It’s an unwieldy name, but if you want to take a lump sum out of your pension, you’ll need to get to grips with uncrystallised fund pension lump sums (UFPLS). ‘Uncrystallised’ is a technical term that means your pension has not yet been touched, and no money has been withdrawn.

Your pension will be ‘crystallised’ when you arrange to take some or all of the tax-free lump sum, buy an annuity, or set up a pension drawdown scheme.

For more on pension drawdown, see A Brief Guide to Pension Drawdown

For more on annuities, see Should I buy an annuity with my pension?

A UFPLS is a direct withdrawal from your pension pot after you’ve reached the required age (currently 55). With this option, you can either take out your entire pension at once, or through a series of lump sum withdrawals.

Pension freedom means everyone can take a 25% tax-free lump sum from their pension (although this is capped at £268,275). But where the pension is uncrystallised, each time you take a UFPLS, the first 25% is tax-free. The remaining 75% will be taxed, based on the rate of income tax you are paying at the time of the withdrawal.

UFPLS can be useful for those with a fairly small pension pot, where it’s not worth buying an annuity or setting up a pension drawdown scheme.

People also use UFPLS to give themselves more time before making big decisions about what to do with their pension. Perhaps you’re reaching retirement age but still want to keep working, or not yet ready to buy an annuity. In these cases, you might consider using UFPLS in the meantime.

There are several disadvantages to using UFPLS as a more sustained way of accessing your pension. For example:

• Your pension pot is finite, and needs to last as long as you do. So, there’s a big risk that you could withdraw too much in one go, meaning you don’t have enough left in the pot for later life.
• Once you start making pension withdrawals, you are missing out on potential investment growth of that money, had it stayed in your pension.
• Because at least 75% of each UFPLS withdrawal is taxable, you may end up paying more tax on your income than necessary. Also, you don’t have the option of taking that big one-off 25% tax-free lump sum that you would otherwise be entitled to withdraw.

Let’s say you have a pension pot worth £200,000 that has not been accessed, and you decide to withdraw a one-off UFPLS of £20,000.

Of this amount, £5,000 is tax-free, whereas the remainder (£15,000) will be subject to income tax. You retain £180,000 in your pension pot, which you can use to buy an annuity or set up a flexible pension drawdown scheme. You could also use the remainder to make a series of lump sum withdrawals.

Depending on your circumstances, pension drawdown – also known as ‘flexi-access drawdown’ – is arguably a more efficient way of withdrawing money from your pension pot. First, you get to take out a lump sum of up to 25% of your pension tax-free (subject to the £268,275 cap). The rest of your pension stays invested, meaning your investment still has the potential to grow through your retirement (although as with any investment, its value can fall as well as rise).

With pension drawdown, you can still arrange for your pension to pay a regular income, without actually buying an annuity. And unlike an annuity, where the income you receive is fixed, pension drawdown allows you to adjust the amount of income you require throughout your retirement, to reflect your changing needs.

Finally, with pension drawdown, if you pass away before releasing your entire pension, you can nominate a relative or even a charity to receive the remaining funds on your behalf.

Because pension drawdown ensures more of your pension stays invested during your retirement years, most of the risks and disadvantages of pension drawdown are investment related. Investment values can go up as well as down, and there’s no guarantee on how your investments will perform. Any losses you incur will have a greater impact at this point in your life, as your investments won’t have much time to recover.

It’s important to consider the risks of choosing pension drawdown over an annuity as well. Whereas an annuity provides a guaranteed income for life, with pension drawdown, there’s always the possibility that your pension could one day run out.

Also, after you’ve taken your tax-free lump sum from your pension and started drawing an income from your pension, you fall victim to the Money Purchase Annual Allowance (MPAA). This means the maximum amount you can continue to pay into your pension while enjoying full tax benefits drops from £60,000 annually, to just £10,000 annually (tax year 2023/24).

Most professional financial planners will tell you that UFPLS is a less flexible form of pension drawdown, and is only really useful as a ‘stop-gap’ income source until you’ve chosen what you want to do with your pension. Pension drawdown, on the whole, gives you greater flexibility – and more tax efficiency – on how you receive that all-important pension income.

For example, while everyone is entitled to receive 25% of the pension pot tax-free (up to the £268,275 limit), with pension drawdown you can access that lump sum separately and pay no tax as a consequence. This is because the government views the lump sum as an incentive to save for retirement, and so they want to encourage people to do so by allowing them to access a portion of their pension tax-free.

With UFPLS, on the other hand, you receive your tax-free 25% incrementally on each withdrawal, while paying tax on the remaining 75%.

Another important advantage of placing your money into a pension drawdown scheme is the control it gives you over how your pension is invested. Your pension will be reinvested with the aim of providing you with stability and growth while you make regular withdrawals. This could be very important in an era when inflation can erode the return on some investments.

That said, the right option for you will depend entirely on your personal circumstances. For that reason, it’s important to speak to an independent financial planner before making any decisions.

The path to a comfortable retirement starts with sound financial planning. At Amber River, our independent financial planners can help create a retirement plan that puts you in control. We call it Life Landscaping®, and it’s all about helping you get the most out of life.