Pension Drawdown: Tax Treatment of Remaining Tax-Free Lump Sum

StevenTHX

I'd appreciate some help understanding this please! Let's say I have a pension pot of £100,000, no Defined Benefits. I've taken a £10,000 tax-free lump sum, leaving me with a potential further £15,000 tax-free. I plan to then take regular monthly withdrawals in drawdown say £3,000 per month and don't plan to take any further lump sum withdrawals so will just take £3,000 out per month until my funds deplete. How does the tax treatment work when my withdrawals eventually start using the remaining £15,000 of potential tax-free lump sum? Does my pension provider track this, or are all withdrawals after the initial £10,000 generally taxable in which case I'd be better off taking the full 25% of cash up front (at least from a tax perspective)?
Thanks

DE_612183

Good question - I've always assumed that if I take £10k - the £2500 is tax free and the £7500 is taxed - I'm not sure if you can say you want to take just the TFLS element without taking the corresponding non-TFLS...

zagfles

To take £10k tax free you'd need to partially crystallise, £40k of the £100k, and take 25% of that £40k as your PCLS. So you'd then have £30k crystallised and £60k uncrystallised. 

You can then draw taxable income from the crystallised pot, and when that runs out you'd need to crystallise some more of the uncrystallised pot for more tax free cash in the same way. Or you could take UFPLSs from the uncrystallised part. 

NoMore

You have to learn the concept of crystallisation, this is what tracks how much tax free cash you can take.

It works like this, initially your pot will be 100% uncrystallised,  every time you want to take some tax free cash, you must crystallise 4 times that amount in the pension. So 10k tax free means 40k is crystallised, providing you have 40k of uncrystallised funds. 10k of this is tax free, the other 30k is taxable.

Once you understand that concept, it becomes easier to understand the two main methods of withdrawing from a pension.

1) Flexi Access Drawdown (FAD). This allows you to take only the tax free amount and the rest of the associated crystallised amount is left in the Pension to grow. Any withdrawals from the crystallised bit will be taxed at your marginal rate. This does not have to be drawn at the same time as the Tax free cash.

2) Uncrystallised Funds Pension Lumpsum (UFPLS), in this withdrawal you always with draw the 25% tax and the associated crystallised amount at the same time. So if you withdrew 10K, 2.5k would be tax free and 7.5k taxed at your marginal rate. No crystallised funds associated with this transaction are left in the pension.

The pension provider will track the uncrystallised/crystallised amounts for you.

You can mix and match both methods as and when, as long as you have enough uncrystallised funds to support the tax free cash.

It sounds complicated at first, but once you get your head around it, its not too bad.

DE_612183

NoMore said:

You have to learn the concept of crystallisation, this is what tracks how much tax free cash you can take.

It works like this, initially your pot will be 100% uncrystallised,  every time you want to take some tax free cash, you must crystallise 4 times that amount in the pension. So 10k tax free means 40k is crystallised, providing you have 40k of uncrystallised funds. 10k of this is tax free, the other 30k is taxable.

Once you understand that concept, it becomes easier to understand the two main methods of withdrawing from a pension.

1) Flexi Access Drawdown (FAD). This allows you to take only the tax free amount and the rest of the associated crystallised amount is left in the Pension to grow. Any withdrawals from the crystallised bit will be taxed at your marginal rate. This does not have to be drawn at the same time as the Tax free cash.

2) Uncrystallised Funds Pension Lumpsum (UFPLS), in this withdrawal you always with draw the 25% tax and the associated crystallised amount at the same time. So if you withdrew 10K, 2.5k would be taxable and 7.5k taxed at your marginal rate. No crystallised funds associated with this transaction are left in the pension.

The pension provider will track the uncrystallised/crystallised amounts for you.

You can mix and match both methods as and when, as long as you have enough uncrystallised funds to support the tax free cash.

It sounds complicated at first, but once you get your head around it, its not too bad.

Thanks @nomore That is a great explanation!

StevenTHX

Great explanation thank you!

Cobbler_tone

I assume they mean 25% would be tax FREE and 75% taxable

Cobbler_tone

'DC learner' here and keen to understand as much as possible and stay ahead of the game for in a couple of years time. Fully up to speed on the DB scheme.

A scenario: you have income that pretty much means you will never be below the 20% level but won't trouble the upper brackets.
You have £160k in a DC scheme and no immediate need for the tax free cash. You are set on drawdown and decided against an annuity. You might need £x a year to see you through to state pension age. You are never likely to be in the position to avoid paying 20% tax on the 75% of the DC pot.

In this scenario could/would you draw down the crystallised taxable part first, leaving the uncrystallised tax free part to grow? In essence getting the same treatment as an ISA? Or you could whack £20k in an ISA and leave the other £20k in their to grow? 
That situation doesn't seem to be covered in 1&2 above.

NoMore

To create a crystallised pot you need to take the tax free cash. You can't do it the other way round and take taxable income and not take the tax free cash to leave in the pension.

You could take the tax free cash and put it in an isa and then draw from the crystallised pot. Which I think is the same thing as you are talking about. 

Cobbler_tone

NoMore said:

To create a crystallised pot you need to take the tax free cash. You can't do it the other way round and take taxable income and not take the tax free cash to leave in the pension.

Gotcha, so you could take £1 tax free and £3 is crystallised, with the most tax efficient way (if you can't avoid dropping below 20%) to stick £20k into an ISA.

So in essence you reverse calculate. You start with your desired net income (from the DC) and then work out the amount required to draw down, factoring in that 25% will be tax free and 75% will be taxed at your usual rate?

NoMore

That’s one way or you could just take 20k tax free cash put that in isa and then draw from the crystallised pot for your taxable income at any amount you want. 

I think that’s effectively the same way you were thinking about in your first example