It’s important to differentiate between the “annual allowance” and “lifetime allowance”.
- “Annual Allowance” is a limit on how much I (& my employer) can put into pensions each year.
- “Lifetime Allowance” is a limit on how much I can take out of my SIPP/DC/DB pension before I get a big tax hit.
There are many ways that money can move between these accounts, all with tax rules associated. Let’s look at the main flow through drawdown.
From age 55 I can set up a Drawdown account, and start to move money into it from my SIPP or DC pension account. When I do that, the drawdown account company can release 25% tax free into my current account. The receipt of a 25% tax-free amount does not trigger a reduction in my “annual allowance”. No need to move all of my SIPP/DC in one go. I need to be clear what I will do with the 25% that lands in my current account – I have ISA input limits, assuming that I plan to put it into an ISA.
Drawdown separates the timing of (1) the tax-free 25% and the lifetime allowance from (2) the pension income. Even if you want to get an annuity when you retire, you can still use a drawdown first.
There’s another plus with splitting the timing of the tax-free 25% from any taxable payments (from drawdown or direct from the SIPP/DC). When I start to take taxable income, each month is taxed on the basis that each month has 1/12th of my annual income tax allowance. That’s fine if I want a steady drip of income, but sudden large sums (e.g. a year’s worth in one go) get hammered for tax to be reclaimed later (unless VERY carefully anticipated). Better to get any sudden large sums from the 25% tax-free or from any ISA. Taxable pension payments are best done steady and monthly.
Ask your SIPP and DC Provider if payments out to drawdown will trigger anything in their rules. My DC providers let me and my employer continue to contribute while at the same time I am moving some to drawdown and taking some tax free.
The value of the money that moves out of the SIPP/DC uses up a percentage of the “lifetime allowance”.
Starting to be paid (taxable) income from a DB scheme doesn’t trigger a big reduction in “annual allowance” .
Moving money from Drawdown to Current Account (or starting payments direct from SIPP to current account) is a serious step. It is liable to income tax. It triggers a big reduction in “annual allowance” which becomes so low that for many people their contribution and their employer’s contributions are likely to exceed it and will have to be reduced. That’s giving up free money from their employer! I’ll only take this step once I have retired from a full-time job.