I am 64, a homemaker, and unemployed with two tax years to go before I receive my state pension at 66 years old. I have a SIPP, that I have not yet touched. I also have an ISA.

I would like to take an income for the next two tax years before I receive my state pension. I’m considering moving my SIPP into drawdown, taking my tax-free cash, and some income so I can take advantage of my personal tax allowance of £12,570, over the next two years before my state pension arrives. However, I have no need for the tax-free cash money right now. I could put it into my ISA, probably buying the same stocks I would have sold in my SIPP.

What are the pros and cons of this approach? 

Susan

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

Moving a pension fund into drawdown offers pension savers flexibility over how to take their pension money. But there are still some rules to follow.

When moving all of a pension fund into drawdown, the entire tax-free cash has to be taken or it is lost. If this isn’t needed, then the money is being moved out of a tax-efficient environment and into the individual’s estate where it could be subject to inheritance tax should the individual die. The pension saver may, therefore, want to consider ways of ‘spending’ that money.

USING TAX-FREE CASH INSTEAD OF INCOME

Part of that tax-free cash could be used in place of an income. The remaining drawdown funds could then be left in the pension pot to benefit from any investment growth.

Some of the money, if not needed, could be gifted to family as long as it didn’t breach the inheritance tax gift allowances.

And some of the money could be reinvested into ISAs. However, if it is, then it will still be part of the estate for the inheritance tax purposes. The amount paid in also has to fall within the ISA annual allowance of £20,000 a year (over all ISAs in one tax year). But once invested in the ISA then it can be withdrawn tax-free at a later point. Another way of ‘spending’ tax-free cash may be to reinvest it back into the pension. But pension savers would need personal earnings to substantiate their contribution. If they didn’t earn anything they could still contribute £2,880 each year into a SIPP and get tax relief payment from the government boosting the whole contribution to £3,600. They could then withdraw that later and take a quarter of it as tax-free cash.

(A word of warning though – there are rules on ‘recycling’ tax-free cash that people should be aware of. My colleague Tom Selby has covered this in previous Shares articles.)

ALTERNATIVE OPTIONS

However, there are alternatives which would mean not taking the whole tax-free cash.

If someone only wanted a small income, then they could take an ad-hoc lump sum from their pension scheme. A quarter of it is tax-free, and a quarter of it is taxed as income. (Another name for an ad-hoc lump sum is an uncrystallised funds pension lump sum – UFPLS.)

If the individual had no other income, then the maximum they could take from their pension – to avoid paying tax - would be £16,760. In this case £4,190 would be tax-free, and £12,570 would be taxed as income. But if they had no other income then this would fall completely within the personal tax allowance, providing a tax-free income.

As ever, when considering withdrawals from a pension, people should consider how much money they need. Removing money from the pension pot means taking it out of a tax-efficient environment.

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