I am 59 and have a deferred defined benefit pension. I currently work as a consultant and bill my clients through a limited company; the company pays my monthly salary and the company makes contributions to my personal SIPP.

If I decided to start drawing my defined benefit pension and continue to work as a consultant as I am doing now, could both me and my limited company continue to make contributions to my SIPP?

Paul

Rachel Vahey, 

AJ Bell Head of Public Policy, says:

Instead of the notion of a fixed day when retirement starts, many people ease into full retirement by taking some form of retirement income at the same time as continuing to work, perhaps on a part-time basis.

You have a defined benefit pension. Also known as a final salary pension, this is one where you are promised annual income for life, based on your salary, the ‘accrual rate’ of the scheme and the number of years you have been a member of the scheme.

You can access this pension from the age of 55 (rising to age 57 in 2028). However, if you take this type of pension before the ‘normal retirement age’ of the scheme then a penalty – sometimes referred to as an actuarial reduction – will probably be applied to lower the promised level of income.  The size of the penalty may depend on how early you take your pension. The normal retirement age differs depending on the scheme but could be 60, 65 or 66 (the current state pension age). You may want to consider what any penalty means for the income you expect to receive.

If you do decide to take a retirement income, then this won’t affect the ability for you or your company to continue to contribute to your SIPP. You will obviously just need to make sure the level of contributions you pay in meet all the usual rules based on the amount of your consulting earnings. However, there is a potential pitfall to be aware of.

RULES TO PREVENT MANIPULATION

HMRC has rules in place designed to prevent people manipulating the pension system to get extra tax relief. This concept is referred to as ‘recycling’ and applies specifically to your use of any tax-free cash you take alongside your defined benefit income.

The authorities are worried people will take out their tax-free cash and immediately reinvest it into their pension to get an extra slice of tax-free cash. For example, someone has a defined contribution pension valued at £40,000, and takes out their maximum tax-free cash (25% of their fund value or £10,000) but rather than spending it, invests it straight back into their defined contribution pension.

They would get tax relief on the ‘new’ contribution immediately boosting the value of the contribution by £2,500 to £12,500 and can then access 25% of that money (£3,125) tax-free as well.

To stop this from happening HMRC has put in rules to prevent ‘excessive’ recycling. Broadly, these rules kick in where someone takes tax-free cash of £7,500 or more, and where the payment of a tax-free lump sum has resulted in a 30% or more increase in contributions to the pension compared to what might normally have been expected.

The increase in the contributions could happen before or after the person receives the tax-free cash amount.

MOST LUMP SUM PAYMENTS WON’T BE AFFECTED

Another key condition is that the recycling must have been pre-planned – there must be a conscious decision to take the tax-free cash so that, directly or indirectly, significantly greater contributions can be made to the pension.

Most lump sum payments won’t be caught by these rules. But it’s worth being aware of them and how they work – anyone who breaks these rules risks being hit with an unauthorised payment charge.

If you are at all uncertain about how these rules might apply in your specific circumstances, it’s worth speaking to a regulated financial adviser before doing anything, particularly if you’re thinking about increasing your SIPP contributions about the same time as accessing your defined benefit pension.

DO YOU HAVE A QUESTION ON RETIREMENT ISSUES?

Send an email to askrachel@ajbell.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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