Getting at my personal pension and the 25% tax free

[PuzzledObserver]

DH and I are well set up with defined benefit and state pensions which will arrived at various points over the coming years. We also both have a defined contribution personal pension pot, mine with Aviva, his with Royal London. We are looking at accessing these imminently, as we have already jacked in the 9-5 and have been living off savings.

I’m hoping someone can help me understand the following. I have gleaned that we can take up to 25% of our respective personal pension pots as tax-free cash, and use the remaining 75% to fund flexible drawdown. Both providers are telling us that the 25% does not need to be taken all in one go. That’s great - we only want a bit of it straight away, happy to leave the rest until we have decided on the dream holiday, want a new car, house burns down or whatever.

I had imagined that we would divide our pots 25/75 and effectively have one from which we can take out tax free cash when it suits us, and the bigger one from which we take a (flexible) monthly income. But going through the (huge mass of) blurb which Aviva provides, it seems to work like this: take a tax free lump sum, and 3 times that amount is transferred to another pot from which you can then take the flexible monthly payment. I think this is called crystallising benefits or something like that? The remainder of the original pot stays where it is until you take another tax free lump sum, and 3x that amount is added to your drawdown pot. Royal London don’t seem to say this - it sounds more like you divide the pot 25/75 and treat each part separately.

Does anyone know whether what Aviva are describing is the way it always works (as in, those are the regulations), or whether it’s just a feature of their offering?

Before I discovered that you didn’t have to take all the 25% at once, I had assumed we would take it all and would then have to figure out where to invest the bulk of it. But if this thing of putting 3 x the lump sum you take into a separate pot from which you can take an income is part of the regs, then it’s probably simpler to revert to the original plan: take 25%, invest it, take drawdown from the rest.

It depends how you want to phase the tax free element. If you took 25% in one go, reinvested it elsewhere, and took income or capital from those investments, it would be taxed income (unless you reinvested in ISAs). If you want 25% tax free each year - maybe that keeps you under a tax threshold? - then the Aviva way makes logical sense.

You should really speak to a decent financial planner/advisor.

You can take the 25% tax free then take out chunks from the remaining pot that are subject to 20% income tax, deducted before you get it. If your income is below threshold then at end of tax year you write to hmrc for a refund. Or you can take chunks from your pot and each chunk has 25% tax free, with the remaining 75% having 20% deducted before you receive it. Ditto re threshold.

It is a technicality - there is no other way of differentiating between pots that have tax free cash and pots that do not have tax free cash.

Most providers work like Aviva, although I have also come across Royal London which just confuses everyone. It makes no difference to what you want to do.

Apart from that you should also be able to take regular uncrystallised payments, meaning each payment has 25% tax free with the remaining 75% taxable.

Taking tax free cash and investing it outside a pension wrapper is not normally recommended unless you are coming close to 75.

I’ve recently decided to retire completely on my 500k + DC pension pot and have taken 20k tax free cash. My retirement account now consists of 2 parts - pension savings account and pension income account. My available tax free cash is now 25% of the value of the savings account. I’ll take another 20k this time next year, I’ll then have 2 ‘sub accounts’ within the income account. I don’t see the point of taking all the tax free cash and then reinvesting elsewhere? Unless needed to pay off a mortgage, etc. I’m with the Pru.

Hmm, complicated.

Let’s say that what I actually want is £5K cash for a posh holiday plus £1,500 per month net income. I could achieve this by asking for a £10K lump sum (of which I’d put £5K on deposit) and asking for £1,400 per month. The £1,400 would be taxable but I have my personal allowance to use, so should receive £1,335 per month - a bit less than I really want. But I’ve got that £5K on deposit I can access when things feel a bit tight. And maybe that’s something towards next year’s holiday as well.

£30K will go into the drawdown fund, out of which the £1,400 per month comes, and that should last me the best part of two years if I keep the monthly amount the same. Maybe longer if the underlying investments do well. Then when the drawdown pot is getting low, I request another £10K lump sum and repeat the process.

Is that how you would work it?

There is plenty in the pot to last me until the DB’s are all in payment.

Or is it more like this: I ask for £1,600 pcm. 25% of each payment is tax free. The remaining £1,200 is taxable, but after applying my full personal allowance I will only pay £30.50 tax a month. Hence I will receive £1,569.50 a month into my bank account.

Aviva are working it out the correct way as you can only have 25%tax free from the money once. So if the pot was worth 100k:

You would be entitled to 25k tax free, but you don't want that all at once so

12500 tax free payment (half of the 25%) would mean that 37500 would move to the pot for you to drawdown from. Anything further taken from this £37500 will be taxable.

This would leave 50k still invested in the original pot that you can then take another 25% tax free from, if it performs well you could end up with a higher amount of tax free cash then you took originally as the % will include any growth (it could also go down and you end up with less).

If I’ve understood correctly: your pension income account stands at £60K (the 75% corresponding to the £20K tax free cash you’ve already taken) while your pension savings account is what you started with minus £80K. And you can take whatever monthly amounts you want from the pension income account.

Is that right?

What happens when I’ve used all the 37,500 so need to access the other half of the pot, but don’t need/want to take another lump sum? Do I lose the tax freeness?

For each tax free pot of money your paid the provider needs to seperate the other 75% associated with it. So if you want a regular payment that includes the 25% tax free then you would have the other 75% paid out to you each month eg if you want 1000 a month, then 250 would be tax free and the 850 taxable. They would only put the associated 75% into another pot if you weren't having it paid out to you

Both Aviva & Royal London are basically doing the same thing, just they call it something different. And you are others are basically right too. If you want 25% TFC then the equivalent 75% is crystallised and put into a separate "pot" / "account". Any future payments taken from that crystallised part is then taxable. Anything taken from the remaining uncrystalised pot is then split 25/75 as before.

In essence you currently have ex on your pension pot. When you start taking benefits the money is split into 2 - the uncrystalised remains in pot 1 and the crystallised funds in pot 2.

As others have said, managed it correctly and the crystallised pot can still give you "untaxed" benefits, whether that is a lump sum or regular income......but they are initially taxed and either you claim any tax back from HMRC, or the provider will get your tax code & tax it appropriately....just like being PAYE.

Yes, that’s right. Although I don’t intend to take any money from the income account for a few years yet, just taking tax free amounts. Combined with savings I should be OK until state pension kicks in in 3 years.

Right - so you’re living off savings plus the £20K tax free cash, and leaving the corresponding £60K’s to accumulate and grow. And when you’re ready to use that, it will be taxable at your marginal rate at the time.

we have been living from savings (ISAs) since we stopped work. And there would be sufficient to support us until pensions kick in, but we are not currently using our personal allowances. It occurred to us that we would get more of our total pots tax free overall if we take an income from the personal pensions and use our personal allowances. That will leave more in the ISAs for later.

This video gives a good explanation of utilising a tax free lump sum in the most effective way, and mistakes to avoid.

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Having read a bit more, I’ve got my head round the difference between 25% tax free with the rest going into a separate drawdown account, and “take a sequence of lump sums” aka Uncrystallised Pension Fund Lump Sum - of which 25% is tax free.

My next question is: does anyone know whether providers will do the UPFLS option on a monthly basis, or do they push you towards doing it less frequently, either by punitive fees, or just by limiting how often you can take it?

The specific providers of interest are Royal London and Aviva.

I think aviva might be 4-6 rimes a year

You are spot on. If you have nil rate band available, you should take taxable income from your pension (if you do need income) - it does come with 25% tax free cash so you just add that on, i.e. £12,570 (if you have had no income this tax year) equals 75% taxable income plus £4,190 representing tax free cash.

As previous poster mentioned, HMRC will treat this as if you are getting paid this amount every month and you will be taxed emergency tax if you take the lot in one go. If you split this into more than one payment, HMRC will issue a new tax code to the provider which should then adjust the tax deducted. You will still have overpaid some tax but not as much. HMRC is sitting on billions of overpaid pension tax every year.

Even more confused now - went off looking for more info on UPFLS’s and found an article on unbiased.co.uk saying they should only be used as a stopgap, not long term. The logic was that the underlying investments of your pension fund are designed for growth, not drawing an income.

I’ve also had people telling me don’t take 25% tax free just because you can, take it because you have a plan to use it. Fair enough. But if I put some of my pot into drawdown so I can get an income from it, would I then lose the tax relief of the corresponding 25% if I don’t take it? If I would, then I have to take it and invest it elsewhere. Which is a faff.

For further info - we are only looking at this option for 7 years for me and 2 years for my husband. By then, all our DB pensions will be in payment and we’ll have plenty of income for our needs. We have plenty of capital, although almost all of it is in ISA’s. Our only actual income for tax purposes is a small honorarium, less than £1,000 each. My accountant sister reckons we could use the trading allowance for those, but even if we can’t, we still have the rest of our personal allowances available and currently unused.

I don't understand your last question @PuzzledObserver . What do you mean "losing 25% tax relief". There is no relief once the money is in the pension.

Re UPFLS - it is generally taken as a one off lump sum & usually when someone has a smallish pot (less than £50k) and wants to take it all at once. Sometimes they might spread it over 2 tax years (say March 31st & then again April 10th) to utilise their Annual Personal Allowance for those tax years, but I've not known anyone do it on a more frequent basis.

It really would be a good idea to speak to a financial adviser. Not only can they guide you through this tricky maze but they can also advise you on where the monies should be invested, so that they can give capital growth & security.

Thank you. I do have an appointment with an IFA and with pension wise, but I like to do some prior learning so that I understand more of what they are telling me.

I hope your dealings with Aviva are better than mine. I had 2 policies with them and it took nearly 6 months to get my pension sorted. The 2 together were worth £76,000, I requested everything my email, no some correspondence came through the post and some by email, but for one policy I never received anything. In the end I merged the 2 and took 25% tax free and put the balance in an annuity where I get £270 each month for life. I also got £200 compensation.

@PuzzledObserver It would be good if the tax-free cash could be preserved in the pension when it’s not needed and instead just taxable income is taken to use up nil rate band, however, there is no way to facilitate this so your options are either tax-free cash only or taxable income (after 25% cash has been paid out on the drawdown amount).

The growth v income underlying fund is a bit of a red herring, I think. You should be able to change any underlying funds regardless. The traditional approach has been the 5y time horizon. Any amounts likely to be deinvested during that period should be de-risked, certainly for the next few months’ worth. This scenario was traditionally used before you had to buy an annuity - I am not sure it still fits the flexible pension market. It really depends on how long your fund is going to last or whether you could make alternative arrangements during a market downturn.

@Biggaybear what I mean is, with the drawdown option every £1K of tax free cash allows £3K to be made available for drawdown. If I want, I dunno, £90K of income over the next 4 years, then I can have £30K tax free cash. But if I only actually want £10K of cash, I either have to take an extra £20K and invest it elsewhere, or leave it in the main pot. And if I leave it, I can’t come back later and ask for a further £20K tax free without transferring more into the drawdown pot.

@messybutfun my other bit of useful learning has been that I don’t need to do the same thing with all of my pot. I can put enough for a few years’ worth of income into drawdown and leave the rest where it is, and then revisit what to do with it later on.

I suppose that means I can have different investment strategies for the uncrystallised pot and the drawdown pot…..

I get my state pension at 66, but my bigger DB pension at 65. It’s slightly larger than my state pension. So I only need to fully rely on the DC pension for a bit over 4 years, and can then reduce the amount I’m taking from it.

@PuzzledObserver

I have a similar set up as you but with a Hargreaves Lansdown SIPP.

Took early retirement 3 yrs ago at 58, DH still working.

I have 2 DB pensions payable at 65, a company DC pension and my Hargreaves SIPP. DH has mainly DC pots, plus some large shareholdings and we both have S&S ISAs too.

I realised immediately that I should drawdown £1k/month from my SIPP, to make use of my tax allowance.

Hargreaves work similar to Aviva, so I still have a SIPP account, but also a SIPP drawdown account running alongside it, from which my £1k/mth is paid.

I ‘crystallise’/move some of my SIPP into the drawdown account every 12mths or so, getting the corresponding 25% paid as cash from my SIPP. I don’t think there is an option NOT to get the 25%, which seems to be one of your questions?

On the first move, I sold funds and moved cash into drawdown account, but on subsequent moves I have transferred the 75% as funds, which continue to grow/fall as they would in my SIPP, and I sell 1k worth each month to pay my drawdown income.

In terms of what you do with your 25% tax free cash, can you feed it back into an ISA? That’s something that I have thought about for mine, but so far I have found uses for it 🤣🤣.

Holidays, work on house, a motorhome! We are also drip feeding some cash into our young adult kids ISAs, which will eventually be house deposits.