Taking tax-free cash from your pension

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MoneyPlus Features Team

21st February 2018 at 4:00pm

The good news is you can normally take a quarter of your pension savings free of tax, with the rest taxed as income when you take it any time from the age of 55.

The good news about taking tax-free cash from your pension

It’s great to think about getting a sum of money free of tax, to help you live the kind of future you want. Perhaps buying a new car or heading off on a fabulous holiday is on your wish list.

How and when you can take tax-free cash is one of the things people tell us they want to know more about when they’re thinking about taking their pension savings.

Our research shows that just over a third of our customers know how tax-free cash works.

Whether taking your pension is on your list, or you want to know more, there are a few things we’d encourage you to think about to help you make the most of your money.

A quarter of your pension is tax-free

The good news is you can normally take 25% – a quarter – of your pension savings free of tax with the rest taxed as income, from the age of 55.

“There are myths around tax-free cash we’d like to bust,” explains David Downie, our technical pension expert here at Standard Life.

Explore your options and look at ways to make the most of your money in retirement.

You can you take it right away, or take it later

You don’t have to take any or all of your tax-free cash. You can leave it as long as you want, still invested in your pension with the potential to keep on growing. Of course, your pension can go down as well as up, and you could get back less than you paid in.

“There’s one really important thing to consider,” continues David, “and that’s if you spend a quarter of your pension fund at once, how sure are you that you’ll have enough left to last you?

“The reality is more of us are living longer, with men likely to live until they’re nearly 80 on average and women almost 83*. And even if you don’t take your tax-free cash, you still need to take care not to run out of money.”

Make sure you have the flexibility to take tax-free cash when you want

Before pension freedoms arrived in 2015, taking all your tax-free cash first then buying an annuity was what most people did. Things are different now.

More people now take a flexible income when and how they want through pension drawdown.

When it comes to taking the tax-free cash, you don’t have to take it all at once. With us, you can usually take your tax-free cash first, in full, or in chunks when you want.

Some pension providers don’t let you take your money in such a flexible way.

Graphic showing ways of taking 25% cash from a £200,000.00 pension pot

Taking your tax-free cash in chunks could make your savings go further

“It means you can control how much of your pension income is tax-free and how much is taxable,” adds David Downie. “And it can make a real difference to how much tax you might pay in the long term. It could even make your savings go further.

“With a bit of planning to make the most of your allowances and tax bands, you could keep more of your savings. That’s because most people pay less tax in retirement, as their income is lower.”

You can take tax-free cash while you’re still working

It’s possible to take your tax-free cash and keep saving while you’re working, as long as you’re in a modern, flexible pension.

If you’re in a workplace pension that lets you do this, it could make sense for you to keep saving as you probably wouldn’t want to give up any employer contributions and that all-important tax-relief on what you pay in.

“But do be aware that if you take more than your 25% tax-free cash and take an income from your pension, how much you can keep saving tax-efficiently was recently cut to £4,000 each year,” continues David Downie.

We guide you through what this could mean for you in our Real-life Q&A: ‘Can I take tax-free cash from my pension and keep paying in?’

Busting the age myth: There’s no age limit

You can take tax-free cash at any age, once you reach 55.

But after age 75, if you die without taking it, what may have been tax-free might not be when it’s passed to your beneficiaries – they’ll pay income tax at the rate they pay.

Do think about inheritance tax

Many of us want to pass on our wealth to family and friends when we die, and your pension is great way to achieve this as it’s usually protected from inheritance tax.

But take your tax-free cash out of it and anything you haven’t spent is part of your estate no matter what age you are. And that could mean a 40% IHT charge and affect what your dependents get.

This might be more than the income tax they’d pay if you’d left your tax-free cash in your pension, so you need to weigh things up.

You can find out more about inheritance tax on Gov.uk.

Where you can get more guidance

We know there’s a lot to think about and how and when to take your tax-free cash depends on your circumstances.

It’s worth considering advice on this from your financial adviser if you have one. If you don’t, try unbiased.co.uk, or find out more about advice and financial planning on our website. Please note there is a cost for advice.

The Government’s free and impartial PensionWise has more information, as does our tax in retirement page.

Tax and legislation may change and the information here is based on our understanding February 2018 and shouldn’t be taken as financial advice.

Your own circumstances will have an impact on tax. A pension is an investment and you could get back less than you paid in.

*Office for National Statistics, September 2017.