09/10/20Should you take a tax-free lump sum from your pension?

Your 55th birthday, rising to 57 in 2028, often marks being able to access your pension for the first time. The opportunity to take a 25% lump sum tax-free is certainly attractive and can be too tempting to resist but it is not a decision to take lightly and it is not the right move for everyone.

The ability to take a tax-free lump sum means that pension savings are becoming disconnected from retirement, research suggests. For many of us, retirement is still some way off at 55 and you may plan to work for many more years. Removing a quarter of your savings before you give up work could affect your long-term income.

Deciding when and how to access your pension is important. Despite this, a survey from PensionBee indicates thousands of over-55s are not fully considering the impact early withdrawals will make. In fact, almost half (48%) had not considered how they would manage throughout retirement.

So, what should you think about before you withdraw that lump sum?

1. Why do you want to take a lump sum from your pension?

According to the survey, just 3% of those considering accessing their pension did so because they were retiring or stopping work. A further 17% would use the money to cover day-to-day expenses and 9% would spend it on something special.

If those thinking about accessing their pensions are not planning to spend the money, why are they taking this step? Three popular responses suggest that for some, the reasons do not align with financial goals.

  • 32% worry about pensions falling in value
  • 20% would make a withdrawal so they would have more ‘control’
  • 12% said they simply felt a pressure to do something with it

What is the issue with these responses?

First, pensions are typically invested, and you should expect some short-term volatility. If you are worried about your pension losing value, it is important to focus on the long term. If you do not plan to use your pension as an income for several years, leaving it invested is likely to be most appropriate. It is also worth noting that if you choose to take a flexible income from your pension, the money you do not withdraw will usually remain invested. Speak to us if you have concerns about pension investments and market movements.

Second, you do have control over your pension investments. With a typical Defined Contribution pension, you are usually able to choose from several different investment funds to match your risk profile and goals. This is suitable for most pension savers. For some, a Self-Invested Personal Pension (SIPP) is an option to explore but this can be complex and you must be comfortable managing investments, we are here to provide guidance where needed.

Finally, do not feel under any pressure to make pension withdrawals just because you have turned 55. For most people, if you are not retiring, it makes sense to leave savings invested through a pension and continue adding to it.

2. What will you do with your tax-free lump sum?

The figures above established that relatively few people considering accessing their pension to withdraw a lump sum intend to spend the money. If you do plan to spend, you need to consider the long-term consequences first, which we will look at in the next point.

However, if you do not plan to spend the money, what are your options?

Placing the money in a savings account: Some responders indicated they intended to withdraw money to place it into a cash savings account. If you are nervous about pension values falling or want retirement savings to seem more tangible, this may be viewed as a ‘safe’ option. After all, market movements will not affect the lump sum withdrawn.

However, inflation will affect savings. Interest rates are low at the moment and while values will not fall because of investment performance, the value will decrease in real terms. That means over time your savings will buy less due to inflation.

Investing the money: If you are thinking about taking money out of your pension to invest it, remember your pension is likely already invested. Pensions are a tax-efficient way to save for retirement. Leaving your money invested in a pension and adding to it until retirement makes financial sense for most people. It is worth taking the time to understand how your pension savings are currently invested, the associated costs, and the long-term investment performance before you make any decisions.

3. What impact will it have on your retirement plans?

Over a third (35%) of people said they did not know how to find out how much they could expect to receive from their pension in retirement.

Before you make plans to make any withdrawals, it is essential you understand the value of your pension and how this will translate to an income. If you took the maximum 25% tax-free lump sum from your pension, that is a sizeable amount. Doing it while you are still in your 50s, with retirement perhaps several years away, means you are missing out on the investment growth of this sum too.

Making a pension withdrawal as soon as it becomes an option could mean your income is far lower during retirement. Would you still take a lump sum to spend now if it meant the 30 years you spend in retirement are less comfortable?

The key here is to understand what impact taking the tax-free lump sum would have. We are here to provide insight. We will help you to see what income your pension will provide if you take a lump sum now, taking it further down the line, or not taking it all, taking your retirement goals and plans into consideration.

If you are able to take a tax-free lump sum out of your pension and want to understand your options, please get in touch. We will help you see how removing a lump sum from your pension now will affect your income in retirement and how to make the most of any withdrawals.

Please note: This blog is for general information only and does not constitute advice. The information is aimed at retail clients only.

The value of your investment can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance. Your pension income could also be affected by the interest rates at the time you take your benefits.

Levels, bases of and reliefs from taxation may be subject to change and their value depends on the individual circumstances of the investor.