If there is a straight choice between flexi-access pension drawdown and uncrystallised funds pension lump sum, flexi-access wins by a country mile in virtually every situation.
The Treasury prefers to pronounce UFPLS as “uffplus”, presumably because the plus syllable lends a positive quality to this otherwise ridiculous expression. Most pension professionals prefer to pronounce it as “uffpuls”, which reflects the essentially second-rate quality of this particular retirement solution.
I recently heard an accountant on Radio 4’s Moneybox say that his plan for drawdown was to start with UFPLS for some of his pension pots and then move onto flexi-access drawdown for the rest. At the time I could not understand the logic of such an approach and several weeks later I still fail to see why one would follow such a strategy. Given the choice between UFPLS and flexi-access, it is hard to see why one would choice UFPLS in any situation.
If you have not yet worked out the difference between UFPLS and flexi-access, here is a fast and dirty explanation. Flexi-access is almost always the preferred solution because it allows a very high degree of flexibility about the way you can draw your pension. You can draw some or all of the tax-free pension commencement lump sum without drawing the income at the same time, you can draw some or all the income without taking the PCLS or you can take some of each. Broadly speaking when you draw any PCLS, you have to designate three times the amount for drawdown – but you do not take it at the time.
In contrast, UFPLS is simple but inflexible. If you draw tax-free PCLS, then you have to draw three times the amount at the same time in the form of taxable income. So £1,000 of PCLS is coupled with £3,000 of pension income taken simultaneously.
The tax treatment of death benefits of the funds are the same either way, regardless of whether they have been crystallised for drawdown. The death benefits are tax free if the member has died before reaching the age of 75. However, if death takes place at age 75 or later, the funds are still free of inheritance tax but may be subject to income tax on the recipient.
UFPLS was offered as a concession to trusts and providers who did not want to take on the complexities of handling flexi-access but were prepared to provide their members with some kind of pension freedom without having to make a pension transfer to another provider. There are indeed some schemes that do not even offer UFPLS.
To be fair to UFPLS, there is one situation in which it is as good as flexi-access and might even be superior in some circumstances. That is where the individual wants to take tax-free cash and income together at the same time. The most common situation is likely to arise where the client wants to draw the whole of their pension pot at once. In such a situation, the UFPLS solution might sometimes be cheaper than the flexi-access solution, especially if it does not involve the expense of making a transfer to another scheme.
AJ Bell has identified another (fairly rare) position where UFPLS might be slightly advantageous. This might arise where a client’s highest priority is to make the most of their lifetime allowance and the client wants to take a mix of income and PCLS. In calculating the extent of the use of the lifetime allowance, HMRC allows rounding down of the percentage used. A flexi-access payment of income and PCLS involves two roundings down, while UFPLS allows just one. A single basis point is not a big deal for one payment but over the years the difference from lots of such payments could mount up to something more significant.
A fair number of providers have set up facilities to offer both UFPLS and flexi-access, although it is hard to see why this would be necessary. Everything that can be done through UFPLS is available with flexi-access and with a lot more choice as well.
For someone who is contemplating drawdown as a long-term income strategy, flexi-access is the obvious solution. They can choose to have income in years when their tax rates are low and tax free PCLS (if there is any left) in years of high income and tax.
In most cases, as Scottish Widows’ Ian Naismith has pointed out, the default option will be to draw tax-free PCLS in the early years of retirement in order to provide a target amount of net income. It would then make sense to draw on the taxable after using up all the tax-free allowance. This general approach allows the client to keep the most assets rolling up tax free in the pension fund for the longest period, extending the life of the fund and maximising their long-term income.
In a very simple example, a client has a fund of £200,000 and is a 40 per cent taxpayer. Her target income from this particular pension pot is £10,000 a year net of tax. If she took tax-free PCLS first, she could have £10,000 a year for five years and there would still be £150,000 left in her pension fund – even assuming no growth. But if she started drawing taxable income, it would mean depleting the fund by about £16,667 a year and, at the end of five years, there would be only about £116,665 in the pension: £38,335 less.
Flexi-access provides a wonderful opportunity for advisers to add real value to their clients’ pension investments.
Danby Bloch is chairman of Helm Godfrey