Pensions: What will you do with your tax free lump sum?

27/10/11
Annuities

How do you intend to spend yours?

We are of course referring to the tax free lump sum from your pension. In our experience most people take the tax free cash from their pension, but what do they do with it?

The options are almost limitless but some seem far more popular than others, we’ve done a quick poll of our advisers and put together a list of what we think are the most popular ways of spending, saving or investing the tax free lump sum from your pension.

1. Save

This is probably the most popular option, particularly amongst those people who do not want to commit their capital to any of the other choices or indeed simply want to build up a ‘rainy day’ fund.

The problems are the same though whether you are saving your pension lump sum or indeed any other money, namely high inflation and low interest rates.

Using Cash ISAs (Individual Savings Accounts) can help as the interest is tax free and inflation linked accounts may have a place, however at least for now, savers need to accept that they are unlikely to get an inflation beating return.

2. Spend it

Spending the tax free lump sum on large items is still very popular.

Sometimes these are necessary purchases, perhaps replacing a roof or buying a car to replace the company car which has gone back.

However, we still see clients spending their tax free cash on more exciting luxury items such as a special holiday or home improvements, we’ve also seen clients indulge their passions and hobbies, one client even bought a small boat!

For many people the tax free cash is the largest amount of money they will receive as a lump sum, it can therefore be tempting to spend it, obviously this means it is not available for other purposes, but then again, you only live once!

3. Repay debt

Not as exciting as a round the world trip, new car or even a boat, but sometimes extremely necessary.

With the failure of many Endowments to meet their targets and the rise in interest only mortgages we have seen some people use their tax free lump sum to repay the remainder of their mortgage.

We have also seen people use the lump sum to repay unsecured debt, such as credit cards and personal loans.

Repaying debt frees up income in retirement, which would otherwise have been used on monthly repayments and where unsecured debt is concerned the interest rate payable is likely to be higher than the return you would get from a savings account.

4. Use it to supplement income

As Annuity rates fall and inflation rises using the tax free lump sum to provide an additional income stream is becoming more popular.

There are a number of ways to do this, for example a deposit account could be used to provide a monthly income, however interest rates are at all time lows and in almost all cases the interest rate on a savings account is below the rate of inflation, meaning a loss in real terms.

The money could be invested rather than saved, in the hope that stocks and shares will produce a better return than savings accounts. Over the long term this will probably be true, but the short term fluctuations can be unnerving for some.

One often overlooked option is a Purchased Life Annuity (PLA), which provides a guaranteed level of income, and can include all the options normally available on a traditional Annuity. However a PLA benefits from preferential tax treatment, meaning not all of the income is subject to tax.

In times of high inflation, low interest rates and volatile stock markets a PLA is worth considering.

5. Invest

Whether it is for income or growth and despite stock market volatility we are still seeing people invest their tax free lump sum.

As inflation rises and interest rates stay so low we are seeing a number of people take the step of investing rather than saving, as they look for greater returns.

Of course investing comes with more risk and this needs to be factored in, but it is still a very popular option.

6. Gifts

Since the economic downturn started in 2007 the calls on people’s capital have never been greater.

As interest rates fall more money is needed to produced the same amount of income, and more income is needed as inflation rises.

However, you may still want to help out your children or indeed grandchildren as they are hit by the tough economic times.

Perhaps you want to help your children out because they have been made redundant or grandchildren may need help with the costs of university or a house deposit.

As the tough times continue we can certainly see more tax free lump sums being gifted to other family members.

Our team of Independent Financial Advisers here at Investment Sense don’t just arrange Annuities we can also help guide you through the options for your tax free lump sum.

If you would like to talk to one of our advisers about your tax free lump sum they can be reached on 0115 933 8433 or emailed at info@investmentsense.co.uk