Ask Money: How can I remedy my pension income headache?

James Jones-Tinsley at Barnett Waddingham helps a reader with questions about his retirement planning.

Two articles on the lifetime allowance (LTA) in your excellent July issue impelled me to undertake research into what gross and net pay I can expect when I fully retire at the age of 60 in three years' time. While there is a wealth of research available, I have come away more confused than I was before.

I currently have a drawdown SIPP, from which I have already taken 25% tax-free, £124,200. I also have a public sector defined benefit (DB) pension, due when I turn 60, that is likely to pay £12,000 a year gross and a one-off lump sum of £36,000.  In addition, I have a DB company pension likely to pay out £30,000 a year. The overall value is £1.38 million and I have individual protection to the value of £1.16 million, so the LTA has been exceeded by £223,000. I don't intend to take 25% tax-free from either my public sector pension or my company pension.

Could you please explain the calculations that will show me what gross and net income I will have, and help me understand whether I should pay the LTA excess as a one-off 55%, which might be difficult to fund, or accept the 25% charge, which I assume is paid indefinitely and might well eventually exceed the charge if I paid it all upfront.

M Hodges, by email.

James Jones-Tinsley, a self-invested technical specialist at Barnett Waddingham, replies: Although you intend to fully retire at 60, you are under no compulsion to simultaneously draw all of your pension benefits from that age. Indeed, staggering the drawing of retirement benefits over more than one tax year may reduce the amount of LTA excess penalty charges payable.

However, I would strongly recommend that you seek regulated financial advice to help you decide when and in what order you draw benefits from your three pension arrangements. That order will dictate which pension(s) are then subject to an LTA excess tax charge, as well as whether you should pay the tax charge via a lump sum or via pension income.

I note that you don't intend to take any tax-free cash from either of your DB pensions. For the public sector pension, this is not an option. A tax-free cash sum is automatically paid out as part of the benefits structure. In your case, this is the quoted lump sum of £36,000. For the company DB pension scheme, you should be able to choose whether or not to take a tax-free cash sum – also known as a pension commencement lump sum (PCLS).

However, there are two potential benefits from taking a PCLS. Most obviously, it is not usually subject to income tax. Less obviously, it could help reduce the amount of LTA excess tax charges you will have to pay.

How? A DB pension is valued against your LTA by multiplying the expected gross annual pension income by a factor of 20. So for your company DB scheme, if the expected amount is £30,000 a year, this will use up £600,000 of your LTA (£30,000 x 20). But a PCLS is valued at 'face value' for LTA purposes.

Therefore, a PCLS of, say, £100,000 and a reduced pension of £20,000 a year would collectively use up £500,000 of your LTA (£100,000 + £400,000) and therefore leave more of your remaining LTA available for the other pension arrangements, thereby reducing the potential excess.

Similarly, you have gone into flexi-access drawdown via your SIPP but have only taken a PCLS to date. Doing this will have used up some of your LTA, and your SIPP provider should have provided you with a certificate stating how much has been used.

Because you have obtained individual protection, your 'personal' LTA of £1.16 million is higher than the current standard LTA of £1.05 million and is based on the total value of your three pensions as at 5 April 2016. However, if you are eligible for fixed protection, you can still apply for it, and that would then give you a personal LTA of £1.25 million, reducing the excess above your LTA even further (as well as the resultant tax charge).

If you take pension as a lump sum, the scheme administrator(s) will pay the one-off 55% excess tax charge directly from your pension arrangement. There is no further tax due.

You will not have to fund this charge personally, as it will be deducted from your pension benefits by the scheme administrator. For the income route, the one-off 25% penalty charge is funded in the same way and your pension income payments are then taxed at your highest marginal rate of income tax. The two tax routes are designed to work out to broadly the same amount in charges.