How pension drawdown crystallisation works | Examples

How pension drawdown crystallisation works

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    If you are coming up to retirement, you may have heard the terms ‘crystallised’ and ‘uncrystallised’ in relation to your savings – financial jargon at its finest! But it’s essential to understand the difference so you can plan your retirement benefits in the most tax-efficient way.

    If you haven’t taken your pension benefits, then your pension is known as uncrystallised. When you come to take your benefits, this crystallises your pension. Any income you take from your crystallised pensions will be subject to income tax at your marginal rate of income tax.

    If you want to have full control over how you take an income from your pension, then income drawdown or Flexi Access Drawdown could be for you. In this article, we explore how it works and how you can use it to your advantage to take a tax-free retirement income.

    Watch my video on flexible retirement income and subscribe to the channel for more useful videos!

    What is drawdown?

    Essentially drawdown gives you the flexibility to take as much income or as many lump sums from your pension pot as you like. Usually, 25% of the pension is tax-free, and the remaining 75% ‘crystallised pension’ will be classed as taxable income.

    With drawdown, it’s possible to take just your tax-free cash and no income. This is particularly useful if you are still working or don’t need an income. When you come to take an income from the pension, the remaining pension fund is invested, and so the potential growth can help to offset the withdrawals.

    For more information, read our blog, How you can take tax-efficient pension income with drawdown.

    How is a pension crystallised?

    When you come to take the tax-free cash from your pension, known as a ‘pension commencement lump sum’ (PCLS), this crystallises your pension.

    If you haven’t taken any income or tax-free cash from your pension, then your pension is classed as ‘uncrystallised’.

    Let’s use the example of a £100,000 pension pot. If John takes all of the tax-free cash from his pension fund, he will have a fully crystallised pension.

    £25k will be paid to John as a tax-free lump sum, and the remaining funds are then designated as ‘crystallised’ funds within his pension scheme. He can take an income from his crystallised pension, but the withdrawal is subject to income tax at his marginal rate.

    John’s crystallised pension remains invested, and he can take as much or as little income as he likes.

    What if you only take some of your tax-free cash (pension commencement lump sum)?

    If you take all of your tax-free cash, the concept of crystallisation is straightforward. But what happens if you only take some of your 25% tax-free cash? Do you lose the rest?

    Let’s use the same example, but John only takes £10,000 of his tax-free cash from his uncrystallised pension fund.

    John decides to crystallise £40,000 of his pension pot, taking £10,000 of this as tax-free cash. That means £30,000 will remain in his pension, designated as crystallised funds.

    If you remember, he can still withdraw these crystallised pension funds at a later date, but these funds would be subject to income tax at his marginal rate.

    pension commencement lump sum example

    £60,000 or 60% of his pension would still be uncrystallised, which means he could take 25% of this amount tax-free in the future (£15,000).

    Can your tax-free cash increase?

    Using the same example, but John leaves the remaining pension for eight years, and his pension has grown to £150,000, how much tax-free cash does he have remaining? Is it still £15,000? No.

    The tax-free cash would be 25% of the 60% of the pension that is still uncrystallised.

    This means he can take £22,500 as a tax-free lump (60% x £150k x 25%).

    He will crystallise £90,000, with £22,500 paid as a tax-free lump sum and the remaining £67,500 designated as crystallised funds within his personal pension. If you remember, he can take his crystallised funds as a regular income or even as smaller lump sums, but the income drawdown will be subject to tax at his marginal rate.

    How you can use your drawdown pension for a tax-free income?

    It is possible to take a combination of your uncrystallised funds (tax-free cash) and crystallised pension (that is subject to income tax) to provide a tax-efficient or even tax-free monthly income from your pension savings.

    With this option, you can stipulate exactly how much tax-free cash and taxable income you want to take to maximise tax efficiency and utilise your personal allowance.

    Your personal allowance is the first £12,570 of your taxable income, which is taxed at 0%. With this option, you can take taxable income from your crystallised pension up to your personal allowance and then take the remainder from your tax-free cash. 

    See an example of how this works in our blog, How you can take tax-efficient pension income with drawdown – link to blog

    Do I have to take my tax-free cash as one lump sum?

    You do not have to take all of your tax-free cash as a lump sum withdrawal from your uncrystallised pension.

    It is possible to take it as a series of lump sums or even as a regular income made up entirely of tax-free cash.

    Let’s see an example. John has retired and has a pension worth £100,000 that is uncrystallised. He needs £4k to cover his expenditure and has turned to his private pension. He is a Basic Rate taxpayer, so if he took any further lump sums or income from his pension, they would be subject to 20% income tax.

    However, John can take a monthly tax-free cash withdrawal of £333 per month to meet this shortfall. He will not be able to do this indefinitely, as he will eventually use up all of his 25% tax-free cash. If we assume no investment growth, this will be in approximately six years.

    Each withdrawal of £333 would crystallise £1,332, with £333 paid to him, and the remaining amount of £999 would be designated as crystallised funds within the drawdown scheme.

    Contact Heritage Financial Planning for pension withdrawal advice

    Strategic planning and awareness of pension drawdown tax rules can empower you to minimise the tax you pay on your pension income. The expert financial advisors at Heritage Financial Planning can help you devise a personalised strategy for a financially secure retirement. Don’t miss out on potential tax savings – reach out now and start optimising your pension income and work towards your financial freedom.

    Frequently asked questions about pension drawdown crystallisation

    What happens after I take my tax-free lump sum?

    Your remaining pension savings will be crystallised and will remain invested within your drawdown pension. You then have the option to take as much or as little as you like from your drawdown fund.
    You could even use the crystallised pension to buy a guaranteed regular income, which is known as an annuity from an insurance company.

    Do you pay tax on withdrawals from your crystallised pension?

    The tax implications will depend on your own circumstances. If you take any income from your crystallised pension, what tax you pay will depend on what tax bracket you are/will be in. You also have your personal allowance available, so if the withdrawal is within this allowance and you have no other income, then no tax will be payable.

    What is an uncrystallised funds pension lump sum (UFPLS)?

    With an UFPLS, 25% of the withdrawal will be made up of your tax-free cash, and the remaining 75% will be classed as taxable income. Uncrystallised funds pension lump sums can be another tax-efficient way of taking your pension benefits.

    How do you know if pension drawdown crystallisation is right for you?

    If you decide income drawdown is right for you, the ‘best’ way of taking income drawdown will depend on many factors such as your tax status, other retirement income you may have and if you have any other pension benefits both now and in the future.
    Although there are lots of advantages to pension drawdown, there are many risks associated with it. Therefore, we would recommend speaking with an Independent Financial Adviser before making a decision.

    Further reading, Which is the best pension option to take?

    What is the Money Purchase Annual Allowance?

    If you take any lump sums or income from any of your flexible crystallised pensions, then you will trigger the money purchase annual allowance (MPAA). This means you will be restricted to a maximum pension contribution of £10,000 per tax year.
    If you are thinking about taking any funds from your crystallised pensions and you are still contributing to your pension, you should bear this in mind.
    HM Revenue and Customs practice and the law relating to taxation are complex and subject to individual circumstances and changes which cannot be foreseen. The Financial Conduct Authority does not regulate tax planning

    Alex Norman-Jones​

    Alex Norman-Jones​

    I am one of the founders of Heritage and I am highly motivated to deliver bespoke financial planning solutions to my clients.

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