Capped drawdown

These FAQs are for financial advisers only. They mustn’t be distributed to, or relied on by, customers. They are based on our understanding of current legislation, which may change.

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Capped drawdown allows pension funds to remain invested in a pension scheme after a tax-free lump sum has been paid. Income withdrawals can be made up to the maximum Government Actuary Department (GAD) limit in any one pension year. Any income taken can’t exceed this limit but the amount of income taken can be varied from year to year. If the maximum income is not taken in a pension year, the difference can’t be taken in a later pension year. 

Any capped drawdown arrangements in existence before 6 April 2015 (with pre-6 April 2015 funds in them) continued unchanged when the pension flexibility rules were introduced on 6 April 2015.

New capped drawdown arrangements (including dependents’ capped drawdown arrangements) can’t be created after 5 April 2015 unless it’s to accept a capped drawdown to capped drawdown transfer. The transfer must be on a ‘like for like’ basis so the maximum income limit and review cycle will carry over to the new arrangement. Not all schemes will be willing to accept such transfers into a new capped drawdown arrangement.

Additional funds (designations) can be added into existing capped drawdown arrangements on or after 6 April 2015 although not all existing arrangements will permit additional fund designations to be made. This will need to be checked with the relevant provider.

Capped drawdown is different from flexi-access drawdown. You can find more information on ‘Flexi-access drawdown’ in our FAQs of the same name. 

Yes, they can be transferred to a new capped drawdown arrangement in another pension scheme that is willing to accept a capped drawdown transfer. The transfer must be on a ‘like for like’ basis so the current maximum income limit and review cycle will carry over to the new arrangement. The main advantage of remaining under the capped drawdown rules is that taking income within the GAD limit from a capped drawdown arrangement does not count as having flexibly accessed pension rights. This means that the client would not be subject to the money purchase annual allowance (MPAA) provisions (unless they had flexibly accessed pension rights under a different arrangement).

It’s also possible to move funds in capped drawdown to flexi-access drawdown – see the next question below. 

Yes, provided the additional designation is made to their existing capped drawdown arrangement rather than creating a new drawdown arrangement under the scheme.

When topping up a capped drawdown arrangement, the additional designation will cause the maximum income available, calculated at 150% of the GAD rate, to be reset for the remainder of the review period. The new maximum will apply immediately if it is higher. If it is not higher, it will start from the beginning of the next pension year. The recalculation does not change the duration of the review period, and the arrangement will continue under the capped drawdown rules.

The main advantage of remaining under the capped drawdown rules is that taking income within the GAD limit from a capped drawdown arrangement does not count as having flexibly accessed pension rights. This means that the client would not be subject to the money purchase annual allowance (‘MPAA’) provisions (unless they had flexibly accessed pension rights under a different arrangement). 

It’s possible to convert an existing capped drawdown arrangement to flexi-access drawdown. The conversion to flexi-access drawdown can be done by any one of the following actions:

  • an income withdrawal is taken above the maximum GAD limit, or
  • a member, or dependent, notifies the scheme they want to convert their existing capped drawdown arrangement to flexi-access drawdown and the scheme accepts the notification, or
  • on transfer to a new drawdown arrangement in another scheme, the member or dependent notifies the receiving scheme they want to designate the transferred funds to a flexi-access drawdown arrangement and the receiving scheme accepts the notification.

In practice, providers may require any capped drawdown funds to be transferred to a new flexi-access drawdown arrangement as opposed to being able to switch from capped to flexi-access within the same arrangement.

If someone remains in capped drawdown and does not flexibly access any pensions benefits elsewhere (for example, through taking an uncrystallised funds pension lump sum (UFPLS) or by taking income from flexi-access drawdown), then the standard annual allowance (£40,000 for 2016/17) will apply.

If someone converts their capped drawdown arrangement to flexi-access drawdown on or after 6 April 2015 by taking income above the maximum GAD limit, this will trigger the £10,000 money purchase annual allowance (MPAA) immediately. However, if they convert their capped drawdown arrangement to flexi-access drawdown on or after 6 April 2015 by notification to the scheme and the £10,000 MPAA hasn’t already been triggered, it will only be triggered when the first income payment is taken from the flexi-access drawdown arrangement. The £10,000 MPAA won’t apply to a dependent who converts their pre-6 April 2015 dependents’ capped drawdown arrangement to dependents’ flexi-access drawdown on or after 6 April 2015. They will retain the standard annual allowance unless they trigger the money purchase annual allowance as a member in some other way, for example, taking an UFPLS from their own pension savings.

The maximum income limit for capped drawdown is 150% of the basis amount. The basis amount is broadly equivalent to a single life, level, nil guarantee annuity that could be bought on the open market with the drawdown pension fund. There is no minimum income limit so people can have funds invested in capped drawdown without drawing an income.

The limit is calculated using the 2011 tables provided by the Government Actuary’s Department (also known as GAD tables). The basis amount needs to be worked out first, using the applicable gilt yield and the member’s age attained. The male rates (aged 23 or over) also apply to females. There is also a table for people under 23, which is to cater for situations where someone chooses to set-up a drawdown fund in their own name on the death of a member.  

The gilt yield is rounded down to the nearest 0.25% to obtain the relevant basis amount from the GAD table. The basis amount is then applied to each £1,000 of drawdown pension fund and multiplied by 150% to get the maximum income limit.

The 2011 GAD tables and instructions can be found here. As no new capped drawdown arrangements can be set-up from 6 April 2015, the tables will now just be used for dealing with situations where a review of income limits is required.

Example

Andrea is aged 62 and moves uncrystallised funds of £136,000 into capped drawdown on 20 April 2016 when the applicable gilt yield is 2.06%. The GAD tables show that the basis amount for this gilt yield (rounded down to 2.00%) is £49 per £1,000 of drawdown pension fund (using the male table).

The basis amount is £136,000/£1,000 x £49 = £6,664.

The maximum income limit is £6,664 x 150/100 = £9,996. 

Where someone is under age 75, the maximum income limit is usually reviewed every three years. The basis amount is recalculated using the drawdown pension fund, the member’s age attained and the applicable gilt yield at the date of the review. The new maximum income limit applies at the start of the first pension year of the new three-year review cycle (also known as the reference period).

Where a person is age 75 or over, the maximum income limit is recalculated each year. The yearly reviews start from the first pension year after the member reaches age 75.

Reviews can also happen when:

1. The member requests an ad-hoc review.

  • the maximum income limit is recalculated at the start of the next pension year and a new three-year review cycle (reference period) starts. Note that a scheme administrator can turn down a member’s request for an ad-hoc review – it’s not a right.

2. Further uncrystallised funds are added to capped drawdown in the same arrangement (fund designation).

  • the maximum income limit is recalculated at the date the funds are added.
  • it applies immediately if it’s higher or from the start of the next pension year if it’s lower.
  • the current review cycle doesn’t change.

3. Funds are removed due to a pension sharing order on divorce.

  • the maximum income limit is recalculated immediately but applies from the start of the next pension year.
  • the current review cycle doesn’t change.

4. An annuity is bought with some of the funds.

  • the maximum income limit is recalculated immediately but applies from the start of the next pension year.
  • the current review cycle doesn’t change. 

Income payments are taxed through the PAYE system at a member’s highest marginal rate and the tax is deducted from the payment before it’s paid to the member. A P60 is issued to the member for each tax year that income is paid.

A capped drawdown arrangement can continue to run on beyond age 75. If the arrangement was set-up before 6 April 2006, there is no benefit crystallisation event at age 75 for the remaining funds held in drawdown at that time. If the arrangement was set-up after 5 April 2006, then there is a benefit crystallisation event (BCE 5A) at age 75 to test the remaining funds held in drawdown at that time.

Example

Andrew took his pension benefits in December 2014 when his pension fund was worth £100,000. £25,000 was paid as a tax-free lump sum with the balance of £75,000 going into capped drawdown. This used up 8% of the 2014/15 standard lifetime allowance of £1,250,000 (£100,000/£1,250,000 = 8%). He reached age 75 on 1 May 2016 and his drawdown fund was worth £85,000 at that time. The amount tested at age 75 is £10,000 being the difference between the value of the drawdown fund at age 75 (£85,000) and the amount designated into drawdown in December 2014 (£75,000). This uses up a further 1% of the 2016/17 standard lifetime allowance of £1,000,000 (£10,000/£1,000,000 = 1%).

Note – if the value of Andrew’s fund at age 75 was below £75,000, then there would be no further lifetime allowance used up at age 75. 

Information on death benefits and who they can be paid to can be found in our ‘Death benefits’ FAQs. 

A person may want to remain in capped drawdown as it may suit their retirement income needs to stay within the capped income limits or they may be happy with their current investment strategy. Also, if they stay in capped drawdown and don’t flexibly access any pension benefits elsewhere, the normal annual allowance rules will still apply.

Pensions Technical Services