RPSM09103520 - Technical Pages: Member benefits: Drawdown pension: All types
This guidance has been written from the members’ perspective.
Guidance for all types of drawdown pension
Which schemes can pay me a drawdown pension?
What are the different types of drawdown pension?
Is there a minimum amount of drawdown pension?
Is there a maximum amount of drawdown pension?
What happens if I get more than the maximum amount of drawdown pension?
At what age can I start a drawdown pension?
Is there an upper age limit for starting a drawdown pension?
How do I get a drawdown pension into payment?
Can I have a tax free lump sum when I start to go into drawdown pension?
Do I have to take a pension commencement lump sum when I start to go into drawdown pension?
Do I have to use all of the funds in my pension scheme to provide a drawdown pension?
Do I have to use all of the funds in my pension arrangement to provide a drawdown pension?
Is drawdown pension tested against the lifetime allowance?
How is my drawdown pension taxed?
Can I pay contributions into any pension scheme to build up extra pension after I have started to take drawdown pension?
Can I transfer a drawdown pension in payment to another pension scheme?
I am currently drawing a scheme pension/have purchased a lifetime annuity. Can I switch to capped drawdown?
Which schemes can pay me a drawdown pension?
[s165 Pension Rule 4]
A drawdown pension can only be paid from other money purchase arrangements and cash balance arrangements. A defined benefits (often called final salary) arrangement cannot pay a drawdown pension. So if you do not have an other money purchase arrangement or cash balance arrangement in your pension scheme you cannot have a drawdown pension.
A pension scheme does not have to pay pension in the form of a drawdown pension. Many pension schemes do not offer this option.
What are the different types of drawdown pension?
[Para 4 Sch 28]
A drawdown pension comes in two basic forms
- income withdrawal, and
- a short-term annuity.
With income withdrawal your pension is paid directly from the funds in your pension scheme.
With a short-term annuity you use some of your drawdown pension fund to buy an annuity contract from an insurer. This contract will pay you a certain income each year for a fixed period of up to five years.
Income withdrawal splits into two types
- capped drawdown, and
- flexible drawdown.
From any other money purchase arrangement or cash balance arrangement you can have drawdown pension paid as
- capped drawdown,
- capped drawdown and short-term annuity,
- short-term annuity,
- flexible drawdown, or
- flexible drawdown and short-term annuity.
[s165 Pension Rule 5]
Is there a minimum amount of drawdown pension?
No.
Is there a maximum amount of drawdown pension?
This depends on whether or you are taking your drawdown pension as capped drawdown or flexible drawdown.
If you are taking your drawdown pension as capped drawdown there is a limit on the amount of pension you can take each year from each pension arrangement providing capped drawdown pension. This limit applies to the total of payments taken as income withdrawal and short-term annuities from the arrangement.
If you are taking your drawdown pension as flexible drawdown this limit does not apply to the pension arrangement providing the flexible drawdown pension. You can take as much pension as you like from a pension arrangement using flexible drawdown.
You can only take your pension using flexible drawdown if certain conditions are met.
Go to RPSM09103590 to find out more about flexible drawdown.
RPSM09103550 explains what the maximum amount of capped drawdown pension is.
What happens if I get more than the maximum amount of drawdown pension?
[s208]
If your income withdrawal plus any short-term annuity payments for an arrangement is more than your maximum drawdown pension for a drawdown year the amount over your limit will be classed as an unauthorised payment. You will have to pay a tax charge of 40 per cent of the unauthorised payment. If the unauthorised payment is very large you may have to pay an extra 15 per cent tax charge. In addition to your tax charge your scheme administrator will have to pay a scheme sanction tax charge of at least 15 per cent of the unauthorised payment.
At what age can I start a drawdown pension?
[s165 Pension Rule 1]
You can start a drawdown pension at the same time as you can start to get any authorised pension from a registered pension scheme. Normally this is when you are 55. However you can start your pension earlier if
- you are retiring due to ill-health, or
- you have a protected pension age (see RPSM03106000) which allows you to retire earlier than 55.
Is there an upper age limit for starting a drawdown pension?
[s165 Pension Rule 6]
No.
How do I get a drawdown pension into payment?
[Para 8 Sch 28]
You start a drawdown pension by ‘designating’ part or all of your pension funds to provide you with a drawdown pension. This means that you tell your scheme administrator that you want to use £Y to provide you with a drawdown pension. The funds that you have put aside (designated) to provide a drawdown pension will form your ‘drawdown pension fund’. Your drawdown pension will be paid from your drawdown pension fund.
Each pension scheme that offers drawdown will have its own processes for documenting how members designate benefits into drawdown pension.
Having designated your funds into drawdown pension you can choose how much and when you will be paid a drawdown pension. You can choose to get regular payments or just draw funds when you want to. You will need to agree this with your pension scheme which may have specific rules about how your drawdown pension can be paid.
Can I have a tax free lump sum when I start to go into drawdown pension?
Yes. This type of lump sum is called a pension commencement lump sum.
Do I have to take a pension commencement lump sum when I start to go into drawdown pension?
No you are not required to take a pension commencement lump sum. If you wish you can use all your pension funds to provide a drawdown pension. However you cannot take a pension commencement lump sum later if you change your mind or didn’t take the maximum available initially.
Do I have to use all of the funds in my pension scheme to provide a drawdown pension?
[Para 8 Sch 28]
No. Drawdown pension is provided at ‘arrangement level’ as opposed to ‘scheme level’. Most people think of themselves as members of a pension scheme, but each pension scheme can be a single arrangement or split into two or more pension arrangements. Generally each arrangement can pay benefits separately from each other. This allows benefits to be taken in tranches at different times.
Traditionally personal pension schemes have been split into many arrangements for one person allowing them to stagger pension payments over time. Occupational pension schemes have not tended to do this. But there is no reason why an occupational pension scheme cannot be designed to have lots of arrangements for each member. This is a matter for the employer and scheme trustees to decide when designing their pension scheme.
What this means is that you can designate funds in one arrangement to provide a drawdown pension and leave funds in other arrangements until a later date, all within the same scheme. You can take drawdown pension from different arrangements under a pension scheme at different times.
You will have one drawdown pension fund for each pension arrangement. The maximum amount of drawdown pension you can have is calculated for each arrangement.
Example
Chris is a member of a pension scheme where his benefits are split across two other money purchase arrangements - arrangement A and arrangement B. Each arrangement contains £200,000. He has not put any of his pension funds into payment.
On 1 June 2011 Chris takes a pension commencement lump sum (PCLS) of £50,000 and designates £150,000 into drawdown pension in arrangement A. This creates a pension drawdown fund of £150,000. The scheme administrator works out that the maximum pension Chris can have each year from this drawdown pension fund is £7,650.
On 1 September 2011 Chris designates £100,000 into drawdown pension in arrangement B. He has chosen not to take a PCLS on this occasion. This creates a new pension drawdown fund of £100,000. The scheme administrator works out that the maximum pension Chris can have each year from this drawdown fund is £5,400.
Chris now has two drawdown pension funds under the scheme, being
-
- £150,000 drawdown pension fund under arrangement A, and
- £100,000 drawdown pension fund under arrangement B.
The maximum annual pension Chris can be paid from arrangement A is £7,650. The maximum pension Chris can get each year from arrangement B is £5,400.
Do I have to use all of the funds in my pension arrangement to provide a drawdown pension?
[Para 8 Sch 28]
No. If your scheme allows you can choose to designate only part of the funds in a pension arrangement to provide you with a drawdown pension. You can add to your drawdown pension at any time by designating extra funds from your arrangement into your drawdown pension fund.
Is drawdown pension tested against the lifetime allowance?
[s216 BCE1]
Your drawdown pension will be tested against your lifetime allowance when you put (designate) pension funds into your drawdown pension fund if you are younger than 75.
Any funds in your pension scheme that you have not put into payment (designated) by the time you are 75, will be tested against the lifetime allowance on your 75t h birthday.
Any increase in the value of your drawdown pension fund will also be tested against your lifetime allowance on your 75t h birthday.
If you put pension funds into drawdown pension when you are 75 or over this will not be tested against the lifetime allowance because, as explained above, they will already have been tested when you reached age 75.
How is my drawdown pension taxed?
[s579A-579D & 683(3) ITEPA 2003]
You are liable to income tax on any payment of drawdown pension you get. If your drawdown pension is being paid as either capped drawdown or flexible drawdown tax is due on any payments you receive in a tax year. If your drawdown pension is being paid using a short-term annuity the taxable amount is the amount due to be paid in the tax year under the terms of the contract, even if you don’t get the payment in the tax year.
Your pension scheme (or the insurer paying the short-term annuity) should deduct the tax due using the PAYE system before making the payment.
Can I pay contributions into any pension scheme to build up extra pension after I have started to take drawdown pension?
[Para 14 Sch 28]
Yes, you can. You can pay contributions into the scheme providing the drawdown pension, or into another pension scheme. But if you are considering taking your drawdown pension as flexible drawdown you will need to consider the tax consequences if you wish to continue making contributions (see RPSM09103590).
Can I transfer a drawdown pension in payment to another pension scheme?
[Reg 12The Registered Pension Schemes (Transfer of Sums and Assets) Regulations - SI 2006/499]
Yes, you can. However the transfer needs to meet the following conditions.
- The transfer must be made to a new ‘empty’ pension arrangement
- The benefits from the new arrangement must be provided on a like-for-like basis. So, for example, if your drawdown pension is being provided as a short-term annuity it must continue to be paid as a short-term annuity or if your drawdown pension is being provided as income withdrawal it must continue to be paid as income withdrawal. If the transfer does not meet these conditions it will be an unauthorised payment. This mean you will have to pay a tax charge of 40 per cent of the amount transferred. If the amount transferred is 25 per cent or more of the value of your funds in the original pension scheme the amount of your tax charge will be 55 per cent of the amount of the transfer. In addition to your tax charge your transferring scheme administrator will have to pay a scheme sanction tax charge of at least 15 per cent of the unauthorised payment.
If your drawdown pension started on or after 6 April 2011 the maximum amount of drawdown pension you can get will not change on the transfer.
If your drawdown pension started before 6 April 2011 the transfer can trigger a review of the maximum amount of drawdown pension you can get.
I am currently drawing a scheme pension/have purchased a lifetime annuity. Can I switch to capped drawdown?
[Para 7 & 8 Schedule 28]
No. You cannot convert your existing scheme pension or lifetime annuity into drawdown pension.
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