I have a final pay pension that will pay £37,000 a year from my retirement plan and a separate defined contribution pension from another company, which will be worth around £290,000.
I understand that their total pension value is a simple calculation of £37,000 x 20 years + £290,000 = £10,030,000, which is less than a lifetime allowance of £1,073,100.
What I want to be able to do is get 25 percent of the net worth tax free and not bother the last pay pension, but can I do that?
Money question: Can I take 25% tax free cash from my retirement savings without touching my last pay pension?
Is the 25 percent tax-free allowance limited to 25 percent of each individual pension pot or is it just that you can take 25 percent from any combination of pots you may have?
Simply put, can I take £257,500 out of the defined contribution pension tax free and leave the final pay pension to be paid as usual?
If not, why is it not allowed and should not be, because otherwise it penalizes those who have money spread among pensioners?
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Steve Webb replies: It is important to recognize the difference between the rules for receiving tax-free cash from an individual pension plan and the way Lifetime Allowance (LTA) is calculated for tax relief purposes.
You cannot use the LTA calculation to disregard the rules on 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.
Steve Webb: How To Ask Former Pensions Minister Questions About Your Retirement Savings Check Out The Box Below
The value of the defined contribution pot can go up and down so 25 percent is calculated at the point you choose to take your money.
Turning to your salary-related (defined benefit) pension, you will likely be able to take the full amount as a regular pension or as a combination of (less) regular pension and tax-free lump sum.
But the size of the tax-free lump sum will depend on the individual plan and how it converts regular pension income into tax-free cash.
What you calculate for your defined benefit pension is to draw 20 times your annual pension (20 x £37,000 = £740,000).
And this is (broadly) how it works when it comes to evaluating your pension against the LTA. But you cannot infer from this that your defined benefit pension will be 25 per cent of the £740,000 lump sum.
Different defined benefit pension plans work as lumpsums in different ways and you will need to find out which combination of regular pension and lump sum is available to you from your own plan.
You ask why you have to take your tax-free cash out of your separate plans and why they can’t be treated together.
Basically this is because each individual plan (defined benefit or defined contribution) exists in isolation and is subject to a set of rules (such as a 25 percent limit on tax-free cash).
Although the LTA comes along and adds them all together to see if you get ‘too much’ tax relief overall, each individual plan is administered separately and subject to different rules.
If each member of each plan could take in tax-free cash based on their specific circumstances instead of a standard percentage per plan, it would be extremely complex to administer.
Your defined benefit plan may have more flexibility than you realize. Some defined benefit plans will allow you to convert a percentage of the value of your pension into tax-free cash (up to a limit of 25 percent).
So, for example, you can take less pension and tax-free cash from a defined benefit plan and top up less regular income by regular withdrawals of taxable cash from the balance of your defined contribution pot.
Broadly speaking, it appears to provide you a combination of tax free cash (from both the schemes) and a regular taxable income (from both the schemes also) at the desired level.
In short, although the tax rules don’t allow you to do 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 can mean that you can still make money on your own. You can flex pension eligibility in a way that will help you achieve your goals.
Ask Steve Webb Pension Questions
Former Pensions Minister Steve Webb Is This Is Money’s Agony Uncle.
He’s ready to answer your questions, whether you’re still saving, in the process of stopping work, or messing with your finances in retirement.
Steve left the Department of Work and Pensions after the May 2015 election. He is now a partner in the actuary and consulting firm Lane Clark & Peacock.
If you have any questions to ask Steve about his pension, please email him at [email protected]
Steve will do his best to respond to your message in an upcoming column, but he won’t be able to reply to all or communicate privately with readers. Nothing in their answers is regulated financial advice. Published questions are sometimes edited for brevity or other reasons.
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If Steve is unable to answer your question, you can also contact the Pension Advisory Service, a government-backed organization that provides free help to the public. TPAs can be found Here And its number is 0800 011 3797.
SteveReceives a number of questions about E State Pension Forecasting and COPE – Contracted Out Pension Equivalent. If you’re writing to Steve on this topic, he answers a specific reader question. Here, It contains links to several earlier columns about Steve’s kingdom…