Capped Drawdown and retaining the £40K Annual Allowance

The Annual Allowance (AA) places a limit on the maximum amount of tax relievable pension savings that can be made, by and on behalf of an individual, to all registered pension schemes without incurring a tax charge.

The AA is currently £40,000, plus any ‘unused’ AA that can be carried forward from the previous three years.

From 6 April 2015 though, a new money purchase annual allowance (MPAA) of £10,000 for defined contribution (DC) savings will apply to anyone who takes advantage of the new pension flexibility rules after 5 April 2015 (unless the fund is valued at no more than £10,000 and is being commuted under the ‘small pot’ rules).

Whilst, however, it will not be possible for an individual to enter into a new capped drawdown arrangement after 5 April 2015, anyone who is already in capped drawdown on 5 April 2015 will not be subject to this £10,000 MPAA as long as they continue to withdraw no more than the capped income amount after this date. Broadly, this capped amount is 150% of the otherwise available single life, level annuity that the individual could have bought with the fund designated to drawdown, although anyone in capped drawdown has the freedom to choose a flexible income of anywhere between 0% and 150% of this amount.

Capped income drawdown, which provides an alternative means to an annuity for paying an income whilst keeping the funds fully invested, will not be suitable for investors who need a guaranteed income and/or do not have the capacity to accept the investment risk that this inherently entails. However, for those for whom it would be suitable and who wish to continue making DC pension contributions of at least £10,000 a year, this presents an interesting planning opportunity.

Planning Opportunity

Where an individual has a DC pension fund that is designated to capped drawdown in several tranches over a period of time (typically referred to as phased capped drawdown) there are two different ways in which the drawdown funds designated can be administered by the scheme administrator. These differences are typically driven by the systems used by the scheme administrator but each separate tranche of designated funds can either be:

• used to create a separate drawdown arrangement with its own cycle of three yearly review dates for calculating the maximum income; or

• added to an existing drawdown arrangement (referred to in the legislation as ‘’additional fund designation’’).

If the drawdown provider adopts the second option above (and assuming the legislation comes in as currently proposed), this option can present a long-lasting advantage for anyone who will attain age 55 and who designates some funds to capped drawdown on or before 5 April 2015.

This is because, if they were to designate even just a relatively small element of their DC pension fund to a capped drawdown pension on or before 5 April 2015, they would have a capped drawdown fund that could be augmented at a later date, by means of ‘’additional fund designation.’’

When additional funds are designated to an existing pre 6 April 2015 capped drawdown arrangement after this date, the maximum income that can be drawn would need to be recalculated by the scheme administrator based on the increased drawdown fund value. Even if the maximum capped income limit increases significantly after an ‘’additional funds designation’’ exercise though, the investor can continue to draw an income from their capped drawdown pension fund up to this new higher limit, without subsequently becoming subject to the £10,000 MPAA in respect of any future pension funding that they may wish to make.

Not with-standing the fact though that this planning opportunity will clearly only work if the selected drawdown pension provider operates phased drawdown on the basis of ‘’additional fund designation’’ there are a number of other factors to consider. For example:

• An individual can only make personal contributions up to 100% of their relevant UK earnings.

• Care needs to be given to the possibility of an individual exceeding their lifetime allowance if funding is continued.

• Would a more advantageous planning point be to build up a spouse or partner’s pension rights to ensure their personal allowance is fully used in retirement?

Another point to consider however is the proposed change to the tax treatment of death benefits for those who die with drawdown funds and/or uncrystallised funds before and after age 75, as covered in the previous article.

Hopefully this article highlights what, depending on your circumstances, may be a potentially useful planning opportunity. If you require any further information or guidance on the forthcoming pension changes please feel free to contact us.

This article is for information purposes and should not be construed as advice. Quest Financial Solutions do not take any responsibility for actions taken as a result of reading this article.