According to provider data collected by the Financial Conduct Authority (FCA), some 57,568 clients aged over 55 have fully encashed their pension fund as an uncrystallised funds pension lump sum (UFPLS) since the new rules came into force. The vast majority of these (47,331 or 82%) withdrew pots up to £30,000 under the triviality rules while, at the other end of the scale, a small number of customers (137 or 0.24%) took pots worth £250,000 or more.
Given that there are over 17 million people aged over 55 in the UK, the number of pensioners actually drawing their fund in full seems a far cry from the hoards driving around in a drop-top Lamborghini with their hair neatly covered by a Hermes scarf that the popular press would have us believe!
That said, however, the issue of income tax paid on 75% of the fund value, particularly for those drawing larger pots, is not an issue that can be taken lightly. Looking at an example of a higher rate taxpayer with a pot of £250,000:
- Pension Fund - £250,000
- Tax Free Lump Sum - £62,500
- Taxable Lump Sum - £187,500
- Income Tax Due @ 40% - £75,000
While a lump sum of £175,000 may be appealing to the client, a tax bill of £75,000 won't be!
If a client has the available funds to invest (and of course a suitable risk profile) it is possible to reduce this liability to a much more palatable level or even mitigate it completely.
Funds placed into an EIS attract Income Tax relief of 30%. Using the example above, an investment of £100,000 into an EIS would attract income tax relief of £30,000 thus reducing the effective rate of income tax due on the taxable part of the pension to 24% or 18% if looking at the entire pension fund. An investment of £250,000 would wipe out the tax liability entirely.
Clients with pots of this size are also likely to be able to benefit from the other valuable tax reliefs offered by EIS investment and, once held for two years, will qualify for BPR and therefore the client will be in no worse an IHT position as they would be if they had stayed within the pension.
Of course EIS are not magic investments that can make the income tax burden disappear free of risk. They are, by nature, higher risk than traditional equity investments with the consequent higher risk of loss of capital. This can be reduced by investing across a number of underlying companies however cannot be removed completely. They can also be illiquid and, in any case, must be held for the minimum qualifying period to prevent the tax reliefs being clawed back.
Many advisers are nervous of recommending these more specialist investments, however where there is a clear tax advantage, it is important not to dismiss them as 'too risky' as they can open up a lot more freedom within the new pensions freedom rules.