Keywords: pension, tax-free lump sum, retirement, income, investment, financial advice, scams
Introduction
With the cost of living rising and many people struggling to make ends meet, the temptation to take a 25% tax-free lump sum out of your pension at 55 can be strong. However, this decision should not be taken lightly as it can have a significant impact on your future retirement income.
This guide will help you understand the key factors to consider when deciding whether to take your tax-free pension cash at 55. We will also provide information on how to get professional financial advice and avoid pension scams.
Taking Your Tax-Free Cash – The Rules
Under current rules, you can usually take a 25% tax-free lump sum from your defined contribution pension once you reach the age of 55. However, different pension schemes can have different rules, so check with your provider to see at what age you can start taking retirement benefits from your pension.
The minimum age at which you can start taking benefits from your private or workplace pension is expected to increase to 57 in 2028 when the State Pension retirement age increases to 67.
You don’t have to take the full 25% at once if you don’t want to. You might decide, for example, that you want to take less than this, or that you don’t want to take any money just yet as you’d rather leave your pension savings to benefit from investment growth for longer.
Consider the Impact of Taking a 25% Tax-Free Lump Sum from Your Pension
There are several things to consider if you’re thinking about taking a 25% tax-free lump sum from your pension:
- What should I do with my tax-free pension lump sum?
You can spend your tax-free pension cash on whatever you want, with some people choosing to use the money to pay off a mortgage or clear other debts. However, if you don’t have an immediate need for the money, think carefully about whether you may be better off leaving it to grow tax-free – although of course as your money is invested there’s always a risk it could fall in value.
- You don’t have to take the 25% tax-free lump sum all at once
There are lots of different ways to take your pension, so you can take your tax-free cash in stages if you want to. For example, if you had a £20,000 pension, you may decide to take £3,000 of tax-free cash and then use £15,000 to buy an annuity, or income for life. You can find out more about how annuities work in our guide Annuities explained. You might then choose to leave the remaining £2,000 invested. Hopefully this would grow over time, boosting the value of the tax-free cash you’ve yet to take. At a later date, you might opt to take the remainder of your tax-free cash. Any withdrawals you make after this would be taxed as income.
- It could affect your entitlement to benefits
Your pension income will be taken into consideration when you’re assessed for means-tested benefits such as tax credits, Universal Credit and housing benefit, so think carefully about the impact that taking a lump sum could have on these and find out whether it will reduce your entitlement.
- The more you take out now, the less you’ll have later
Although a cash lump sum might be tempting, remember that the more you take out of your pension now, the less you’ll have to fund your retirement in years to come. It can also have a compounding effect, as the smaller your pension pot at the start, the less you will benefit from any growth in the value of your investments too.
Options for the Rest of Your Retirement Pension Savings
If you decide to take 25% lump sum cash out of your pension, you’ll then need to think about what to do with the rest of your retirement savings.
There are three main options:
- Leave your pension invested in an income drawdown plan
This means the rest of your pension can continue to benefit from investment growth and you can take money from it in the form of an income, as and when you need it.
- Use it to buy an annuity, or income for life
An annuity is essentially a contract with an insurance company – in return for handing over some or all of your pension, they will provide you with a guaranteed income for the rest of your life or for a set period.
- Cash in your whole pension
If you’re considering cashing in your whole pension remember that only 25% will be tax-free and you’ll have to pay tax on the rest. This could push you up a tax bracket, so you’ll need to understand how much tax you’re likely to have to pay. You’ll also need to think carefully about how you’ll use the money to provide you with an income in retirement.
Getting Advice on Your Pension
Pensions can be complicated, so if you’re not sure how to proceed, it’s worth seeking out professional advice. If you’re 50 or over and have a defined contribution pension, you can get free guidance on the options available to you from the Government’s Pension Wise service. However, if you want personal recommendations or advice about your specific circumstances, you’ll need to seek professional financial advice.
Can I Take a 25% Tax-Free Lump Sum from My Defined Benefit or Final Salary Pension?
If you have a final salary or defined benefit pension, you’ll receive a guaranteed income at retirement which is based on how many years you’ve belonged to the scheme and a proportion of your salary when you stop working. Some defined benefit schemes base your income on an average of your salary during the years you worked for your employer instead.
Withdrawing a lump sum from a final salary pension isn’t as straightforward as taking money out of a defined contribution pension, as this type of scheme isn’t as flexible. The amount you’ll be able to take as a tax-free lump sum from your defined benefit pension will usually depend on your particular scheme’s rules, which can vary widely.
Beware Pension Scams
If anyone promises that they can release your tax-free pension cash earlier than the age of 55, then this is likely to be a scam and you should report it to Action Fraud on 0300 123 2040. If you have any concerns about an offer that has been made to you concerning your pension, contact the Government’s Pensions Advisory Service helpline on 0300 123 1047.
If you do take money out of your pension before the age of 55, then HMRC will consider this as an ‘unauthorised payment’ and you’ll be hit with a hefty 55% tax charge on the savings you’ve withdrawn, along with fees from your scheme provider for transferring your pension.
It is only possible to access your pension savings before the age of 55 if you are suffering from a serious illness. If this is the case, talk to your pension provider directly who will advise you about your pension’s rules – it’ll depend on their definition of ill health as to when you can access your money.
Beware anyone who cold calls you about your pension or who says that you can release money from it before the age of 55 as this is likely to be a scam. Find out more about pension fraud and scams in our article Don’t let scammers steal your retirement.
Conclusion
Deciding whether or not to take your tax-free pension cash at 55 is a big decision that should not be taken lightly. There are a number of factors to consider, including the impact it will have on your future retirement income, your entitlement to benefits, and your investment goals.
If you’re unsure about what to do, it’s worth seeking professional financial advice. A qualified financial advisor can help you to understand your options and make the best decision for your individual circumstances.
Should I take out a tax-free lump sum from my pension?
There are several reasons why you might withdraw a lump sum of money from your pension that is tax-free. But just because you can start taking your PCLS at 55 doesn’t mean you have to. You could leave your pension to grow and take your lump sum later if you don’t need the money right now. On the other hand, you might never take it all and instead want to use the funds to increase your retirement income.
Paying off your mortgage and other debts in order to lower your retirement expenses is frequently at the top of the list of reasons to take a tax-free lump sum. Or perhaps you want to remodel your house or buy a new car.
If your plan is to simply transfer your tax-free pension funds into a cash ISA or savings account, you should reconsider. The benefit of cash savings is that they shield your money from stock market losses. However, because interest rates are still low, investing in your pension still has a higher potential for growth, though this is not guaranteed.
In the end, choosing to receive pension benefits is a personal decision, and there are a variety of factors that may affect which option is best for your particular situation. To make sure you make the right choice based on your retirement needs, you might want to consult a financial adviser.
How can I take my pension tax-free lump sum?
Generally speaking, you are not required to take your PCLS in full at once. It is possible to take it as a series of smaller sums until you reach your 25% limit. But, you can only access your tax-free money at the “crystallization” point, which is when your pension is accessed to pay retirement benefits. To put it another way, this occurs when you’re about to drawdown or buy an annuity.
You can use the so-called “uncrystallized pension fund lump sum” rules to obtain cash lump sums even if you’re not ready to do this. Here, you can take out as much cash as you need while keeping the remaining amounts in your pension. The distinction lies in the fact that the first 25% of each withdrawal is paid tax-free, while the remaining amount is subject to tax at your individual rate.
Your pension provider sets the rules if you have a defined benefit or final salary pension. To find out whether the plan permits tax-free cash withdrawals and how much they might be, you will need to get in touch with them.
Should You Take Your Tax Free 25% Pension Lump Sum at 55?
FAQ
Should I take pension lump sum at 55?
Is it better to take a lump sum or monthly pension?
How do I avoid taxes on a lump sum pension payout?
Does tax free lump sum count as income?
Can I take a lump sum if I’m 55?
The exception is the 25% tax-free lump sum. The rules for taking this lump sum vary according to the type of scheme. You can take up to 25% of a defined contribution (DC) pension tax-free once you pass the age of 55 (rising to 57 in 2028). It’s more complicated if you have a defined benefit (DB) pension, also known as a ‘final salary’ scheme.
Can I take a lump sum from my pension at 55?
You can take a tax-free lump sum from your pension at age 55. Find out how to take a lump sum from your state pension, workplace pension or private pension.
What is a tax-free pension lump sum?
Here’s what you need to know about this rule. What is the tax-free pension lump sum? The pension commencement lump sum (commonly known as tax-free cash) is the amount of money available ‘tax-free’ as a lump sum after the minimum pension age, which is currently 55, rising to 57 in 2028.
Does a tax-free lump sum affect my personal allowance?
The tax-free lump sum doesn’t affect your Personal Allowance. Tax is taken off the remaining amount before you get it. Your whole pension is worth £60,000. You take £15,000 tax-free. Your pension provider takes tax off the remaining £45,000. When you can take your pension depends on your pension’s rules. It’s usually 55 at the earliest.