although the drawdown pot can grow in value from investment, increasing the amount they can take as taxed income, they can’t take any more tax-free cash. That opportunity has closed.

Alternatively, if someone doesn’t need all their tax-free cash in one go, then they can also use an UFPLS to take a lump sum from their pension pot. 25% is tax-free, and the remaining 75% is taxed as income.

Using UFPLS to gradually access their pension pot offers individuals many advantages. It gives them the ability to control when and how much tax-free cash they take (which may depend on their other income). And their remaining unaccessed pension pot stays invested continuing to, hopefully, grow in value, meaning the amount of tax-free cash they can take from that pot can also increase.

TOTAL TAX-FREE CASH CANNOT EXCEED LUMP SUM ALLOWANCE

When someone takes their tax-free cash – either as a PCLS or when they take a UFPLS – then this is called a RBCE. This simply means the amount of tax-free cash you take is compared against your Lump Sum Allowance (LSA), which is usually initially set at £268,275. The total tax-free cash you receive over time cannot exceed your LSA.

For example, if someone took £40,000 UFPLS from their pension pot, then their Lump Sum Allowance would be reduced by the part which is tax free, £10,000, to £258,275.

If they decided to take a regular yearly UFPLS from their pension pot, then every year the tax-free part of the UFPLS would be compared against the remaining Lump Sum Allowance.

Sometimes, however, people only want a tax-free amount, not the taxed income as well. In this situation, pension savers can use ‘phased drawdown’ where they move only part of their pension pot into drawdown. Again, 25% of that slice will be tax free, and the remaining 75% stays in drawdown until the person takes it as taxed income.

Using phased drawdown allows a pension saver to set just the right amount of tax-free cash to take (which can be lower than the full amount available to them). They can also choose what level of taxed income to take, if any.

Hopefully, this demonstrates just how flexible pension freedoms are. By using a combination of tax-free cash, drawdown and UFPLS, pension savers really can take exactly the right amount of taxed and tax-free funds they need from their pension.

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