When you decide to tap into your pension, there’s often an option to take the pension tax free as a lump sum. While this might appear as an appealing method to finance your early retirement aspirations, there are crucial considerations you should ponder beforehand. Accessing your pension is generally permissible from age 55, with an increase to 57 slated for 2028. Typically, you can withdraw up to 25% of your pension without incurring Income Tax.

Having the opportunity to access a pension tax-free lump sum to jumpstart your retirement could enable you to accomplish significant objectives, such as clearing your mortgage or embarking on world travel. However, it’s important to note that withdrawing a tax-free lump sum may not always be the most prudent course of action.

Read on to find out some of the key things you may want to weigh up first.

3 vital questions to answer before you take a lump sum from your pension

1. How would withdrawing a lump sum from your pension affect your long-term income?

Your pension may serve as a primary source of income throughout your lifetime. Consequently, comprehending the enduring consequences of extracting a significant portion of your savings when you commence retirement is of utmost importance.

Aside from diminishing the overall size of your pension fund, your savings are typically invested. Opting for a lump sum withdrawal from your pension could disrupt the accuracy of projected long-term growth. Consequently, the impact on your pension’s value may exceed your initial expectations.

To gain clarity on these matters, it’s advisable to assess your pension and retirement strategies. This evaluation can help you address questions such as:

  • Will withdrawing a lump sum from my pension result in a reduced retirement income?
  • Could a lump sum withdrawal hinder my ability to weather financial emergencies?
  • How long will my pension last after I’ve withdrawn a lump sum?

While withdrawing a lump sum may not necessarily jeopardize your long-term financial stability, a comprehensive financial review can instill confidence in your financial situation and alleviate retirement-related anxieties.

You may find that withdrawing a lump sum doesn’t harm your long-term financial security. Yet, reviewing your finances may still be valuable. It could mean you feel confident about your finances and reduce anxiety about your security in retirement.

2. How and when will you spend your pension tax-free lump sum?

Before you withdraw money from your pension, considering how and when you’ll use it may be important.

A survey from Standard Life, suggests retirees spent or expect to spend a third (32%) of their tax-free lump sum within the first six months of taking it. This may seem sensible, but those with large sums sitting in a savings account could be missing out.

Despite the fact that interest rates are on the rise, they often remain below the inflation rate. As the prices of goods and services escalate, the purchasing power of your savings diminishes. Consequently, if your interest rate falls below the inflation rate, your savings effectively lose value.

In contrast, pensions are typically invested with a focus on long-term growth. While returns are not guaranteed, leaving your funds invested within your pension could result in genuine, inflation-adjusted growth.

Therefore, if you don’t have immediate plans for utilizing your tax-free lump sum, it’s worth contemplating whether your money would be more advantageous if it remained invested within your pension.

Furthermore, it’s important to note that you aren’t obligated to withdraw your tax-free lump sum as a single, substantial sum. Alternatively, you have the flexibility to spread it across smaller withdrawals, potentially aligning better with your specific financial needs and objectives.

3. Is Inheritance Tax something you need to consider?

While you may only just be thinking about retirement, it’s often a good idea to consider your estate plan too. If your estate could be liable for Inheritance Tax (IHT), leaving more of your wealth in your pension could make sense.

Typically, pensions are considered outside of your estate when calculating IHT. By leaving your pension to loved ones, you could reduce or mitigate how much IHT your family may pay when you pass away.

According to separate research from Standard Life, 18% of over-55s do not plan to access their tax-free pension cash specifically so they can pass on more to loved ones. Yet, it could be something many people are overlooking – almost 3 in 10 people said they didn’t know a pension could be a useful option when estate planning.

If the entire value of all your assets, from property to savings, is below £325,000 in 2023/24, your estate would not be liable for IHT as it is below the nil-rate band. Many individuals can also often use the residence nil-rate band, which is £175,000 in 2023/24, if they leave their main home to direct descendants.

As a result, your estate’s value could be up to £500,000 before IHT is due. You can also pass on unused allowances to your spouse or civil partner to make estate planning as a couple more effective.

If your estate could exceed IHT thresholds, considering how you may use your pension to pass on wealth might be valuable.

Remember, your pension won’t usually be covered in your will. While not legally binding, you will need to complete an expression of wishes for each pension you hold to state who you’d like to receive it when you pass away.

Do you have questions about accessing your pension?

The decisions you make when accessing your pension could affect your financial security for the rest of your life. Seeking advice could help you better understand your options and what you may need to consider when making decisions.

Please contact us to arrange a meeting to talk about your retirement plans.

Please note: This blog is for general information only and does not constitute advice. The information is aimed at retail clients only.

A pension represents a prolonged investment typically inaccessible until the age of 55 (or 57 starting in April 2028). The value of the pension fund can experience fluctuations, potentially leading to a decrease, which in turn may affect the amount of pension benefits obtainable. It’s important to note that past performance does not serve as a dependable predictor of future outcomes.

The tax implications of pension withdrawals will be based on your individual circumstances. Thresholds, percentage rates and tax legislation may change in subsequent Finance Acts.

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