Pension tax free lump sum on retirement

I get a lot of questions around the pension tax free lump sum on retirement. Most people are aware they can take a tax free lump sum on retirement from their pensions but are unsure how much and how it works. This article aims to provide clarity.

Most pension schemes (not final salary pensions) will allow you to take up to 25% of the pension value as a tax free lump sum on retirement. Also know as the Pension Commencement Lump Sum.

The remaining 75% of the pension value will be subject to Income Tax. The rate of Income Tax you pay on further withdrawals will depend on what other income you receive at the time.

Final salary pensions are different. Most will still give you the option of a tax free lump sum on retirement however the amount will depend on the individual scheme rules.

Older style pensions may also give you more than a 25% tax free lump sum on retirement so you should always check this before transferring these types of pensions into newer schemes as you will lose this benefit on transfer.

What you should do to clarify your tax free lump sum on retirement

1. Write to all your pension providers and ask for the latest pension value, also ask them if you are entitled to any additional protected tax free cash.
2. Multiply the pension values by 25%, this will give you your total tax free lump sum entitlement.
3. Add any extra protected tax free lump sums and any lump sums from final salary pensions.

How and when should you use your tax free lump sum on retirement

#1 Age

• You don’t need to wait until you actually retire in order to access your tax free cash lump sum.
• You can access your pensions and begin drawing from them from age 55.
• Even if you are still working.

#2 All in one go or bit by bit

• You don’t need to take your tax free lump sum all in one go.
• You can take 5% of your pension, 10%, 20% or whatever percentage you like up to 25% tax free.
• You can keep making withdrawals tax free until the total amount you have withdrawn is 25%, then withdrawals become taxable.

#3 Do you need the tax free lump sum on retirement?

• Do you have any large debts that need paying off or particular expenditure that you have earmarked the lump sum for?
• If not then why take it out of the pension?
• Remember money invested in pensions is growing in a tax free environment and the longer you leave it the bigger your future tax free cash lump could be.

#4 The more pension you take as a tax free lump the less future retirement income you have

• The more you spend now the less you have for later so make sure you run forecasts to work out how much income you will likely need in future years.
• Don’t forget to factor in future increases in prices.

#5 Watch out for the Lifetime Allowance

• • There is a limit to the total amount of money you can save into pensions without facing a nasty tax charge. The current limit is £1 million.

• If your total pension ‘pot’ is worth more than £1 million then your tax free cash lump sum on retirement is limited to 25% of the current Lifetime Allowance e.g. £250,000.

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.