Pension Freedoms arrived in 2015 and were predicted to bring about a so-called ‘dash for cash’ – retirees scrambling to take their pension pots as one-off lump sums with little thought for how long their pension income would last.
Since then, more than £33 billion has been taken out of pension funds as lump sums according to FT Adviser. The numbers taking benefits at age 55 (the earliest age a pension can usually be taken) have also increased – up 10% from the previous year according to FCA figures for 2018/19 reported in FT Adviser.
There are potential tax implications if you take retirement benefits early, and increasing life expectancies mean your retirement income will probably need to last longer than it would in the past. Here’s your guide to taking a pension lump sum responsibly.
You can access a lump sum ‘flexibly’
Pension Freedoms give you greater flexibility when choosing how to access your pension benefits.
The ‘traditional’ route – a Pension Commencement Lump Sum (PCLS), in conjunction with an annuity paid for life, is simple and gives you a regular income, but can be inflexible. You take up to 25% of your pension pot as a PCLS, paid tax-free, and the rest of the fund is ‘crystallised’ and used to provide your income.
Since 2015, you can access a pension lump sum in several other ways:
- As an uncrystallised funds pension lump sum (UFPLS) – This involves taking your pot as a lump sum, 25% of which is tax-free, with the rest taxed at your marginal rate.
- Flexi-access drawdown – You take up to 25% of your pot as tax-free cash and invest the rest to provide you with an income. The difference between this and a regular income is that you can choose when you take the income, making it more flexible.
- Small pot payments – If you have a pension pot with a total fund of less than £10,000 you can take it as a one-off lump sum, 25% tax-free with the rest taxed at your marginal rate. You can take up to three non-occupational plans in this way. There is no limit on the number of occupational schemes you can take as a small pot payment.
This increased flexibility has placed greater responsibility on individuals to manage their retirement funds. Pension income should last you for the rest of your life. So, if you want to take advantage of Pension Flexibility and receive a lump sum payment, how do you do it responsibly?
Benefits of accessing a lump sum
1. Access to a large amount of cash, quickly
Lump sums, especially a full pot UFPLS, have the benefit of releasing a large amount of cash in one go. This is great if you plan to go travelling or help towards a deposit for a child’s first house, for example.
2. You decide what you take and when
By taking flexi-access drawdown you control the amount of retirement income you take from your pot, and when.
Why might I opt not to take a lump sum?
1. You decide what you take and when
Having control over your retirement income is also a massive responsibility.
You will need to keep track of your remaining pension fund. Good retirement planning should allow your pension fund to outlive you (without leaving too much) whilst maintaining your desired standard of living and allowing you to put aside an emergency fund for unforeseen future expenditure.
The onus is on you to ensure you don’t run out of money.
Contact us if you’d like to discuss any elements of your current retirement plan.
2. Triggering the Money Purchase Annual Allowance
The MPAA is a cap on the amount you can contribute to a pension and get tax relief when you are already flexibly accessing pension benefits. It replaces the Annual Allowance of £40,000 with a reduced MPAA of £4,000.
It’s designed to stop the double benefit of getting tax relief on contributions and then tax-free benefits again at retirement. It also looks to stop people from getting a second round of tax relief by withdrawing savings and reinvesting them into their pension.
If you want to take a flexible option (especially early on in your retirement) you’ll need to consider whether you plan to continue contributing to a pension.
Small pot payments don’t trigger the MPAA. If you have several smaller pensions and are thinking about consolidating them, consider taking them as small pots instead.
3. You might push yourself into a higher tax bracket
Taking one-off lump sums from the whole of your pension pot could push you into a higher rate tax bracket. Since Pension Freedoms were introduced in 2015, the Financial Times states that ‘more than 170,000 savers have been overtaxed to the tune of £400 million’.
When you take a lump sum, HM Revenue & Customs will assume the amount is the first in a series of equal, regular payments. This is how their Pay As You Earn system works. But it means that on a lump sum of £10,000, you’ll likely be taxed as though your annual earnings are £120,000.
If you notice you’ve been overtaxed, you’ll need to fill in a form to reclaim the overpayment but the process can be time-consuming. If you have an amount set aside for a specific purpose, be sure to factor in the possibility of a greater tax charge than you’d bargained for,
If you’d like to discuss your retirement plans, please get in touch. Please email info@investmentsense.co.uk or call 0115 933 8433.
Please note
A pension is a long-term investment not normally accessible until age 55. 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. Levels, bases of and reliefs from taxation may be subject to change and their value depends on the individual circumstances of the investor.
