Dear Kate,
I’m lucky enough to have a final salary scheme with a previous employer. I’m expecting this to pay out a guaranteed pension of around £35,000 a year plus a tax-free lump sum of around £200,000 when I reach my ‘normal pension age’ of 62 in two years’ time. I also have a small “defined contribution” pension with my current employer, worth around £100,000.
I’m planning on working until my 64th birthday and won’t be taking my pensions until then. I have two questions. How will deferring my “defined benefit” pension impact the amount I can continue to pay into my defined contribution pension? And are my pensions likely to exceed the lifetime allowance? I don’t have any other private pension benefits.
Anon, via email
Kate says:
Many people, like yourself, approaching retirement have both defined benefit and defined contribution pensions and will want to understand the pension rules when deciding when and how to take benefits.
The way the amount saved in defined benefit, sometimes called “gold-plated” schemes, and defined contribution schemes are measured against the annual allowance and the lifetime allowance are very different. It’s fair to say that the defined benefit rules are considerably more generous than those for defined contribution schemes.
Saving into a pension
Assuming you have income of under £240,000, the maximum that can be paid into a pension without incurring a tax charge is £40,000 each tax year – known as the annual allowance.
This includes your own contributions, those made by your employer and any third-party contributions made on your behalf. You may also have the option of carrying forward unused allowances from one or more of the three previous tax years to increase the contributions that can be made this tax year.
You only receive tax relief on your own (or any third party) contributions of up to the greater of 100pc of your taxable earnings or £3,600 gross in a tax year.
Measuring defined contribution against the annual allowance
It’s relatively straightforward to measure pension contributions paid into a defined contribution pension scheme each tax year. You simply total the gross amount of any contributions paid by you, your employer and any third-party on your behalf and compare this to the annual allowance.
Measuring defined benefit against the annual allowance
For defined benefit you need to work out any increases in the capital value of your pension in the tax year and measure this against the annual allowance. After taking account of the increase in inflation, you then multiple this number by a factor of 16. This gives the amount to be measured against the annual allowance.
Final salary deferred member ‘carve-out’
As you are no longer working for the employer that provided your defined benefit scheme you will be classed as a deferred member. The good news is that this means as you are no longer building up future benefits and are likely to be “carved-out”. This means your final salary benefits will be revalued from the date you left the scheme in line with the scheme’s rules, up until your normal pension age of 62, but the increases in the value of your benefits each year won’t be tested against the annual allowance.
This “carve-out” continues as long as the revaluation isn’t more than the rate of increase of the Consumer Price Index, or more than that set out in your pension scheme rules as Oct 14 2010 (or Apr 6 2012, if RPI based increases only).
Defined benefit pensions are designed to be paid from a normal pension age set out in the scheme rules. In your case, this is age 62. Your scheme rules will also state how your pension will be enhanced to take account of late payment beyond age 62 – this varies by scheme. You’re likely to benefit from the carve-out, provided your scheme rules on late retirement enhancements have not changed since Oct 14 2010 and the enhancement factor is expressed as a percentage.
Just to be clear you will still need to measure contributions paid into your defined contribution pension against the annual allowance.
Lifetime allowance
The lifetime allowance caps the amount of pension benefits that can be taken from all your pension schemes, without triggering an extra tax charge. The standard lifetime allowance is currently £1,073,100, frozen until April 5 2026.
Every time you take benefits from your pensions, they will be tested against your available lifetime allowance. At the point you take any benefits that result in you exceeding your lifetime allowance, a tax charge will be payable.
Measuring defined contribution against the lifetime allowance
For defined contribution pensions, the measurement is simply the fund value. Assuming that your defined contribution fund increases from £100,000 to £150,000 by the time you start taking it in four years’ time, due to paying in contributions and investment return, it’s this amount that will be tested against the lifetime allowance.
This would use up just under 14pc (£150,000/£1,073,100 x 100) of the standard lifetime allowance.
