Uncrystallised funds pension lump sums (UFPLS) were introduced to help “pension freedoms” and allow pension holders to withdraw some, or all of their uncrystallised funds as a lump sum.
The idea is that you don’t have to take your DC pension pot and pay tax on it, you can take up to a quarter of its value as tax free cash whether in a single go or as part of your income from your pot.
I wrote over the weekend about the way people manage their ISA pots and the importance people place on having cash growing tax free. Many people regard cash ISAs as important in later life and prefer to have their savings in cash than invested. This is one of the reasons for the phenomenal success of cash ISAs , they are the destination for much pension saving and it’s a problem.
In the long term cash is not a good place for money, despite the panic that short term issues such as Trump’s Tariffs. The FT have an article registering the Treasury’s concern that too much long-term savings isn’t being invested but stuck in cash ISAs.
Rachel Reeve is reviewing the rules around Cash ISAs so that more savings is invested for the future – for later life retirement. My suggestion is that we make pensions more attractive to people by promoting pensions paid under UFPLS.
This would mean that your pension , so long as you did not raid your tax-free allowance up front, would be paid 25% tax free (under UFPLS).
Not only would this mean that the “take home” pension was 25% higher, but that it stayed invested to grow and help the country grow.
I have been thinking this since having a conversation with a pension expert who is also an economist. He reckons that the tax-free cash that he considers gets taken too early and for all the wrong reasons, needs to be re-thought.
In my view we should keep allow people the freedom to take their cash in one go but make it something people should have to choose to do. If we are to have a default decumulation income paid from the DC pot, it should be paid – by default – as an UFPLS.
This would mean savers who take no decisions about their pensions (about 90% of us- 98% at Nest) would find themselves with a quarter of their pension tax-free and the rest subject to tax. Since most people have taxable income from work, the state pension and other pensions, most people will see the UFPLS pension paying a higher take up because of the tax-freebie from the UFPLS.
I have not tested this with the HMRC or with pension administrators or payroll experts but it is in accord with the noises coming out of the DWP/HMT about using “nudge” for pension decumulation.
Unless the people organising the Pension Bill have already considered it , I suspect it is something for a future development of the “decumulation default”. If Rachel Reeve wants a simple way of stemming the huge amount of money coming out of pensions through upfront tax-free cash, defaulting UFPLS for those drawing pensions is an elegant and sensible solution for DC pensioners and the economy alike.
I’ll send my thoughts to my friendly economist, he’s managed to get a lot of pension decisions right and clearly he thinks how we take tax-free cash a major decision for those leaving his in-house managed DC scheme. He’s worked out that the days of pension freedoms as the default are numbered . I wouldn’t be surprised if paying tax free cash as income not a capital sum is the default approach in future. It makes sense.