Dear Kate

I'm in the early stages of planning my retirement and feel like I am being given conflicting advice. I want to take out my 25pc tax-free lump sum, but I am not ready to stop saving into a pension. I am worried that by taking the 25pc allowance, I will trigger the "money purchase annual allowance" which means I can only save £4,000 per year into a pension.

The Pensions Advisory Service has told me that I can take the 25pc tax-free lump sum out of my personal pension, "crystallise" the remaining 75pc, and this won't trigger the tax, so I can continue paying £40,000 a year into another pension.

They told me that as long as I don’t touch the 75pc, I will be fine. Is this correct? I don’t have any defined benefit pensions.

CA, via email

Kate says...

Accessing one of your pension pots can severely impact the amount you are able to save in another pension, or any other type of defined contribution plan such as a self-invested personal pension. You need to be very careful when touching a pension account and understand the consequences it could have on your ability to save more.

Unfortunately, many people have been caught out by this little-known pension tax rule, the "money purchase annual allowance". This stops people from contributing more than £4,000 a year into their Sipps without a tax penalty.

Annual allowance

The standard pensions annual allowance is £40,000 – the maximum that can be paid into a pension each tax year to benefit from tax relief.

Contributions paid by you or your employer count towards the annual allowance. You can make personal contributions of up to 100pc of your income each year but if total contributions exceed your annual allowance (including any allowance you carry forward from the three previous tax years) you will have a tax charge to pay.

Money purchase annual allowance

If you have accessed your pension, contributions where savers can obtain tax relief are limited to £4,000. This was introduced to stop people flexibly taking money out of their pension (under pension freedom rules) and then paying it back in to obtain tax relief.

Triggering the money purchase annual allowance

However, as pointed out by The Pension Advisory Service, if you take your 25pc tax-free cash lump sum and move the remaining 75pc to a drawdown account, but do not take any income, it does not trigger the money purchase annual allowance. So the good news is that if you do this, and you earn at least £40,000, you can continue paying £40,000 into your other Sipp account.

You can take an income from the remaining 75pc of your pot whenever you want but as soon as you do, you will trigger the money purchase annual allowance, and how much you save into a pension tax free will fall from £40,000 to £4,000. Once triggered, there is no going back.

How will I know if I’ve triggered the money purchase annual allowance?

Your pension provider will write to you and tell you.

Exceeding the money purchase annual allowance

If add more than the the money purchase annual allowance to your pensions, you will be liable to a tax charge on the excess.

When doesn’t the money purchase annual allowance apply?

The money purchase annual allowance isn’t triggered if you just take your tax-free lump sum and leave the rest of your pension pot untouched. There are a number of other circumstances where the reduced annual allowance doesn’t apply. These include taking a pension income from a defined benefit scheme or buying an annuity.

You can find out more here