I am in the process of moving a defined benefit pension to another fund with a view to being in control of my money.
My question is that I thought when it was moved I could take a chunk of cash 25 per cent tax free leaving the remainder invested?
Then I read that for example if I took £20,000, £5,000 would be tax free and £15,000 taxable, or is this something else that follows later?
My financial adviser seemed to think as I did that the former was correct. I was hoping to get a whole quarter of the fund tax free in the first instance?
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Pension transfer: Saver is moving her defined benefit pot and then wants to withdraw 25% tax-free lump sum immediately
Steve Webb replies: Once you are aged 55 or over, you have a range of options about what to do with your pension pot if it is in a defined contribution scheme.
The rules are different and can be more restrictive if you are in a defined benefit scheme – although this kind of pension is typically more generous and provides guaranteed payments until you die.
Some people with a defined benefit pension choose to transfer their funds and invest them in a defined contribution plan if they are still working, or an income drawdown scheme if they are about to retire as you have done.
Now you have decided to transfer your money, you have several options and the way in which your withdrawals are taxed will depend on which one you choose.
Let me run through the main choices open to you and the tax implications of each.
First, you can take the pot of money in a pension fund and convert it into an income for life or an ‘annuity’.
You can take a 25 per cent tax-free lump sum first if you want, or use the whole fund to buy an annuity. Annuities are subject to income tax like most other forms of regular pension income.
If you were to use any part of your pension pot to buy an annuity, the whole amount of the annuity would therefore be subject to tax.
A second option would be to take your pot of money and draw it out in chunks, with one quarter being tax free and the remainder subject to tax.
This is known by the ugly title ‘Uncrystallised Funds Pension Lump Sum’ or UFPLS for short. This is what you have heard about where each withdrawal is in part tax-free and part subject to tax.
However, you do not have to go down this route. A third option is to take your full 25 per cent tax-free cash right at the start and then invest the rest in something called ‘Flexi-Access Drawdown’.
Any withdrawals from your drawdown account are then subject to income tax in full. It sounds as though this is what you want, but obviously your financial adviser should be able to confirm this.
There are two other things to be aware of. The first is that each year you can have total taxable income of £11,500 before you pay any income tax.
When you take taxable cash out of a pension fund, this is added to other taxable income such as earnings, state pensions, other pensions and so on.
If you take a big taxable amount out of your pension in one go, you could find you pay quite a lot of tax, whereas if you spread your taxable withdrawals over a longer period of time you are likely to pay less tax.
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This is worth thinking about when you are deciding the speed at which to withdraw the taxable cash from your pension.
The second thing to be aware of is that taking taxable cash out of your pension could severely limit your future ability to put further cash *into* a pension in future.
This is a complex area, but in brief, most people can put up to £40,000 per year into a pension and benefit from tax relief on their contributions. There are separate rules for people earning more than £150,000 a year, which I discussed in a previous column here.
However, those who start the process of taking taxable cash out of their pension can see this annual allowance cut to £10,000 and possibly to £4,000 depending on whether the new government goes ahead with its previously announced plans.
If you only take a tax-free lump sum then this would not be a problem – your annual allowance remains at £40,000.
But if you take taxable cash you need to be aware you are potentially severely restricting your ability to build up your pension savings again in future.
The Government’s free ‘PensionWise’ service provides helpful information about your options and you can access this information over the phone, in person or on its website here.