Can I put 25% of my work pension in a Sipp and leave the rest

When I am 55, can I take my 25 per cent lump sum and put it in a Sipp, as this would give me access to many more investment funds than the handful available in my defined contribution work scheme?

I would prefer to keep my work pension going though so I can still put more money in and get employer contributions too. 

If this is allowed, would there be any tax implications?

Tanya Jefferies, of This is Money, replies: This might sound like a good idea but there are several obstacles to your suggestion, even if you are understandably frustrated with the fund choice in your work pension.

We asked a financial expert to explain.

Richard Harwood, financial planner at wealth manager Brewin Dolphin, replies: If it is broader investment options that you are interested in there are a few points to consider.

There are rules against ‘recycling’ pensions, which are meant to prevent people gaming the system to gain extra tax relief from the Government.

These rules are complex, but broadly speaking if you put more than £7,500 of your 25 per cent tax-free lump into a Sipp, HMRC could apply a tax penalty.

You don’t say how much 25 per cent of your pension would amount to, but if it is more than that it would not be worth starting to access your pension if your only reason for doing so was to put that money straight into a Sipp.

Meanwhile, the rules and practice of defined contribution pension schemes are somewhat complicated regarding whether you will be able to make a 25 per cent tax-free withdrawal from your pension and still carry on paying in to it afterwards.

So, the first thing you need to do is check what your scheme’s rules are to see if it even permits what you want to do.

If you were in a final salary scheme you would not be allowed to do this, as they are set up solely for retirement purposes, so when you take the benefits everything usually comes into payment and there is no mechanism to carry on funding it.

What else should you consider before starting to tap your pension?

Pensions can involve complicated rules with some plans being more appropriate than others for different people at different times of life.

It is possible to take a tax-free cash lump sum from a pension from the age of 55, and to start drawing on the rest or even take the entire amount, but it is worth thinking carefully about when and how best to do this to fund your retirement.

1. What do you want the money for?

Any tax-free cash taken is available for any purpose – though there are limits on recycling it back into a pension as explained above.

But usually, once it is taken the money will be outside a pension.

However, as funds in the pension are generally free from inheritance tax on death and grow tax free, there is usually little benefit in taking the funds until they are needed.

It is worth remembering that pension funds are there to provide for retirement when earnings stop, and taking tax free cash earlier does risk reducing living standards later in life.

2. How much do you want to pay into a pension in future?

It is possible to take a 25 per cent tax free lump sum and continue to pay into a pension at a level up to the lower of your earnings or £40,000 each year, and continue to get tax relief.

But you need to be careful because if you exceed that and start taking a taxable income, your future pension contributions are reduced to £4,000 per year – a limit referred to as the ‘money purchase annual allowance’.

You also need to remember the rules against recycling pensions explained above.

3. What kind of pension do you have and does it suit you?

There are different types of occupational pension plan. They offer the advantage of receiving free contributions to your pension from your employer.

Some people, particularly public sector employees, are members of final salary or defined benefit schemes which provide a guaranteed income at retirement but there is little flexibility around how that is paid.

Most people are members of defined contribution schemes, like the one you are in, which involve building up a fund that is invested to provide benefits at retirement.

Some of these offer greater flexibility or investment options, but that increased complexity usually comes at a cost.

Most are simple and also cheaper, but the lower cost of such schemes is often reflected in the investment options, as you have found when looking at what funds are available to you.

An employer will look to run the scheme in an efficient way so will not normally offer flexibility if it is inconvenient or adds cost.

The ‘default’ fund, which members automatically invest in unless they actively make other choices, often make higher risk investments for younger people, and investments that are likely to be less volatile for those approaching retirement.

These will generally offer a good way of accessing investments which are broadly appropriate to an inexperienced investor. 

What should you do now?

It might be worthwhile transferring some of the fund into a Sipp – subject to the caveats I explained at the start – but probably only if this allows for flexibility that you would use.

This might include the ability to take retirement benefits or death benefits in a particular way, or improved returns from any different investments if they outweigh any additional costs.

So, before making any decisions I would suggest making sure that any of the advantages you expect are worth the costs. If in doubt, seek professional advice.