Should you take a lump sum from your pension?

A £20 note released from a padlock


MoneyPlus Features Team

14th December 2015 at 3:33pm

Is it really possible to take your pension as cash? The answer, for some pension investors, is yes.

New pension freedoms have made pensions become more flexible with the rules around small pension pots and how you can take your pension changing.

This new legislation has provided us with more options than any generation before us, which is a positive, however it could also give rise to more temptation than previous retirees have faced.

What’s changed?

As always you can take a quarter of your pension as a tax-free lump sum. Yet for decades most people have effectively needed to use the remainder of the money to buy an annuity – a product that pays you an income each year until you die. This is no longer the case.

Now, if you’re age 55 or over you can take all or part of your savings as cash.

This may sound attractive, but you should think carefully before you go ahead. It’s important to consider the impact of taking a lump sum, as it will deplete your retirement income.

Thinking of taking a lump sum?

If you’re thinking of taking a lump sum then it’s important to understand how this could work.

There’s different ways you can take cash but if you’re over 55 and:

  • your total pension savings are under £30,000 and/or;
  • you have individual pension pots under £10,000 each

You can usually take a whole pension pot worth up to £10,000 as a lump sum – 25% is tax free. This is called a ‘small pot’ lump sum.

You can get:

However, if it’s paid from more than one pension scheme, there’s a few rules to consider first – you must:

  • have your savings in each scheme valued by the provider on the same day, no more than 3 months before you get the first payment
  • get all payments within 12 months of the first payment

And if you take payments from a pension pot before taking the rest as a lump sum, you’ll pay tax on the whole lump sum.

You also now have the option to take your whole pension pot as cash in one go if you wish. The first 25% (quarter) will be tax-free and the rest will be taxed at your highest tax rate – by adding it to the rest of your income.

Your pension pot is £60,000. You take £15,000 tax-free. Your pension provider takes tax off the remaining £45,000.

Things to think about

Yes, you’ve now more options than ever, but before you do anything, there are some things you should really consider first:

Do you need the money now?

It’s a good idea to only take cash if you need it. Any money removed from your pot won’t have the same tax advantages so if you have money in other investments you could consider using that first. The more you take now, the less you’ll have in the future.

Watch your withdrawal doesn’t take you into the next tax band

Once you go over your tax-free cash limit you’ll pay income tax on the rest. You could end up paying more if your withdrawal added to any other income in that tax year takes you into a higher rate tax band. You may pay less tax if you spread out your cash withdrawals and keep below higher rate bands.

Payments into any pension could be restricted

Taking out more than your tax-free cash limit (when you start accessing taxable income) restricts the payments you or an employer can make to any of your pensions, normally to £10,000 a year. This can be a problem if you’re still earning and either have other savings you want to pay into a pension or if you intend to make significant payments into any of your pensions.

State benefits

Your entitlement to means-tested state benefits, if applicable, may be affected if you take cash or income from your pension – check this isn’t going to be a problem before going ahead.

And of course a big question you should ask yourself is…

What are you going to live on in retirement?

Taking cash from your pension savings now means there will be less to provide an income in the future. You’ll not only miss out on the cash you have taken but also any investment growth that you might have earned on that cash.

Take care

With new pension freedoms there may well be greater simplicity, choice and flexibility, but there is also now more decision making required. If you’re looking for more guidance then the Government’s Pension Wise service is a good first stop, and you can consult an independent financial adviser.

So make sure you’ve weighed up all your options, got the right advice if you need it, and make an informed choice before acting.

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The information in this blog or any response to comments should not be regarded as financial advice. A personal pension is an investment and its value can go up or down and may be worth less than you paid in. Laws and tax rules may change in the future. The information here is based on our understanding in December 2015. Your personal circumstances also have an impact on tax treatment.