If a person has defined benefit pension and two SIPPs, can they take a tax-free lump sum from that pension in, say, year 1, and subsequently a monthly taxable income; then in, say, year 4, take a tax-free lump sum from SIPP 1 and start drawdown; then, in, say year 7, take a tax-free lump sum from SIPP 2 and start drawdown? All the while assuming the cumulative value does not exceed the LSA currently at £268,275.

I believe the subsequent sequence of events can occur across different tax years and it is the cumulative value of the lump sums taken.  I also recognise that once you crystallise a defined contribution or SIPP, you are immediately limited to the amount of further contributions which can be made to a SIPP.  But what is the effect if I take an income from a defined benefit scheme?

Peter

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

Let’s start with the basics. From age 55 (rising to age 57 from April 2028), everyone can access their private pension. They can take up to 25% of their pension pot as a tax-free lump sum, and then they have to take a taxable income from the remainder.

If they have a defined benefit pension then this will be paid as a ‘scheme pension’, out of scheme funds, for the rest of their life.

If they have a defined contribution pension, for example a SIPP, then the taxable income can be paid from drawdown (giving people the flexibility to set how much they take and when) or they can buy an annuity to pay a guaranteed income for life.

The amount of tax-free lump sums from all pension schemes is subject to the lump sum allowance (LSA) which is set, for most people, at £268,275 over their lifetime.

So, if you took a £100,000 lump sum from your first pension you would only have £168,275 of the LSA left.

If, three years later, you took another £50,000 tax-free lump sum from another pension, you would have £118,275 left, as it works on a cumulative basis.

These rules are simpler than the ones we had under the old lifetime allowance regime, where you used up a percentage of your lifetime allowance every time you ‘crystallised’.

Using percentages did mean it was easier to deal with the ever-changing value of the lifetime allowance, but nowadays we deal in pounds and pence used up.

For now, as long as the LSA stays at £268,275, everything is clear, but if one day the government decides to reduce that figure people could find they have less of their LSA left than they previously thought.

It’s worth saying it is likely some sort of protection would apply, but we have no way of knowing what may happen in the future. 

The second part of your question involves the money purchase annual allowance (MPAA).

Everyone can individually contribute up to 100% of their earnings into a pension and receive tax relief on this, although another check applies – the annual allowance – which means all contributions including the employee’s and the employer’s, plus tax relief, cannot exceed £60,000 or the excess is subject to a tax charge.  

However, in some situations the annual allowance can be lower, so where someone is a very high earner (earning over £200,000 a year) the annual allowance can be tapered down to a maximum of £10,000.

Also, if you take a taxable income from your defined contribution pension then this will trigger the MPAA, which will reduce the amount you, and your employer, can pay into your pension, to £10,000 a year.

If you are still building up benefits in a defined benefit scheme then it’s worth noting you will also get an ‘alternative annual allowance’ of £50,000 a year (tapered down for very high earners) which covers benefits built up in your defined benefit pension.

Any unused MPAA cannot be carried forward to a future tax year to boost contributions paid then.

The MPAA is only triggered when someone takes a taxable income from a defined contribution pension. So, if you only take tax-free cash from your SIPP, but no taxable income, then the MPAA won’t be triggered. Nor will it usually be triggered if you buy an annuity with your remaining defined contribution pot.

If you start receiving a (taxable) scheme pension from a defined benefit scheme this also won’t trigger the MPAA, and the standard annual allowance will continue to apply. 

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