Should I take my tax-free pension cash at 55?

Let’s face it, if you’re 55 or over, the idea of being able to take out 25% of your pension tax-free is pretty appealing.

Just think of all the things you could do with the money – perhaps you’ve always wanted to travel the world, finally clear your debts, or make some much-needed home improvements?

But before you grab that tempting cash carrot, bear in mind that taking a big chunk out of your pension pot will have a big impact on your future retirement income, so it isn’t something you should enter into lightly.

Here we outline the things you need to consider, and how to get advice on your pension

Taking your tax-free cash – the rules

Under current rules, you can usually take a 25% tax-free lump sum from your 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 (there’s a 10-year gap between the minimum pension age and the State Pension age, so when the State Pension age rises, so does the minimum pension age.)

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

There are several things to consider if you’re thinking about taking a 25% tax-free lump sum from your pension:

What are your plans for the money?

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.

Depending on the level of interest you are paying on your debts, this might affect your decision on whether to focus on paying these off or leave the money invested in your pension. There are lots of different factors to consider, so you may want to seek professional financial advice to help you with your decision. For example, with best buy mortgage rates currently so low, you’ll need to weigh up whether, over the long term, the investments in your pension might be a better place for your money than paying off the mortgage. If however, you’re paying interest on credit cards at 20% or 30%, then it might be easier to argue that clearing those debts should be a priority.

You don’t have to take the 25% 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. 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.

Another option may be to take smaller regular amounts from your pension and opt for 25% of each of these payments to be tax free. So, for example, if you had a bigger pension pot and were to take £1,000 from it each month, £250 of this would be tax-free whilst the remaining £750 is taxable.

It could affect your entitlement to benefits

Your pension income will be taken into consideration when you’re assessed for benefits such as tax credits 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.

You’ll still be able to pay into your pension

If you just take your 25% tax-free lump sum, you can still pay in up to £40,000 a year into your pension and benefit from tax relief, known as your Annual Allowance, but as soon as you take out more than this, for example if you put your pension money into a drawdown scheme and you start to take income, or you’ve used it to buy an investment linked annuity where your income could go down, the maximum you’ll be able to pay into your pension each year will fall to £4,000. If you buy a lifetime annuity that provides a guaranteed income you’ll normally be able to retain your £40,000 Annual Allowance.

Bear in mind that there are rules which prevent you from taking your 25% tax-free cash and paying it into another pension – if you do this there could be both tax consequences and extra charges to pay. This area of pension planning can be highly complex and will almost always depend on your own personal circumstances, so it’s worth speaking to a professional financial advisor who can help you navigate this.

Find out more about tax relief in our article How pension tax relief works and pension allowances in our article Understanding your pension allowances.

Options for the rest of your retirement pension savings

If you decide to take a 25% lump sum 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. Annuity rates can vary widely, and therefore give you a very different retirement income from the same level of pension savings, depending on which provider you go to. This makes it essential to shop around for the best possible annuity deal and never just go with your existing pension provider.

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. You can find a local financial advisor on VouchedFor or Unbiased, or for more information, check out our guides on How to find the right financial advisor for you or How to get advice on your pension.

Finally, beware pension scams

If anyone promises that they can release your pension tax-free 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.

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