‘I’m receiving a DB pension – can I keep saving into my personal one?’

Our reader wants to know about any restrictions they face after starting to receive a pension

May 25, 2023

If you have started to draw from a final-salary pension it might make sense to contribute to another pension if you are working
You should prioritise workplace scheme contributions over Sipp contributions to get employer contributions
But there may be lower limits on what you can contribute

‘I’m receiving a DB pension – can I keep saving into my personal one?’

You can keep paying into a self-invested personal pension (Sipp) after you have accessed a workplace pension, although must be under age 75 to qualify for tax relief on contributions. It can make sense if you're still working and have a final-salary pension scheme that has started paying out, particularly if any increases you receive in income for delaying taking the pension don't make financial sense. Some public sector schemes start paying out at age 55, but people often continue working in other jobs after they have left their public sector roles.

Paying into a Sipp after you have started to take another pension can provide additional funds after your death to partners and spouses (see box below). Pension contributions receive tax relief at your marginal income tax rate in areas of the UK other than Scotland.

However, there are limits to what you can put in, depending on your circumstances. You might be able to contribute up to £60,000 a year or the value of your taxable earned income, whichever is lower. However, bear in mind employer contributions also count towards this limit and if you are employed and earn more than £10,000 a year, your employer is obliged to pay into a pension for you. If you don’t have any taxable earnings because, for example, you have retired, the most you can put into your pension and receive tax relief on is £2,880 a year, which increases to £3,600 following the 20 per cent tax relief.

How paying into a pension after retirement can help

David is 60 and Angela is 57. He has just retired and receives a DB pension of £55,000 a year, which more than meets both their financial needs. The pension is guaranteed for David’s lifetime and at least five years. Thereafter it reduces to 50 per cent of the value of David’s pension. Angela will receive the state pension and has a money-purchase pension worth £10,000.

David and Angela want to remain in their home. But if David dies before Angela she might have to sell it as her income will be insufficient to afford to live there.

Angela is a non-taxpayer but qualifies for 20 per cent tax relief on pension contributions. So each annual payment into her pension of £2,880 [the most she can contribute] is topped up with tax relief of £720. By saving £3,600 every year until she is age 75, she could have a fund worth £64,800, before any growth or charges, for a cost of £51,840.

If Angela dies before David, she has nominated her grandchildren to receive the pension fund. This money is outside her taxable estate, so they would be able to draw it tax-free if she dies before age 75 or as taxable income if she dies after 75.

However, if accessing a workplace pension triggers the money-purchase annual allowance (MPAA), because it is defined-contribution or stakeholder pension, then you cannot save more than £10,000 a year, including employer contributions, and receive tax relief. But even if you have triggered the MPAA, you can have an occupational defined-benefit (DB) pension which increases in value by up to £50,000 each tax year – whether from contributions, growth or a combination of the two. This may be the case, for example, if you have an NHS pension alongside a money-purchase pension.

There are ways to draw from money-purchase pensions without triggering the MPAA. Only spending the 25 per cent tax-free cash entitlement or buying a lifetime annuity does not trigger the limit. Cashing in a small pot worth £10,000 or less are also exempt.

Recycling rules

There are restrictions on paying tax-free cash from one pension into another and if you fall foul of the recycling rules, unauthorised payment charges could be applied.

HM Revenue & Customs (HMRC) applies three tests to determine whether tax-free cash is being ‘recycled’ as follows:

The tax-free cash, including any taken in the past 12 months, is worth more than £7,500.
The total value of the increases in pension payments in that tax year and the two tax years either side of it is worth at least 30 per cent of the tax-free cash taken.
The pension payments made are significantly larger – generally 30 per cent – than might be expected.

If HMRC considers that an unauthorised payment has been made, three potential charges could arise, as follows.

A 40 per cent 'unauthorised payments charge' paid by the saver.
An unauthorised payments surcharge of 15 per cent of the payment received paid by the saver.
A 40 per cent sanction charge paid by the pension provider.

Gary Smith, partner in financial planning at Evelyn Partners, says: “The overall effect of these tax charges is around 82 per cent. The increased contributions might not fall foul of these conditions [but] pension savers should be aware of this because if HMRC deems the increased payments to be unauthorised, tax charges could result. Therefore care needs to be taken when pension contributions continue after retirement benefits are taken.”

For example, you contributed £500 a month to a Sipp before taking your workplace pension and continued to contribute this amount after starting to take your workplace pension, it probably wouldn’t be considered to be pension recycling. And taxable income from one pension scheme can be paid into a new pension plan and qualify for tax relief if you have annual allowance available.

Should I do it?

Contributing to a Sipp may not be the best option even if you have enough annual allowance. If you are in a workplace scheme and your employer contributes to this, you should prioritise putting money into this over a Sipp and, if possible, put in as much as you need to get the maximum possible contribution from your employer.

Also consider whether to contribute to any pension. Although the lifetime allowance limit of £1,073,100 is due to be abolished from 2024, and during the current tax year there are not any charges for breaching it, tax-free cash rules will change and be capped at £268,275.

Smith adds: “Tax-free cash is capped at 25 per cent of the current lifetime allowance or your protected amount, if your pension values exceed the lifetime allowance making additional contributions [won’t] increase your tax-free cash benefits."

‘Should I draw from my Isa or pension first?’

The order in which you draw from your accounts is influenced by a number of factors, but often it is best to use unwrapped assets first, within your annual tax allowances, then draw from Isas and finally pensions.

Assets in Isas and pensions can grow more tax efficiently than unwrapped ones. Isa withdrawals are tax-free whereas pension withdrawals, other than the 25 per cent tax-free entitlement, incur income tax at your marginal rate. You can draw up to £12,570 from the taxable part of your pension each year, using up your personal allowance for income tax, if you have no other earnings. However, if you receive the state pension this is likely to use up most of your personal allowance.

Smith says: “If you continue to work and earn an income, it might be beneficial to make up any shortfall in expenditure from an Isa. However, if you have completely retired, receive no taxable income and are not receiving your state pension, you could take £16,666 as a lump sum from your pension. Twenty-five per cent (£4,166) could be tax-free cash and 75 per cent (£12,500) income. As the income would fall within the personal allowance, there would be no tax charges. You could also draw from an Isa to top up your income."

If you wish to pass on assets tax-efficiently to beneficiaries, and your estate has or is likely to have a value worth more than your IHT allowances, drawing from Isas first might make sense as pensions sit outside your estate for IHT purposes. Married couples and civil partners can inherit Isas from each other IHT-free, although when the second spouse dies, the Isas fall into their taxable estate.