DB Reduction, Tax-Free Cash and the MPAA
Alan, 59, earns £95,000 as a higher-rate taxpayer. He has a defined-benefit scheme promising £28,000 a year at 65 and a defined-contribution pot of £420,000. He wants to stop work at 60 and needs £45,000 gross a year until State Pension age 67, then £38,000. He holds £80,000 in ISAs and £25,000 cash. The DB scheme's early-retirement factor at 60 is 0.82. He has unused annual allowance from the previous three years and has never taken pension benefits. He plans to take £100,000 tax-free cash from the DC pot at 60, move it to an ISA, and draw £30,000 a year from the remainder. He also wants to contribute £40,000 from this year's bonus to the DC pot. His wife Sue, 57, has a small DB pension. Alan worries about running out of money and about triggering the money purchase annual allowance.
1. Assess whether Alan can afford to retire at 60. Show the income gap and the main risks.
Read the worked answer
Alan's DB pension at 60 is £28,000 × 0.82 = £22,960. Against a £45,000 gross income need, the gap is £22,040 a year for seven years to State Pension age. The DC pot is £420,000; taking £100,000 tax-free cash leaves £320,000. Drawing £30,000 a year is a 9.4% withdrawal rate, which is not sustainable over a possible 30-year retirement. If he draws only the £22,040 gap, the rate is 6.9%, still high but manageable with the ISA and cash.
From 67, State Pension of, say, £11,500 plus DB £22,960 gives £34,460, leaving a £3,540 gap to £38,000. The long-term position is therefore not as alarming as the £30,000 drawdown suggests. The permanent cost of retiring at 60 is £5,040 a year (the difference between £28,000 and £22,960). If he deferred the DB to 65, he would need to bridge £22,960 a year for five years (£114,800) from the DC pot; the extra £5,040 a year would take about 23 years to repay, so deferral is not automatically better.
Conclusion. Retirement at 60 looks feasible, but not with a £30,000 drawdown. He needs a 3.5–4.5% withdrawal policy, a two-year cash reserve, inflation stress testing and a review of the mortgage and emergency fund. The DB statement and State Pension forecast are essential.
2. Evaluate Alan's proposed £100,000 tax-free cash and £30,000 annual drawdown, including MPAA and annual allowance.
Read the worked answer
The £100,000 tax-free cash is within the 25% limit (£105,000), but moving it to an ISA is not immediate: the ISA allowance is £20,000 a year, so £80,000 would sit outside the ISA unless spent. That may be acceptable if it is held in short-dated gilts for spending, but it should not be assumed to be tax-sheltered.
The critical sequencing issue is the money purchase annual allowance. Taking only tax-free cash does not trigger the MPAA. Taking £30,000 of taxable drawdown does, reducing future DC contributions to £10,000. Alan's £40,000 bonus contribution should therefore be made before any taxable drawdown, using carry-forward if available. The annual allowance is £60,000; his £95,000 salary supports a £40,000 gross personal contribution, and higher-rate relief is available because the contribution extends his basic-rate band. If he triggers the MPAA first, the £40,000 contribution would be limited and could create an annual allowance charge.
He could instead use the ISA and cash to fund the early years and delay taxable drawdown. That preserves the MPAA and lets the DC pot grow. The £30,000 drawdown plan is too rigid; a flexible withdrawal policy using UFPLS or FAD should be modelled. The tax-free cash should be taken only as needed, not all at once.
3. Recommend a sequencing and tax strategy for Alan's first five years of retirement.
Read the worked answer
Before 60. Contribute the £40,000 bonus before any taxable pension withdrawal, check carry-forward and confirm relevant earnings. Do not trigger the MPAA unless the tax cost is understood. Keep the £25,000 cash as an emergency reserve.
At 60. Take the DB pension at 60 only if the cash-flow model supports the permanent £5,040 reduction; alternatively, compare deferring to 65 and bridging from the DC pot. Take tax-free cash in stages rather than £100,000 at once, and subscribe £20,000 a year to the ISA. Use the £80,000 ISA and cash as a bridge so that taxable drawdown is kept below the higher-rate threshold. The DB income already uses the personal allowance, so drawdown is taxed at 20% up to £50,270.
Withdrawal policy. Draw only the £22,040 gap, not £30,000. Use UFPLS if a 25% tax-free element on each withdrawal is useful; use FAD if he wants a tax-free lump sum and flexible income. Hold two years' spending in cash and short-dated gilts. Review annually against inflation, investment returns and longevity. Check State Pension forecast and NI record. If health is poor, deferring the DB may be less attractive; if longevity is expected, the DB reduction is more costly. The strategy should be written down with review triggers.