Should the tax-free lump sum be separated from pension decisions?

By Amanda Newman Smith

Aug 28, 2018

The FCA wants the government to explore ‘decoupling’ the 25 per cent tax-free lump sum from decisions about the remaining pension pot.

When trying to solve any problem it is good to consider all your options. Perhaps this is where the FCA is coming from in the final report of its Retirement Outcomes Review.

The regulator is concerned that, post-pension freedoms, some consumers are only moving into drawdown to access their 25 per cent tax-free cash – known formally as the pension commencement lump sum – and are not engaging with the rest of their pot. Under current rules, drawdown is the only way that people who do not want an income from their retirement pot can access the PCLS and some may have to transfer to a different product, with many not shopping around.

The FCA wants the government to consider enabling consumers to access their tax-free cash without having to choose drawdown or an annuity. The regulator concedes there would be detailed policy and practical issues which the government would need to consider but thinks decoupling is worthwhile exploring. Does the industry agree?


Under the current rules, many people do not need to transfer out of their existing pension to access the PCLS. Royal London pension specialist Helen Morrissey says: “The facility to decouple the 25 per cent tax free lump sum from making a decision about what to do with the rest of the fund is already a feature in most modern personal pensions and self-invested personal pensions that offer integrated drawdown. It is more of an issue for those with legacy products or those in occupational pension schemes which require benefits to be taken in one go.”

However, she says that allowing decoupling in these products would require them to be significantly restructured and would require major changes to tax legislation.

Adviser view: Jade Connolly, strategy & acquisitions manager, Ascot Lloyd 

If the government made it mandatory for all pension providers to offer pension freedoms, we wouldn’t need to have any further rule changes to allow individuals to take their tax-free cash and not go into drawdown. It is providers out there not offering flexibility at retirement, coupled with a poor level of understanding by the consumer, that is leading to people ending up in drawdown for the wrong reasons.

Without advice and with the freedom of taking the largest lump sum many consumers will ever have available to them, wrong choices are likely to be made. Rather than changing the rules again, the government should work with pension providers to provide better guidance and support around taking benefits and encourage more providers to offer greater flexibility.

Aegon pension director Steven Cameron points out that, under HMRC rules, taking the PCLS is linked to crystalisation, which has tax implications including assessment against the lifetime allowance.

He says within the current rules, pension policies can be segmented, enabling people to take their tax-free cash from some segments and leave the others untouched so they can still contribute to those uncrystallised segments. However, this is complex and not all providers can do it, especially those with legacy products.

Standard Life head of financial planning propositions Alastair Black believes decoupling could pose significant challenges around implementation and costs for consumers.

“While it’s likely to be fairly straightforward for a drawdown contract, that’s unlikely to be the case for other pension contracts where you could see increased costs passed on to the consumer, even if nobody within the scheme actually wants to make use of this flexibility,” he says.


While the FCA believes that providing access to the PCLS with the ability to delay pension decisions could be beneficial, some commentators fear it could be counter-productive.

Primetime Retirement managing director Russell Warwick says: “Allowing people to access tax-free cash in isolation is possible but there are concerns that suggests it will sidestep need for customers to make a conscious decision where to invest for the future  It’s a bit of an amber light flashing, and not making any decision at all is a big risk.”

Montfort head of financial planning Eugen Neagu completely disagrees with the regulator on decoupling.

“The PCLS is a retirement benefit and in many cases, it is used for funding retirement expenditure. By decoupling the link, it will simply increase the behavioural bias for some individuals to spend the PCLS for other needs than retirement. I think this will actually work against receiving a better retirement outcome and the primary intention of this review by the FCA.”

London & Capital head of UK wealth Simon Tuck thinks too many individuals wrongly view the tax-free lump sum as nothing more than a windfall and treat it as such – moving their entire retirement pot into drawdown and leaving it to languish in cash after they have taken what they can.

Adviser view: Fiona Tait, technical director, Intelligent Pensions

We come across a lot of clients looking to access tax free cash who are not looking to draw an income at this point. They are well below 65, not looking to retire but want to repay debt. Considering the demographics, its sensible to look at decoupling. However, it would be very difficult to implement. Quite apart from administration for schemes that don’t currently offer those options, it requires legislation.

The PCLS is a very attractive part of a pension, but I’m concerned that if the government started looking at it in detail it might say it is able to remove it to save money on pensions.

Advice and default pathways

For some commentators, the way to address the FCA’s concerns about people going into drawdown for the wrong reasons is to promote the need for advice.

Portafina managing director Jamie Smith-Thompson says: “What we tend to find is those who have accessed their pensions won’t withdraw anything because they fear doing so, or take the whole lot and struggle to live. Hence, it’s crucial to get advice.

“What hasn’t been picked up on is if you have a defined benefit scheme and it’s worth over £30,000, you have to get advice because you are giving up valuable guarantees. Why doesn’t that apply for all schemes?”

Sanlam UK head of employee benefits Elliott Silk points out that many advisers are not interested in clients with smaller pots, so being able to take the PCLS and defer going into drawdown while still contributing to their pension could result in a higher value pot, for which the client could then seek advice.

He thinks the government could be receptive to the idea of decoupling but implementing it could be tricky.

Some believe the non-advised drawdown problem is more likely to be tackled through the FCA’s proposal of default investment pathways than decoupling.

Mattioli Woods chief operating officer Mark Smith points out that from the FCA’s viewpoint, going into a default investment pathway is better than having money sitting in cash with no investment strategy. “Providers will have to know more about their customers so they can default people into the right pathway. It’s not advice but it’s going further down the ‘know your customer’ route – and that’s quite a challenge for providers.”

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