I want to take a 25% tax-free pension lump sum, but after that can I pay in a £40,000 or £4,000 maximum each year? Steve Webb replies
Tapping your pot: I want to take a 25% tax free lump sum from my pension – can I still pay in £40k a year?
I am a little confused with the Government website on pensions.
It says: ‘You can take up to 25 per cent of the money built up in your pension as a tax-free lump sum.
‘You’ll then have six months to start taking the remaining 75 per cent, which you’ll usually pay tax on.’
It then goes on to say: ‘You may be able to ask your pension provider to invest your pension pot in a flexi-access drawdown fund.
From a flexi-access drawdown fund you can:
– Make withdrawals
– Buy a short-term annuity – this will give you regular payments for up to 5 years
– Pay in – but you’ll pay tax on contributions over £4,000 a year’
I have not been able to find any other reference to the six months in the legislation, and everything else I read says that you should be able to pay in £4,000 so long as you do not take any taxable payments.
So who is right, is the gov.uk web site incorrect or at best misleading? Is it possible to publish more details on this.
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Steve Webb replies: When you take your tax-free cash out of your pension pot, the rules say that this has to be ‘alongside’ doing something with the rest of the pot such as buying an income for life or going into drawdown.
In most schemes you do the two things at the same time, but HMRC do allow a window of time for you to do this.
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If you take the tax-free cash first, you then have to take an annuity or go into drawdown with the rest within six months.
Alternatively, if you do it the other way round (ie buy the annuity/go into drawdown first) then the time limit is 12 months to take some or all of your linked tax-free cash, after which you lose the opportunity to do so.
The section you have referred to on the Government website relates to one particular type of drawdown known as ‘flexi-access drawdown’.
In this arrangement, you have already taken your tax-free cash and any withdrawals thereafter are taxable.
The first such taxable withdrawal triggers the reduction in your annual allowance for contributions into ‘pot of money’ pensions to £4,000.
But you are correct to say that simply taking the tax-free lump sum does not do so.
I agree that the Government website could be clearer. The website to which people are directed when they contact a pension provider about drawdown is the PensionWise site.
One in four savers dipping into their pensions are still paying in too – but risk a shock tax bill
People who start tapping pots for any amount over and above their 25 per cent tax free lump sum are only able to put away £4,000 a year and still automatically qualify for tax relief from then onward.
Find out how to avoid this trap here
This one is slightly clearer in that it talks about people who start to take flexible pension payments and who also save into a pension at the same time as potentially facing the £4,000 limit.
The definitive answer is contained in HMRC’s ‘tax manual’ where it talks about the reduced £4,000 allowance being brought into play by a series of ‘trigger events’.
On flexible drawdown accounts it says: ‘a trigger event occurs immediately before the first payment is made from that member’s flexi-access drawdown fund’.
In other words, it is the first payment out of the drawdown fund which causes the problem. As long as you do not take anything out of your flexi-access account then the £4,000 limit is not triggered.
If you are interested in the fine detail you can find it here.
What is the £40k annual allowance?
This is the amount you can put in your pension – including your own and your employer’s contributions, and your tax relief – and get tax relief each year, writes This is Money.
It currently stands at £40,000. But it has to correspond with your earnings in any particular year, meaning it will be reduced in line with your income if that is less than £40,000.
It is also gradually reduced from £40,000 to £10,000 for those earning between £150,000 and £210,000 a year.
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.
Since leaving the Department of Work and Pensions after the May 2015 election, Steve has joined pension firm Royal London as director of policy.
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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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