Ever since the pension freedoms rules were announced, we’ve discussed the increased scope for clients to take a more flexible approach to their transition into retirement.
However, I think it’s probably fair to say that in many cases, the type of flexibility being looked at is still linear: gradually reducing working days and hours over a period of time and supplementing income with pension funds, rather than simply going home from work one day and instantly switching from salary to pension.
With the pandemic, however, clients who have reached retirement age might be thinking about the flexibility of their defined contribution pension options in a new light. For those whose income has been reduced or lost, their pension may now be a potential source of income – although perhaps only temporarily.
Of course, there will be those for whom their pension would be a last resort.
Disinvesting assets to take income when the markets are low is not ideal.
Indeed, many clients who are already taking pension income are looking to reduce or perhaps halt their income at the moment for that very reason; particularly if their outgoings have also reduced because of the pandemic.
For some, it will be the right option though, and some might not have a better choice. There are still a few important things to consider – particularly if the client does plan to rebuild their pension funds later on once things return to normal and other income streams resume. Where that’s the case, the method by which someone chooses to access their pension becomes very important.
I won’t discuss annuities here – this isn’t to downplay their importance in general, but they are less likely to be considered in situations like these where someone most likely only requires income temporarily.
These clients probably don’t want to access their whole pension, so they might be considering whether their provider offers partial or phased crystallisation options.
Neither of these is an official legislative term and they are often used interchangeably; however, both refer to an option to only crystallise part of the pension as needed.
The distinction between the two is that phased crystallisation normally specifically describes an arrangement where the client is taking regular payments, each of which is partly taxable and partly tax-free. Partial and phased crystallisation can be achieved either through drawdown or uncrystallised funds pension lump sums (UFPLS).
Clients who may want to rebuild their funds in the future will need to consider whether triggering the money purchase annual allowance (MPAA) will affect their plans. Triggering the MPAA is irreversible and will reduce the client’s annual allowance for money purchase pensions to just £4,000 – a tenth of the normal annual allowance. It’s long been said that while its original purpose was to prevent over 55s from re-routing salary through a pension in order to save income tax and possibly National Insurance, the MPAA instead serves more as a stumbling block for those taking a flexible approach to retirement. More clients are discovering this now as they consider their options.
Only certain actions trigger the MPAA. Taking a taxable income payment in flexi-access drawdown is a trigger, as is a UFPLS payment. Tax-free cash (PCLS), however, is not. Clients might, therefore, consider accessing part of their PCLS only and leaving income alone for now. There are other consequences here too though. For example, if the client doesn’t have any other taxable income at the moment, accessing PCLS only might not be the most tax-efficient option, as it won’t allow the client to take advantage of their personal allowance.
Also, assuming normal PCLS entitlement, the client will need to crystallise four times more than they actually need to withdraw.
While the lifetime allowance is increasing (admittedly not by very much each year at the moment), any given amount will use up a slightly higher percentage of lifetime allowance the sooner it is crystallised.
We’re not talking vast sums, but for clients who may be close to the lifetime allowance, it’s something they might want to take into account.
As with so many things relating to pensions, the right choice will entirely depend on the client and their circumstances and preferences. Inevitably, it seems, having a lot of flexibility also means there are a lot of factors to consider with any given choice.
Jessica List is pension technical manager at Curtis Banks