Can you afford to take a lump sum out of your pension?


Are you thinking about withdrawing a lump sum from your pension? Whilst it can be an attractive option, it’s important to remember that a pension is designed to provide you with an income throughout retirement. Before making a withdrawal, you should ask yourself:

  • Would taking a lump sum now affect the lifestyle you can comfortably afford?
  • Could it mean you run out of money during retirement?

Taking a lump sum from your pension

Once you reach the age of 55, your pensions will be accessible. You’re free to choose how you want to access your pension and when. However, you can take a lump sum, usually up to 25% tax-free. As a result, accessing a portion of your savings by withdrawing a lump sum can be attractive.

There are many reasons why a lump sum can be useful. It may help you pay off debt, such as your mortgage, so you’re able to enjoy retirement debt-free. Alternatively, you may want to use it to kick-start retirement plans, such as travelling more or undertaking big changes to your property. But could it put your financial future at risk?

The impact of withdrawing a lump sum

It can be difficult to fully understand how taking a lump sum from your pension now will have an impact over the long term. But it can be significant for several reasons.

First, taking out a lump sum will obviously mean you have less in your pension to provide a retirement income. It could mean your pension savings fall short. You’ll need to consider your annual expenditure and life expectancy to get an idea of whether withdrawing a lump sum could affect your financial security or if compromises will need to be made.

One key issue here is that many people underestimate how long they’ll live for. Whilst average life expectancy can be a useful indicator, thousands of people exceed this every year. It’s now not uncommon to spend 30 or even 40 years in retirement. It may mean your pension needs to stretch to provide you with the income needed.

Second, pension contributions are typically invested. As you can’t access the money, investment returns are invested so you benefit from compound interest. This helps your savings to grow at a faster pace. Taking out a lump sum means your expected investment returns will fall too. Taking a lump sum at 55, when you don’t intend to retire for another ten years, means missing out on investment returns.

Using cash flow modelling to understand your choice

Working with a financial planner can help you understand the short, medium and long-term impact of your decision to take a lump sum from your pension.

Using cash flow modelling tools, we’ll help you visualise how your wealth would change. Inputting a variety of information, such as expected investment returns on your pension and the point at which you want to make a withdrawal, our goal is to demonstrate the consequences.

Whilst incredibly useful, it’s important to note that the outcomes modelled through cashflow planning tools can’t be guaranteed. The results are reliant on the information that’s input, as well as making certain assumptions.

Often, we find that retirees are in a better position than they first thought. For some, taking a lump sum out of their pension will mean achieving dreams now and still having the retirement lifestyle they want. However, cashflow planning can also indicate where compromises may need to be made. If withdrawing a lump sum means receiving a lower income throughout retirement and lowering spending, would you still choose to do it? Financial planning provides you with the information needed to make informed decisions about your finances.

Financial planning is also an opportunity to explore alternative options. Let’s say you want to use your tax-free lump sum to fund a trip of a lifetime. It may make far more sense financially to use your savings or other investments instead when you look at long-term growth and financial security.

If you’re thinking about taking advantage of the tax-free lump sum, please get in touch. We’ll help you see what options are available to you and the pros and cons of each.

Please note: A pension is a long-term investment. The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available. Your pension income could also be affected by the interest rates at the time you take your benefits. The tax implications of pension withdrawals will be based on your individual circumstances, tax legislation and regulation which are subject to change in the future.