I have a final salary pension that will pay £37,000 a year from when I plan to retire and a separate defined contribution pension, from another company, that will be worth approximately £290,000.
I understand the total pension value of these to be a simple calculation of £37,000 x 20 years + £290,000 = £1,030,000, so below the lifetime allowance of £1,073,100.
What I’d like to be able to do is take 25 per cent tax free of the total value and not disturb the final salary pension, but can I do this?
Money question: Can I take 25% tax free cash from my retirement savings, without touching my final salary pension?
Is the 25 per cent tax free allowance limited to up to 25 per cent of each individual pension pot or is it simply that you can take 25 per cent from any combination of pots you may happen to have?
Put simply, can I take £257,500 from the defined contribution pension tax free and leave the final salary pension to pay out as usual?
If not, why is this not allowed and should it not be, because otherwise this penalises people who have money spread between pensions?
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Steve Webb replies: It is important to recognise the distinction between the rules on accessing tax-free cash from any individual pension scheme and the way in which the lifetime allowance (LTA) is calculated for tax relief purposes.
You cannot use the LTA calculation to over-ride the rules on the individual pensions, for reasons I will explain.
Starting with your ‘pot of money’ (defined contribution) pension, as you know you are entitled to take 25 per cent of this pot tax free.
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The value of the defined contribution pot can go up and down so the 25 per cent is calculated at the point you choose to take your money.
Turning to your salary-related (defined benefit) pension, you will presumably be able to take the whole lot as a regular pension or as a combination of (lower) regular pension and a tax-free lump sum.
But the size of the tax-free lump sum will depend on the individual scheme and how it converts regular pension income to tax-free cash.
The calculation you have done for your defined benefit pension is to work out 20 times your annual pension (20 x £37,000 = £740,000).
And this is (roughly) how it works when it comes to valuing your pension against the LTA. But you cannot infer from this that your defined benefit pension lump sum will be 25 per cent of £740,000.
Different defined benefit pension schemes work out lump sums in different ways and you need to find out from your own scheme what combinations of regular pension and lump sum are available to you.
You ask why you have to take your tax-free cash separately from your separate schemes and why they can’t be considered together.
Fundamentally this is because each individual scheme (defined benefit or defined contribution) exists in isolation and is subject to a set of rules (such as the 25 per cent cap on tax-free cash).
Although the LTA comes along and lumps them all together to see if you have had ‘too much’ tax relief in total, each individual scheme is separately administered and subject to separate rules.
It would be extremely complex to administer if every member of every scheme could take an amount of tax-free cash based on their own unique circumstances rather than a standard percentage per scheme.
It may be that your defined benefit scheme has more flexibility than you realise. Some defined benefit schemes will allow you to vary the percentage of the value of your pension you take as tax free cash (up to the 25 per cent limit).
So you could, as an example, take a lower scheme pension plus tax free cash from the defined benefit scheme and top up the reduced regular income by regular drawing of taxable cash from the balance of your defined contribution pot.
Broadly speaking, this would seem to deliver you the combination of tax free cash (from both schemes) plus a regular taxable income at the desired level (also from both schemes).
In short, although the tax rules don’t allow you to do exactly what you want to do, a combination of the considerable flexibility of defined contribution pensions and the often-neglected flexibility available to defined benefit members may mean that you can still flex your pension entitlements in a way that will help you to achieve your goals.
Ask Steve Webb a pension question
Former Pensions Minister Steve Webb is This Is Money’s Agony Uncle.
He is ready to answer your questions, whether you are still saving, in the process of stopping work, or juggling your finances in retirement.
Steve left the Department of Work and Pensions after the May 2015 election. He is now a partner at actuary and consulting firm Lane Clark & Peacock.
If you would like to ask Steve a question about pensions, please email him at [email protected].
Steve will do his best to reply to your message in a forthcoming column, but he won’t be able to answer everyone or correspond privately with readers. Nothing in his replies constitutes regulated financial advice. Published questions are sometimes edited for brevity or other reasons.
Please include a daytime contact number with your message – this will be kept confidential and not used for marketing purposes.
If Steve is unable to answer your question, you can also contact The Pensions Advisory Service, a Government-backed organisation which gives free help to the public. TPAS can be found here and its number is 0800 011 3797.
Steve receives many questions about state pension forecasts and COPE – the Contracted Out Pension Equivalent. If you are writing to Steve on this topic, he responds to a typical reader question here. It includes links to Steve’s several earlier columns about state pension forecasts and contracting out, which might be helpful.
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