Wealth Management

Assessing Pension Drawdown Strategy In A World Of Increased Flexibility

A little more than four years ago, changes were introduced providing UK pension holders increased flexibility in the way pension benefits can be collected in retirement. Many of the changes and options available generally apply to defined contribution pensions such as personal pensions, group personal pensions, self-invested personal pensions (SIPPs) and stakeholder pensions. The full range of flexible options do not generally apply to final salary pension schemes and some other occupational defined contribution schemes. The changes have resulted in an increased interest by many pension holders to look at transferring out of these company schemes into ones that allow for complete drawdown freedom. Whilst there can be instances that transfers are in the best interest of the pension holder, the FCA is understandably focused on ensuring that pension advice remains suitable for the individual seeking a potential transfer.

Flexible Access To Pensions From Age 55

Since the changes were introduced back in 2015, the government largely no longer mandates a particular way in which pension savings need to be accessed. From age 55, it is generally up to the pension holder to decide whether they want access to funds as a lump sum, through an annuity product or through some flexi-access drawdown product.

There are three general categories that encompass the distribution options: 1) If you require greater liquidity or control over your finances in the short-term you can consider taking your entire pension in one lump sum and invest/spend the funds as you wish, although certain taxation rules apply.

2) If you desire a more secure and regular income stream you can look at purchasing an annuity, either at retirement, or at a later chosen date.

3) If you prefer to keep your assets invested in the tax wrapper for as long as possible and wish to access the funds over time, you can look at purchasing a drawdown product. Individuals can usually choose one distribution option for their entire pension fund or choose different distribution options for segments of their pension fund. The changes have increased tax planning opportunities as there is flexibility to manage potentially both liquidity needs and taxable income in any given tax year.

UK Taxation Of Inherited UK Pensions Mean More Individuals Seek To Preserve Pension Pots

One factor that has become important to consider when assessing distribution options alongside your broader financial situation is that UK pensions are generally held outside of UK Inheritance Tax at your death. In addition, there is slightly different treatment on inherited benefits received by beneficiaries depending on whether you die before or after reaching age 75. The treatment is outlined below:

• Die before age 75 A defined contribution pension can be passed to anyone as a tax-free lump sum, regardless of whether then pension is in drawdown or remains uncrystallised. The beneficiary will pay no tax on the money they subsequently withdraw from the pension, whether it is taken as a single lump sum, or accessed through drawdown over their own lifetime. This is generally only applicable to defined contribution schemes that have not been used to purchase an annuity or are being paid through a pension scheme.

• Die at or after age 75 If you die after age 75, the beneficiary will be able to access withdrawals from the pension flexibly over time and there are no restrictions on the amount that can be withdrawn at once. As funds are withdrawn, whether as a lump sum or over time, the beneficiary will pay tax at their marginal rate of income tax.

The above treatment can potentially lend itself to individuals wanting to preserve their pension pots longer in order to avail themselves of the inheritance tax benefits versus assets held outside of pensions which form part of the individuals UK taxable estate.

Flexible Drawdown Options Have Resulted In An Increase In Pension Transfer Requests

As noted earlier, with the increased flexibility in options to access pension benefits alongside pensions being held outside of

UK inheritance tax, there has been a trend towards individuals looking to transfer out of defined benefit (final salary) pension schemes into defined contribution pots that offer both the flexibility in drawdown options but also the ability to leave the remaining pension pot to heirs in the future. There can be valid reasons for individuals to desire increased access to their pension schemes. However, it is very important that individuals appropriately consider the potential long-term financial implications of drawing down pensions early.

In order to transfer out of many occupational defined contribution schemes as well as company final salary schemes, individuals are required to undertake a Pension Transfer Analysis (PTA). A PTA outlines all potentially valuable benefits that the pension holder will lose if they transfer out of the particular scheme and also performs a cost comparison of the existing plan versus the plan that is being considered. Anyone considering moving out of the existing scheme must fully understand the advantages and disadvantages of making any change and this is the purpose of the PTA.

The cost of a PTA is generally not immaterial. Therefore, regardless of assessing important individual financial considerations, it can often make less sense to undergo a PTA when the pension size is small. Pension holders should be aware that some Advisers may be more inclined than others to push the ‘benefits’ of a transfer. During a study published by the Financial Conduct Authority (FCA) late last year, it deemed less than 50 percent of pension transfer advice was suitable. As such, the FCA has placed increased scrutiny on firms providing PTAs to ensure proper practice is put in place to deliver consistent and suitable advice. Individuals should be aware of this increased scrutiny and the regulations around pensions when exploring whether or not a transfer is right for them.

Which Strategy Is Right For You?

With the general removal of restrictions and limitations placed on the amount of drawdown individuals can take each year, there is greater ability to maintain control over the investment of the pension fund. It also allows increased flexibility on when and how much to drawdown and how one wants to pass funds on to heirs. It

is important to note, however, that this option also bears some risk as it is no longer a secure annuity and requires careful management to ensure funds are not unknowingly depleted through excessive income drawdown.

In order to begin to assess which distribution strategy is right for you, you need to have a good understanding of your financial goals and objectives as well as your income needs from your pension and other assets. You should give some thought to some of the questions outlined below:

• What does retirement mean to you? Will you stop work altogether or will you continue to earn a partial income stream?

• Will you want to continue contributing to a pension scheme in the future?

• How do you want to live in retirement? How much income will you need your assets to generate and will that income be needed regularly or at reaching certain milestones?

• Where do you want to live in retirement? Will you live in the UK or back in the US, or perhaps settle abroad somewhere else?

• How much risk can you afford to take with your income? How much risk do you feel comfortable with? Will short-term volatility affect your ability to meet your everyday needs?

• Do you want to leave an inheritance to a specified individual? It would be remiss to ignore that the flexibility now offered allows US individuals to liquidate their pensions in a tax-efficient manner that makes sense for their individual situation. Individuals no longer potentially face liquidity restrictions if accessing large lump sums is a suitable drawdown strategy for their needs.

Many planning opportunities for Americans present themselves as they approach retirement and decide where their retirement years will be spent. The best place to allocate your pension dollars and the amount you should ultimately seek to contribute to a pension, as well as your planned drawdown strategy in the future should become a planning point of discussion with your Tax and Wealth Adviser.

Risk Warnings And Important Information

All investments involve risk and may lose value. The value of investments can go down depending upon market conditions and you may not get back the original amount invested. Your capital is always at risk. Currency exchange rates may cause the value of an investment and/or a portfolio to go up or down.

into account the specific goals or requirements of any particular individual. You should carefully consider the suitability of any strategies along with your financial situation prior to making any decisions on an appropriate strategy.

The information is based on our understanding of current tax law and practice and sets out some basic information about certain tax considerations from an investment perspective. However, MASECO Private Wealth is not a tax specialist. All tax rules may change and we strongly recommend that anyone considering investing seeks their own tax advice. The tax treatment of any investment or particular strategy will depend on the individual circumstances of each person and may be subject to change in the future. This document does not constitute and should not be construed as investment, tax, accounting, legal or any other advice. The information contained herein is subject to copyright with all rights reserved.

MASECO LLP (trading as MASECO Private Wealth) is a limited liability partnership registered in England and Wales (Companies House No. OC337650) and has its registered office at Burleigh House, 357 Strand, WC2R 0HS.