Tom Lenton talks pension lump sums
There’s still a lot of uncertainty around the financial marketplace, and no-one really knows what the future will look like. To help try and make sense of it all, we thought it’d be useful to ask Tom Lenton, one of our directors, to answer a series of questions on a particular topic. This month it’s all about pension lump sums.
There’s a temptation to just withdraw it all and pay debts, buy a car, or go on holiday. Is this something you’d advise?
‘Paying debts, such as credit cards, loans and mortgages can be a good use of your lump sum. It could mean you’ll be debt free in retirement, and also avoid potentially high interest on credit cards and short-term loans and so on. However, you do need to be wary of how long your pension savings will last in your old age. The saying “once it’s gone, it’s gone” is never truer, especially if you don’t have other pensions or savings.
‘Money inside your pension can be more tax efficient if you don’t need it and means it’s outside of your estate for inheritance tax purposes in the event of your death. If you don’t need the money and don’t have any immediate need to spend it, then leaving it in the pension is probably the right thing to do.’
Do I have to take the 25% in one lot, or can I take it in chunks?
‘You don’t have to take it in one go, so you have the option to take it in smaller amounts, but the maximum amount you can take remains at 25%. By staggering when you take your lump sum, you do have the potential advantage that if the pension fund grows, the amount you get might be bigger over time. Obviously, the opposite can also be true, so you always need to think about which way will be best for you.’
Can I leave it where it is and not take any of the tax-free lump sum?
‘Yes, you can leave your pension where it is. There’s no requirement for you take the lump sum if you don’t want or need to. As I’ve said above, your pension sits outside of your estate for inheritance tax purposes, so in the event of your death before the age of 75, it would be paid to your beneficiaries’ tax free. After the age of 75, any beneficiary would face tax at their marginal rate of income tax on any benefits taken.’
Can I reinvest the lump sum once I’ve withdrawn it? And would I pay tax if I do that?
‘You can’t reinvest the tax-free lump sum in another pension and get tax relief. This is known as pension recycling and is illegal. However, you can reinvest your lump sum in other investments, such as ISAs which are tax efficient in terms of growth. There’s no tax on any future withdrawals either, so they can be a great way of getting future tax-free income.
Can I keep working (full or part-time) and still take my lump sum tax-free?
‘Yes, you can continue to work and even continue to contribute to your pension after you’ve taken your tax-free lump sum. You must be over the age of 55 to access your pension. Be aware though, that if you take even £1 of taxable income over and above the tax-free lump sum, you limit the amount you can contribute to a pension to £4,000 per year.’
Can I take multiple lump sums from different pension pots?
‘Taking money from a pension is very flexible nowadays. You can take up to 25% of all your defined contribution pensions up to your lifetime allowance of £1M tax free. It doesn’t matter whether this is in one pension or multiple pensions - it’s 25% of the total.
‘Any withdrawals over and above the tax- free lump sum (also known as drawdown), as either a one-off lump sum, an annual withdrawal, or a monthly amount, will be added to your income for that tax year, and taxed at your marginal rate. It’s now possible to take withdrawals as a combination of tax-free and taxable income.'
Hopefully, you found this useful. If you need any more info, or would like to talk to Tom about your pension lump sum or tax situation, please get in touch. Also, keep an eye out for future subjects and please let us know if you’d like us to talk about anything in particular.