Take it or leave it? Pension commencement lump sum options
Guy Myles, 20 April 2017
Whether it's to invest in the house, the family, or that sports car you've always dreamed of, accessing the entirety of your tax-free Pension Commencement Lump Sum (PCLS) in one go can be a tempting option.
If you're approaching 55, or there already, it's important that you understand the impact of your choice to take or leave your lump sum. This decision is going to affect your retirement after all. If you're looking to access your cash, you'll need to know what options you have available. So, should you take it or leave it?
Pension Commencement Lump Sum: Pension changes
In the past, savers were able to take up to 25% of their pension pot tax-free but were forced to purchase an annuity to provide income in retirement. While this option is still on the table, since 6 April 2015, savers have been able to choose to keep their pension invested to continue to target growth, while drawing income down from their pot as and when they require. This is known as flexi-access drawdown.
The tax situation
Understanding the changes in pension policy can be confusing. The best way to compare options is to look at this in practice.
If at retirement you have a pension pot of £100,000 and decide to take your whole tax-free lump sum in one go, you'll receive a one-off sum of £25,000 tax-free. You would need to pay tax on the remainder of the pension when you access it, whether that is as cash, or as income received through a flexi-access drawdown product or annuity.
You'll be taxed on this money at your highest income tax band so it's very important to be aware of any other income tax you're paying that year. For example, if you are still in full or part-time work you are going to be using up some of your tax-free allowance already. By planning ahead you can ensure that your pension or annuity income isn't taxed more than it needs to be.
Taking cash in smaller chunks, in this situation, therefore could be a better option long-term.
What is the impact of taking all the lump sum tax-free cash in one go?
It can be tempting to access the tax-free lump sum in your pension as cash, as soon as it's available. Remember though, that's less money remaining to purchase an annuity or a flexi-access drawdown product. And that means a lower level of income likely from those products with which to support your retirement.
You can currently choose to take the lump-sum at any point after 55, but with flexi-draw down can choose when to take the income, deferring this until it's needed (when you give up work for example). Even with greater flexibility, by taking 25% you're reducing the amount you have left to invest, and to live on.
Pension Commencement Lump Sum: Decisions, decisions, decisions
Withdrawing money from a pension pot isn't as simple as just taking money from a current account for example. The money that you take will have an impact on your retirement planning as a whole and can involve some quite complicated calculations, and some important decisions about you and your life.
The decision to take a lump sum or not is down to you, but it's not the only option on the table.
The new pension freedoms have changed the way we approach financial planning in retirement. The freedom is great, but it means getting expert advice is important to understand what options are available, and the impact that your choices - to withdraw 25% tax-free as an example - will have on your retirement.