Lump sum from DB Pension fund

thingswerentthisbadinmyday

Afternoon all,

Am trying to give some general guidance to a family member who should be in receipt of a DB pension (and tax free lump sum in excess of £30k), in about 18 months time. Planning to look at their complete financial situation (cash, stocks and shares, all pensions) to see if it looks realistic to fully retire at 60 (date the main DB pension pays out). There is another, smaller, DB pension which pays at the same time as the State Pension - say 67/68.

Although I don’t yet have full information, I believe there is uncommitted cash in the background which is currently sitting outside of a cash ISA (resulting in an ‘unnecessary’ tax bill re gross interest) and although there is a commitment to move this into cash ISAs, this will take time - even more so when the cash contribution limit reduces to £12k in April 2027.

If the family member wanted to consider setting up a SIPP (let’s say their gross annual income is £25k), what should they be considering - contribution wise - to ensure that they don’t fall ‘foul’ of pension re-cycling rules which I know can be fiendishly complicated?

I”m told that there is sufficient cash in the background to be able to make a lump sum contribution up to the amount of their annual gross salary (less existing DB contributions). But if they were to do this early in the next tax year (18 months or so before their DB tax free lump sum is received), would they still face a potential ‘re-cycling’ issue even though they’d be using their own, existing, cash resources? Would/could it be argued that the DB tax free cash would simply be ‘replenishing’ the cash they’d previous used as a SIPP contribution?

There is absolutely no intention to re-cycle here. What it would give, though, is the opportunity to move a chunk of cash from a non-cash ISA account, into the tax wrapper of a SIPP where it could be invested in a low risk money market fund.

Hope the foregoing makes sense, including the rationale. Grateful for any thoughts/comments.

Cobbler_tone

First thing I'd check is whether the tax free DB lump sum can be converted to additional pension, if they don't need the money. I certainly won't be taking all of my available lump sum. I also wouldn't be throwing cash they already have into a pension. Even if they are paying tax on the interest of £25k it isn't a lot. They could possibly take the second DB pension now (with the reduction) to bridge to the state pension, dependant on their income needs/goals.

Hard to know too much for certain with the vague background and sounds like they could do with some advice.

thingswerentthisbadinmyday

https://forums.moneysavingexpert.com/discussion/comment/81928283#Comment_81928283

Thanks for your thoughts. I do accept that we’re a bit short on detail at the moment.

However, I have already asked the question you posed - i.e. can part/all of the tax free lump sum be used to secure additional pension?

Have also thought about taking the 2nd DB pension early but in relative terms, it’s a much smaller pot and probably won’t make up enough of any shorfall.

Marcon

I”m told that there is sufficient cash in the background to be able to make a lump sum contribution up to the amount of their annual gross salary (less existing DB contributions). But if they were to do this early in the next tax year (18 months or so before their DB tax free lump sum is received), would they still face a potential ‘re-cycling’ issue even though they’d be using their own, existing, cash resources? Would/could it be argued that the DB tax free cash would simply be ‘replenishing’ the cash they’d previous used as a SIPP contribution?

There is absolutely no intention to re-cycle here. What it would give, though, is the opportunity to move a chunk of cash from a non-cash ISA account, into the tax wrapper of a SIPP where it could be invested in a low risk money market fund.

Unfortunately what you're describing sounds exactly like recycling. It's always hard to give a definitive answer, not because the rules are so complex but because they are on the vague side. It's never been possible to get any answers from HMRC (using a FOI request) on how many people have been impacted, because they argue the cost of providing the information would be excessive because each case would have to be examined individually; there's no central record or register.

Making the contribution before receiving the DB lump sum won't get round the problem. Contributions are measured over a five-year period to see if there has been a significant increase in contributions. The period spans:

• the tax year in which the tax-free cash was taken
• the two tax years before the tax year that the tax-free cash was taken, and
• the two tax years after the tax year that the tax-free cash was taken.

Cash is fungible - in other words, HMRC aren't going to be impressed by the fact your relative has taken the SIPP contribution from savings. Some SIPP contributions might be possible, but they should proceed with caution. Helpful reading: https://techzone.aberdeenadviser.com/public/pensions/tech-guide-recycle-tax-free-cash

thingswerentthisbadinmyday

https://forums.moneysavingexpert.com/discussion/comment/81928310#Comment_81928310

Thank you for such a detailed reply.

I was aware of the 5 year period; 2 before the contribution year and the 2 following the contribution year.

Everything I’ve read so far points to vagueness in terms of a definitive answer.

Quite clearly, the only ‘safe’ thing to do here is presumably to keep well away from a new SIPP with any and all lump sums, at least for the 2 tax years following the tax year when the lump sum is received.

The initial step has to be, I think, seeing if all or part of the DB tax free lump sum can be exchanged for an increased annual pension.

leosayer

I'd recommend treading carefully when it comes to family member's finances even though the urge to help is no doubt strong.

Holding large amounts of cash without taking the opportunity to wrap it in a cash ISA makes them seem pretty naive. Going from that to talk of SIPPs (which provider?) and Money Market funds (which manager?) and then into the world of drawdowns and income tax management might be a step too far in a relatively short time period.

If you provide them with awareness of the opportunities and risks then might be enough for them to decide to seek advice or at least educate themselves.