SIPP withdrawal rules

How can you access your pension at retirement? Your pension options explained

Hello, I’m Charlene Young, Senior Pensions and Savings Expert, here at AJ Bell.

The pension rules give people more flexibility as to how they can access their pension savings. It’s a big decision – but in this video I’ll run through the choices you have when it comes to your SIPP, which stands for self-invested personal pension.

Let’s begin by looking at the age at which you can access a pension.

You can usually start accessing your pension from age 55, although this retirement age is increasing to 57 from 6 April 2028.  But don’t worry – just because you reach pension age doesn’t mean you have to retire or stop working to access money in the pot.

It’s also worth pointing out that accessing your personal pension can be done earlier in the life than claiming a State Pension which doesn’t happen until you’re well into your sixties.

This video is about personal pensions rather than state pensions, so let’s bring the focus back to that. You can make an early pension withdrawal if you are too ill to carry on working. The exact requirement will vary between different providers, but you’ll generally need evidence from a registered doctor that you cannot continue working due to illness and are unlikely to be able to do so in the future.

You’ve got several options to access your pension

You can usually take up to 25% of your pension pot tax-free, subject to an overall lump sum allowance of £268,275. This allowance is a cap on the value of tax-free lump sums you can receive from pensions in your lifetime.

Let’s look at an example.

You’ve got a SIPP worth £400,000, that you haven’t accessed at all yet. This £400,000 is known as uncrystallised funds. You could take up to a 25% tax-free lump sum from these funds, which is a maximum of£100,000 . If you do take it all at once, you need to crystallise the rest of your pot, or the other 75%.   

By crystallise, we just mean it needs to be moved into an income option. I’m going to talk about these options shortly but for our example, we are going to assume that you move them into pension drawdown within your SIPP and choose to take no income initially.

Some people like to take the whole tax-free lump sum at once because they have a plan for it – that might be to pay off an outstanding mortgage, to help family, or start enjoying retirement.   

But instead of taking everything at once, you can also access your pension in stages. Back to our £400,000 SIPP example - you might instead choose to take £50,000 as a tax-free lump sum. You’d need to move £150,000 – which is three times the lump sum - into drawdown or buy an annuity with it instead.

This would leave you with £200,000 in uncrystallised funds that you could take more tax-free cash from in the future. This could be 25% of the future value of these uncrystallised funds at the time, which could grow over time. That assumes you’ve got enough lump sum allowance left.

As I mentioned before, taking the pension commencement lump sum (or tax-free cash) option means you also need to choose an income option for the balance. The most common option is now drawdown, or flexi-access drawdown to give it its official name.

These drawdown funds stay invested in your SIPP, and you choose how much income to take, and when. The flexibility means you don’t have to take anything right away and you can leave your SIPP invested, giving it more time to grow. This might suit you if don’t need the income just yet.

But if you do choose to take income - whether as regular payments or ad hoc withdrawals – you should keep in mind that you’ll pay tax on the pension withdrawal.

Taking a flexible income from pensions like a SIPP will trigger something called the money purchase annual allowance (MPAA). This is a lower annual allowance on what you can pay into money purchase pensions like SIPPs or Ready-made pensions going forward and is set at £10,000 a year.

If you’d prefer certainty and a guaranteed income, the other income option for the rest of your pot is an annuity. An annuity is a product you buy from an insurance company – you exchange those crystallised funds for a guaranteed income for the rest of your life.   

Like drawdown, you’ll pay tax on the annuity income, but taking an annuity income does not trigger the money purchase annual allowance.

The income you'll get from an annuity is set at outset and will depend on factors like your age, health, and even where you live. You can even build other options like inflation protection or a spouse’s or dependant’s income if you pass away. It’s important to shop around and consider your options as once you buy an annuity you cannot change it.

If you like the sound of both annuity and drawdown options, you could also mix and match between the two of them.

For example, you could buy an annuity with part of your crystalised funds to give you a base or core level of guaranteed income and leave the rest in drawdown. The drawdown income can be turned off or on depending on your needs and has the potential to benefit from investment returns and grow over time. The annuity part has been paid over to the insurance company at the start, but the drawdown funds can also be used to purchase an annuity in the future.

Pension lump sums are an alternative option. Instead of taking a tax-free cash lump sum and then choosing an income option for the balance, and then an income option, you can take one-off payments from your pension instead. Officially known as ‘uncrystallised funds pension lump sum’ or UFPLS, 25% of each payment is tax-free, and the 75% balance taxed as income.

The tax-free part is tested against your lump sum allowance.

Pension lump sums can work well if you want ad-hoc access without taking a regular income. You could even take your whole pot as one lump sum, but that could leave you short later in retirement, and mean you pay a higher rate of tax at the time you take the payment.

The first time you tax a pension lump sum, you will trigger the money purchase annual allowance.

Summary:

Everyone’s needs are different. When thinking about how you might access your pension, you should think about your income goals, your tax position, and keep in mind that some options require you to continue to manage your investments. Some people like to combine options. The main thing is to consider is how much you want to spend in retirement, as that has the biggest impact on how long your income might need to last.

I hope this video has been useful. If you want further information, we have got lots of helpful content on our website. We cannot give personal advice – so if you want to know what’s best for your personal situation, you should speak to a regulated financial adviser. If you’re 50 or over, you can also get help and information on your options from the free government service PensionWise.