Can I take 25% tax free but leave one pension intact?

I have a final salary pension that will pay £37,000 a year from when I plan to retire and a separate defined contribution pension, from another company, that will be worth approximately £290,000.

I understand the total pension value of these to be a simple calculation of £37,000 x 20 years + £290,000 = £1,030,000, so below the lifetime allowance of £1,073,100.

But, is it possible to take 25% off the value total and keep the final-salary pension intact?

Money question: How can I get 25% off my retirement savings without paying taxes?

Are the 25 percent tax-free allocations limited to individual pension pots or can they be taken from all combinations of pots?

Put simply, can I take £257,500 from the defined contribution pension tax free and leave the final salary pension to pay out as usual?

If so, then why not? And should this be allowed, as it would penalize people with money spread among pensions?

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Steve Webb replies: It is crucial to distinguish between the tax-free access rules of any pension scheme and how the lifetime allocation (LTA), is calculated for tax relief.

For reasons that I’ll explain, you cannot use LTA calculations to bypass the rules for individual pensions.

You can start with your pension ‘pot money’, defined contribution. As such you have the right to 25 percent of it tax-free.

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You can change the value of your defined contribution pot, so the 25 percent is computed at the moment you decide to withdraw your money.

Referring to your salary-related pension (defined benefit), you can presumably take it all as either a regular pension (lower pension) or as an accumulated lump sum that is tax-free.

The size of the lump sum that is exempt from tax will vary depending on how the pension scheme converts regular income into tax-free cash.

The calculation you have done for your defined benefit pension is to work out 20 times your annual pension (20 x £37,000 = £740,000).

Here’s how it works for valuing your pension in relation to the LTA. But you cannot infer from this that your defined benefit pension lump sum will be 25 per cent of £740,000.

Different defined-benefit pension plans calculate lump sums differently, so you will need to determine what combination of regular pension and lump amount is available for you.

It is not possible to consider your tax-free money and separate your other plans together.

Fundamentally, this is because each scheme (described benefit or defined contribution), exists alone and is subjected to a set rules (such the 25 percent cap on tax-free money).

Even though the LTA lumps them together in order to assess if you’ve received too much tax relief, each scheme can be administered independently and is subject to its own rules.

The administration of the scheme would become extremely complicated if each member could be allowed to take a specific amount of cash tax-free, based on their unique circumstances and not a percentage.

You may not realize that you have more options in your defined-benefit plan. Some defined-benefit schemes allow you to adjust the amount of your pension that you can take out as cash tax-free (up to 25%).

As an example, you might take a pension with a lower rate and draw taxable cash regularly from your remaining defined contribution fund to supplement the income.

This would allow you to have both tax-free cash and a regular, taxable income of the level that you desire (also from both the schemes).

Although the tax laws don’t permit you to do what you want, the combination of the flexibility offered by defined-benefit members and defined-contribution pensions may allow you to flex your entitlements so that they can help you achieve your goals.