I am pondering taking 25% tax free cash from my defined contribution pension scheme next month when I turn 55. I will not enter drawdown, as I’m still working full time and don’t need the income.

Up until the government changed the rules in the last Budget, I was facing a lifetime allowance issue, so I have not made significant contributions to my pension for the last six years.

Now the chancellor has decided to give pension millionaires like me a massive tax boost, I am thinking I could max-out contributions using unused allowances from the last three years. In effect, I’d be cashing in my tax-free £268,000 and then putting £180,000 (less 45% tax relief) back in.

Now the annual allowance is £60,000, I am assuming it’s OK to bung-in £60,000 for the last three years? Or would it be £40,000 for the last two years, and then £60,000 for the current year (i.e. £140,000?)

David

Tom Selby, AJ Bell Head of Retirement Policy, says:

Savers with defined contribution (DC) pensions are entitled to take up to 25% of their pot tax-free from age 55, with remaining withdrawals taxed in the same way as income. The age at which you can first access your retirement pot, including your tax-free cash, will rise to 57 in 2028.

In order to access your tax-free cash, you will need to ‘crystallise’ some or all of your remaining pension – this just means choosing a retirement income route. This could be entering drawdown or buying an annuity, for example, but you will need to do this to get your 25% tax-free cash. If you enter drawdown, you do not need to take taxable income from your fund. If you do flexibly access taxable income from your pension, you will trigger the ‘money purchase annual allowance’ (MPAA), reducing your maximum available annual allowance from £60,000 to £10,000.

As you mention, the lifetime allowance charge has now been abolished, with the chancellor stating his intention to remove the lifetime allowance from the UK pensions landscape altogether from April 2024. In addition, the maximum amount of tax-free cash you can claim has been held at £268,275 – a quarter of the £1,073,100 lifetime allowance. Those with an entitlement to a higher amount of tax-free cash under the old rules have been allowed to retain that entitlement.

MAKING USE OF CARRY FORWARD RULES

In terms of boosting your annual pension contributions, this can be done by using ‘carry forward’ rules. Carry forward allows you to use unused annual allowances from the three previous tax years in the current tax year, provided you were a member of a UK pension scheme in each of those years. The maximum someone could contribute to a pension in 2023/24 using carry forward is £180,000 (1 x £60,000 annual allowance in the current tax year plus 3 x £40,000 annual allowances from the three prior tax years).

Your personal pension contributions cannot exceed 100% of your UK earnings in the tax year the contribution is made, however, and the amount you can carry forward from any tax year will be restricted to your available annual allowance in that tax year.

For example, if you were a very high earner in one or more of the tax years, your annual allowance could have been reduced to as low as £4,000 by the ‘taper’. If this is the case, you will only be able to carry forward up to your tapered annual allowance. 

THE DANGER POSED BY RECYCLING RULES

Perhaps the biggest danger inherent in your plans is the risk that, by accessing your tax-free cash and putting it straight into a pension, you could breach HMRC’s ‘recycling’ rules. Anyone who breaks these rules risks being hit with a sizeable tax penalty. 

You also need to consider what you will do with your tax-free cash if you do remove it from your pension and the potential tax consequences of that decision. In particular, by taking it out your pension, the money will form part of your estate for inheritance tax purposes.

Given the significant sums of money involved and the complexity of the rules, I would strongly suggest you speak to a regulated financial adviser before making any decision with your pension.

DO YOU HAVE A QUESTION ON RETIREMENT ISSUES?

Send an email to asktom@sharesmagazine.co.uk with the words ‘Retirement question’ in the subject line. We’ll do our best to respond in a future edition of Shares.

Please note, we only provide information and we do not provide financial advice. If you’re unsure please consult a suitably qualified financial adviser. We cannot comment on individual investment portfolios.

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