You can still pay into a pension after taking a lump sum and it won’t cost you anything in taxes providing you do it the right way.
Most modern day pensions, known as defined contribution pensions allow you to take 25% of the total pension value as a tax free lump sum from minimum pension age.
You don’t need to take the full 25% in one go and could crystallise just part of your pension and take 25% of the smaller crystallised amount.
There can be lots of reasons why you might want to take a lump sum out of your pension whilst you are still working and paying into your pension. You might wish to:
- Pay off the last remaining bit of your mortgage.
- Help your children put down a deposit on their own home.
- Invest in your child’s business.
- Purchase a camper van or holiday home.
The fact you can pay into a pension after taking a lump sum is a bonus because it allows you to continue to build up very valuable benefits. More on this in a moment.
There can however be some harsh financial penalties if you withdraw from your pension in the wrong way or do not have the right pension type. This can ultimately jeopardise your retirement.
Why might you want to pay into a pension after taking a lump sum?
Unless you know your retirement savings number and have already saved this amount paying into a pension is always going to be one of the best ways to save for your retirement. There are two main reasons why:
- You receive tax relief on contributions you make to a pension which is a bit like receiving a free top up from the government.
- The income and growth you earn from your pension investments is not taxed meaning the money inside your pension keeps all its return while it remains in a pension.
Even if you have saved all your ever going to need, if you are still working it can make sense to still pay into a pension because your employer will pay in too and this is like receiving free money. You’re unlikely to get this unless you pay in.
If you’re not working it might still make sense to pay into a pension after taking a lump sum because savings sitting inside a pension are usually free from Inheritance Tax. Your children may thank you for leaving them a nice tax-free lump sum on your death. Please note though that if you don’t have any earnings, you will be limited to contributing £2,880 net per year into a pension.
However, if you’re a couple you could both pay this amount into your own pensions and each payment will be topped up to £3,600 by the government. You can do this all the way up to age 75.
So, if you retired at age 65 and both did this for 10 years, that’s £72,000 shielded from Inheritance Tax before factoring in any investment growth.
If you did need the money, you could also take a 25% tax free lump sum from these ‘new’ savings.
What you need to know if you pay into a pension after taking a lump sum
Whilst you can still pay into a pension after taking a lump sum there are a few things you need to be aware of.
#1 – Tax free cash recycling
So far it all sounds a bit too good to be true in terms of taking a tax-free lump from your pension, then paying back into your pension and taking a further tax-free lump sum in the future.
That’s why there is the tax-free cash recycling rule in place which limits what you can do. However, there is quite a high bar to get over before you break any rules.
To fall foul of the tax-free cash recycling rules, you need to answer yes to each of the following:
- Have you received or are you planning to receive a tax-free cash lump sum from your pension?
- Is the amount received over the last 12 months more than £7,500?
- Have pension contributions increased by more than 30% of what might have been expected?
- Are the additional contributions more than 30% of the tax-free lump sum received?
- Is the recycling pre-planned?
If you answer yes to each of the above questions, then the new contribution will be treated as an unauthorised payment and you will be taxed on it at your marginal rate.
However, if you answered no to each of the above questions then tax free cash recycling didn’t happen.
#2 – Money Purchase Annual Allowance
The subject of this article is all around the tax-free cash lump sum element of your pension. This is usually up to 25% of the uncrystallised value of your pension.
For the ideas mentioned in this article you have to take your lump sum from this tax-free element.
If you were to take your lump sum from the ‘taxable’ element of your pension then you would trigger the Money Purchase Annual Allowance.
This means, going forward you would be limited to only being able to contribute up to £10,000 gross per year into a pension. This figure includes employer contributions.
This may be enough for some people but what if your circumstances changed?
The figure was £4,000 last tax year (2022/23) and this caught some people out as their employer contributions were already over this amount and they therefore had to pay tax on the extra contributions over this amount.
#3 – Employer pension contributions could be cancelled
If you are still working and receiving valuable employer contributions into your workplace pension, then it’s probably not ideal to try taking a lump sum from this pension.
This may result in the pension moving from an ‘active’ pension to a ‘deferred’ pension and that could mean employer contributions can no longer be accepted.
#4 – A pension with protected benefits
If you have an older pension from quite a few years back it may have some extra features like the option of taking a higher tax-free lump sum, over the normal 25%.
Be careful if you do try and take the higher tax-free lump from this type of pension as usually, they only allow you to take it if you take the whole pension in one go. This would mean taking the taxable element as well which could significantly increase your tax bill.
#5 – Have the right pension with the right features
In order to pay into a pension after taking a lump sum you will likely need a pension that offers flexi-access withdrawals.
This may mean you need to transfer and consolidate your older pensions.
Just ensure you have checked the features you are giving up before transferring any pension.
Paying into a pension after taking a lump sum allows you to benefit from some valuable tax breaks and also allows you to keep your options open in the future in terms of where you withdraw your retirement savings from.
The government constantly tinker with tax allowances so the more options you have, the better.
If you would like to understand your retirement number, the amount you need to save for a successful retirement, then please get in touch for a free no obligation 15-minute call. We would be happy to review your position, explain where you stand and what you need to do to get the outcome you desire. We have created hundreds of happy and protected retirements over the years. This could be you too.
Stock market linked investments and any income from them, can fall as well as rise and is not guaranteed. Any figures quoted are for illustrative purposes and should not be taken as a forecast or guarantee. Past performance should not be seen as an indication of future returns and clients may get back less than they have invested.