How To Withdraw Money From Your Pension

Navigating pension terms can be as perplexing as a jigsaw puzzle. With so many Brits pulling from their pensions earlier due to economic pressure, it’s crucial to understand what you’re diving into. The Financial Times today has a guide to help you decipher pension withdrawals, and hopefully, keep more pounds in your pocket. Here’s a summary…

The Current State of Pension Withdrawals

There’s been a spike in people withdrawing from their pensions. The reasons are diverse but largely boil down to the rising cost of living. Recent HMRC data indicates a 15% increase in flexible pension withdrawals in the 2022-23 tax year, taking the amount to a whopping £12.9bn. This is up from £11.2bn in 2021-22 and £9.3bn in 2020-21. While the average withdrawal per person sits at just over £7,000 per quarter, the concern is the method and the implications of these withdrawals.

Navigating the Jargon: UFPLS

The term that gets my “Most Confusing” award is “uncrystallised funds pension lump sum” or UFPLS for short. Introduced in 2015, UFPLS lets you draw directly from your pension. This can be done all at once or in parts, with 25% of each chunk being tax-free and the remainder taxed based on your income.

So, what’s with the term “uncrystallised”? In essence, it signifies that those funds haven’t been used for a benefit yet, unlike a “crystallised” fund which might be tied to an annuity or has had a tax-free sum taken from it.

The More Popular Choice: Flexi-access Drawdown

This method is probably what you’d think of when you imagine drawing from your pension. After turning 55, you can transition part or all of your pension savings into a drawdown fund. This gives you the advantage of taking out a 25% tax-free lump sum independently, with the remaining 75% continuing to grow tax-free.

The main benefit? You can extract tax-free cash without touching taxable income. If you’re still on a payroll, this is a golden ticket.

Why Choose UFPLS?

Some favour UFPLS since it defers bigger pension decisions. For instance, if you’re uncertain about your long-term pension access plans, UFPLS acts as a stop-gap. But tread with caution. If your pension fund investments remain unchanged and are exposed to a volatile market, your withdrawals could be riskier. Plus, you might miss out on the 25% tax-free lump sum.

Moreover, once you start drawing income via UFPLS, the Money Purchase Annual Allowance activates. This limits your tax-free pension contributions to a mere £10,000 annually – a significant drop from the £60,000 cap available otherwise.

The Taxing Issue with UFPLS

When you withdraw through UFPLS, you might be slapped with more tax than needed since 75% of every withdrawal is taxable. To add salt to the wound, HMRC taxes the first flexible withdrawal in a fiscal year using a “Month 1” basis, leading to unexpected and heavy tax bills. Since 2015, people have had to claim back over £1bn in pension withdrawal over-taxation.

A Glimpse into the Future

Jeremy Hunt’s recent Budget unveiled a significant pension shake-up. UFPLS will likely stay after the pensions lifetime allowance vanishes, but the max tax-free sum will be £268,275 (with exceptions). And let’s hope the industry adopts simpler terms like “part and part withdrawals” or “direct access withdrawal”.

Final Thoughts

Understanding your pension and the implications of your choices is pivotal. Always consider consulting a financial advisor, especially when deciphering the best withdrawal method. After all, it’s your hard-earned money – and you deserve every penny.