Ask ii: what are my pension access options at age 55?

A reader asks:“I was born on 10 August 1972, which to my understanding means I access some of my self-invested personal pension (SIPP) on 10 August 2027 when I hit age 55.

If I want to take some money out, what actions do I need to take and who do I need to inform? And what are the pension contributions and tax implications after 10 August 2027?

Ideally, I would continue working and contributing to an employer's pension till I am in my early 60s before retiring.”

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Craig Rickman, personal finance editor at interactive investor (pictured above), says: this is a really important question - one which shines a bright light on some of the delicate and complex rules around taking pension benefits.

It’s vital for savers to think carefully about the choices they make when accessing their pensions, as future funding can be heavily restricted if certain options are selected.

Let’s start by laying out the tax on pension withdrawals. With most defined contribution (DC) pensions, alternatively referred to as “money purchase”, 25% is tax free, while the rest is added to other income and taxed at the individual’s marginal rate of tax.

The tax-free cash doesn’t have to be taken in one go and savers have the freedom to either draw income as and when they please using a SIPP, or secure a fixed guaranteed income through an annuity. The decision here isn’t binary – a combination of the two can be used.

Beware the MPAA

If someone opts for the SIPP route but plans to continue making further pension contributions, they will need to watch out for the money purchase annual allowance (MPAA).

The MPAA restricts the amount that can be paid into pensions every year and receive upfront tax relief to £10,000. This includes any pension contributions from third parties, such as employers.

The MPAA has been subject to frequent tinkering since it was introduced in 2015 and stood at just £4,000 as recently as the 2022-23 tax year. But it’s still far below the standard annual allowance of £60,000.

So, when is the MPAA triggered? Well, it happens when an individual draws flexible income from their pensions that is taxable. One example is where the money is moved into drawdown and the income tap is turned on.

Another is uncrystallised fund pension lump sums (UFPLS), which is where 25% of the withdrawal is tax-free while the remaining 75% is taxable. It essentially means a withdrawal from a fund that hasn’t yet been assigned to drawdown or used to purchase an annuity (crystallised).

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However, the MPAA doesn’t kick in if some or all of the 25% tax-free cash is drawn, and the rest is moved into drawdown but remains untouched. It also isn’t triggered if you use the remaining pot to buy an annuity, or if you’ve taken a defined benefit (DB) pension.

To note, whether a saver is hampered by the MPAA or not, they still cannot pay in more than 100% of what they earn. Triggering the MPAA also means carry forward rules cannot be harnessed, which enable individuals to use any unused annual allowance from the previous three years.

While there is nothing to stop savers contributing above their individual annual allowance (the lower of 100% of earnings or £60,000), there is a charge on any excess which effectively wipes out the upfront tax advantages.

Window of opportunity at 55

As the reader notes, under the current regime in most cases savers can access some or all their DC pensions (in this case a SIPP) on their 55th birthday. However, there are some key things to be aware of, notably the minimum age is rising to 57 on 6 April 2028, which has created an anomaly for some people.

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Put simply, anyone born between 6 April 1971 and 5 April 1973 - so those who will reach age 55 between 2026 and 2028 - have a window to access their pensions on their 55th birthday. Importantly, those who don’t act during this time frame will have to wait until they turn 57. It’s worth stating that HMRC is yet to provide further clarity on this window and the rules could change here.

Advantages of delaying withdrawals

In any case, savers should usually only take money out of their pensions if they desperately need to. This might be because they’ve fully retired or require a lump sum to clear high-interest debt.

Keeping the money in the pension can bring several benefits.

First, the investments will have more time to grow, potentially leading to a larger pot to draw from in the future, and a bigger tax-free lump sum.

Second, any money held within a pension wrapper usually escapes inheritance tax (IHT). In contrast, any unspent withdrawals may form part of the estate, and could be taxed at 40% on death.

Exceptions

In a handful of scenarios, savers can draw from their pensions before they reach age 55. These include terminally ill health or where the pension has a protected age. For the latter, it’s important to check with the pension provider to see if it applies.

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Anyone who reaches the point of wanting to take either a tax-free lump sum or income from their pensions will need to contact their provider and instruct them how they wish to draw benefits.

There is no requirement to stick with the current SIPP provider; savers have the freedom to transfer elsewhere. And this might be worth considering from a cost perspective, as some providers charge for accessing SIPP benefits whereas others don’t.

Alternatively, for those unsure whether they’re doing the right thing, and are especially wary about the MPAA, it can make sense to take professional advice from a regulated financial planner.