I am 59 and have recently taken time off work to provide care and support to my parents. I am a little undecided as to whether I will return to work or call it quits and retire.

As such, I would like to take lump sums from my SIPP once a year.

So, I have two questions:

Should I return to work, will any contributions to a new workplace pension and/or a new SIPP still enjoy full tax relief up to £60,000, assuming I take the maximum amount from my SIPP which does not incur tax each year?

What are the differences and benefits between putting a SIPP into drawdown versus taking uncrystallised lump sums once a year?

Andrew

Rachel Vahey,  AJ Bell Head of Public Policy, says:

Life is not straightforward. One of the advantages of saving in a SIPP is the flexibility it gives you to take your money out of your pension in a way and at a time that suits you.

If you are 55 or over (rising to 57 from April 2028), you can access the money in your SIPP. You don’t have to take it all at once; if you want you can access a bit at a time.

You then have a range of options about how you can take the pension pot.

You can take your tax-free cash, which is usually 25% of the pension pot, and use the remainder to buy an annuity, which is a guaranteed income for life.

If you want more flexibility, you can take your tax free-cash and move the remainder to drawdown. You can then take an income from the drawdown pot, either regularly or on an ad-hoc basis.

This initially gives you a big amount of money in your bank account, so you should plan what to do with it. You could spend some, but if you have no immediate use for it you can save it. That could be within an ISA, but depending on the size of the lump sum it may take more than one year to move the unused money over to your ISA, using up your yearly limit of £20,000.

While you spend only your tax-free cash, you can leave the remainder of the pension pot in drawdown and if it remains untouched you can keep your £60,000 annual allowance.

(Remember your annual allowance covers your contributions, your employer’s contributions, and any tax relief. In addition, how much tax relief you receive on your personal contributions into a pension is limited to 100% of your earnings.)

However, when you start to take an income from your drawdown, which will be taxed as earnings, then the £60,000 annual allowance falls to the money purchase annual allowance (MPAA) of £10,000.

You don’t have to take all your tax-free cash at once though. You could take a smaller portion and leave the rest invested in your pension where it can grow in a tax advantageous environment.

This can be done through drip-feeding into drawdown, or you could take an ad-hoc lump sum (sometimes called an uncrystallised funds pension lump sum or UFPLS). Usually, 25% of it will be tax free and the rest will be taxed as earnings.

The advantage to this latter route is you are leaving more money untouched in the pension where it can continue to benefit from tax-advantageous investment growth and may allow you to take more tax-free cash. The downside is it may immediately trigger the MPAA of £10,000, which may affect your ability in the future to pay higher contributions.

Maybe an example will help explain your options.

David has £200,000 in his pension pot. He needs an income of £10,000 a year. He has no other income.

He could take his whole tax-free cash of £50,000 and move the remainder into drawdown. He can use his tax-free cash to give him an income of £10,000 a year for five years. He can then start to withdraw an income from his drawdown. David gets to keep his higher annual allowance until he starts to dip into his drawdown money. But he will have to find somewhere he can shelter his money until he needs it.

Alternatively, David could take an ad-hoc lump sum of £10,000 each year. Because this is David’s only income, not only is 25% (£2,500) tax free, the £7,500 lump sum is also below the personal allowance of £12,570. But this will trigger the MPAA of £10,000.

A third option is to take £40,000 a year from the pension pot, take £10,000 as tax-free cash and move the rest into drawdown, repeating this over five years.

This again means only taking money out of the pension pot when David needs it, and as David can survive on his yearly £10,000 tax-free lump sums without touching the money in the drawdown pot this means he gets to keep his higher annual allowance.  

Of course, the final decision would depend completely on your own personal circumstances – how much money you need as a yearly lump sum, what other income you have, and the size of your pension pot.

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