Are you approaching retirement and thinking of taking your pension lump sum?
Perhaps you fear the uncertainty of pensions and prefer having it safely in cash where you can access it quickly.
These are concerns I hear often and I want to make sure you are fully aware of all the facts before you make this irreversible decision.
Let me share with you 5 reasons why you may want to leave your lump sum inside your pension.
Brown’s lump sum from gold
For centuries gold has been seen as something of value
There is only so much of the precious metal available around the world and therefore during times where demand for it is high, the price of gold will rise.
Many investors will hold gold as part of their investment portfolio.
During turbulent economic times people will flock to buy gold as they prefer hard assets rather than paper money which can be manipulated by governments.
Governments around the world are actually some of the biggest holders of gold.
During the period 1999 to 2002 the then Chancellor Gordon Brown took the decision to sell half of the UK’s gold reserves. It was a decision many believe was a catastrophe.
The price of an ounce of gold at the time was $282.40. This was the bottom of the market, the lowest price of gold for 20 years and led to some calling it ‘Brown’s Bottom’.
What’s happened since the sale? Gold has risen in price to $1,240.50 per ounce (at time of writing) and the UK government has missed out on an extra $7 billion.
The government at the time had said the decision was taken to diversify the UK’s assets and not be so reliant on gold. But you have to wonder, did Mr Brown see the huge lump sum that could be received from a sale instead of the long term potential of holding on?
Withdrawing your pension lump sum
When it comes to the pension lump sum you may be faced with a similar conundrum.
When you retire you may be able to withdraw 25% from your pension as a tax free lump sum. The size of this lump sum is likely to be significant and therefore it may feel reassuring to take this out of your pension and secure it.
But by withdrawing your pension lump sum straight away you could be giving up much larger future returns and more importantly lifestyle choices.
You see there is no rule saying you have to withdraw the lump sum in full from your pension on retirement, particularly if, when choosing the best investments for retirement, you opt for pension drawdown rather than an annuity.
In fact in the majority of cases it is going to be far more beneficial to leave the lump sum inside your pension.
5 reasons to leave your lump sum inside your pension
#1 – You may not actually need the lump sum?
Are there large one-off spending commitments you need to make as you start retirement?
Things like a holiday of a lifetime or home improvements perhaps?
If there is, then you may not need your entire lump sum to fund these, you may just want to take out some of your lump sum.
If there isn’t, then why take the lump sum out?
#2 – Taking the lump sum out and leaving it in cash is a guaranteed way to lose money
It may feel more secure to get the lump sum out of your pension and into a bank account but remember you would be taking it from a product that is invested in the stock market to a product (savings/current account) that will only earn interest.
Over the long term the average return from stock market equities is around 5%. For cash interest rates it’s 1%.
If we take a lump sum of £100,000, after 10 years that’s a potential £52,427 extra if you had decided to keep it invested rather than have it in cash.
The other downside to holding money in cash is that the returns generally don’t keep up with cost of living increases.
So even if you take out your lump sum and put it in a bank account to use as ‘income’ (e.g. £100,000 = £10,000 withdrawal per year for 10 years), the money is going to be worth far less in the future in real terms.
#3 – You can take out your lump sum bit by bit
You don’t need to take out your pension lump sum in full. You can use it as part of your regular income withdrawals.
For example, as the Personal Allowance is currently £11,850, you could take out £11,850 as taxable income from your pension (but not actually pay any tax as it’s within your Personal Allowance) and use some of your tax free lump sum to top it up.
You can even set up your pension withdrawals so every monthly payment is 75% taxable and 25% tax free lump sum.
#4 – Once you take out your entire lump sum it’s gone
Once you’ve withdrawn 25% of your pension as a tax free lump sum any future withdrawals will be taxable. Therefore if you leave money in a pension for the long term and use pension drawdown you are limiting your future options.
If your circumstances change in the future you will no longer have the option to withdraw a tax free lump sum and may be be forced to make a large taxable withdrawal instead. This taxable withdrawal could mean you end up losing half to tax!
#5 – A pension is a fantastic tax wrapper
A pension is one of the most efficient tax wrappers out there.
Your money grows tax free inside a pension (no Income Tax or Capital Gains Tax) and better still, it is not usually subject to Inheritance Tax.
So the longer you can leave money inside a pension, the more you can pass to your family tax free on your death.
By taking out a large lump sum and putting it in something else like a bank account or even a stocks and shares ISA, you are bringing the money back into your estate and liable to Inheritance Tax.
So think very carefully before you make the decision to pull the lump sum out of your pension. If you genuinely need the money for spending then no problem. But if you are not going to spend the lump sum, it can work far harder for you by remaining inside your pension.
I wonder if Mr Brown regrets his lump sum decision?
QUESTION: What makes you want to withdraw your lump sum from your pension? I’d be happy to listen to any concerns you have and help where I can. Please contact me.
Risk warning:
Stock market linked investments and any income from them, can fall as well as rise and is not guaranteed. Any figures quoted are for illustrative purposes and should not be taken as a forecast or guarantee. Past performance should not be seen as an indication of future returns and clients may get back less than they have invested.
