Should you take your pension tax-free lump sum to kickstart retirement?

Published: September 7, 2023 by Jennifer Armstrong
An older couple hugging on a boat.

When you access your pension, you can often take a tax-free lump sum. While this may seem an attractive way to fund your early retirement plans, there are some essential things you need to consider first.

You can usually access your pension from the age of 55, rising to 57 in 2028. You can typically withdraw up to 25% of your pension without paying Income Tax.

Having access to a tax-free lump sum to kickstart your retirement could mean you’re able to tick off some large goals, such as paying off your mortgage or travelling the world. Yet, withdrawing a tax-free lump sum isn’t always the right step to take. 

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?

You may well need to rely on your pension to provide an income for the rest of your life. So, understanding the long-term effect of withdrawing a significant proportion of your savings at the start of retirement is essential. 

As well as reducing the overall size of your pension, your savings are usually invested. Taking a lump sum from your pension could mean that projected long-term growth is no longer accurate. As a result, withdrawing a lump sum could affect your pension’s value more than you expect.

Reviewing your pension and retirement plans first could help you answer questions like:

– Would taking a lump sum from my pension mean I have a lower income in retirement?

– Could withdrawing a lump sum affect my ability to overcome financial shocks?

– How long would my pension last after I withdrew a lump sum?

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 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.

While interest rates are rising, they are still below the rate of inflation. As the cost of goods and services rises, what you can purchase with your savings falls. As a result, if the interest rate is below the rate of inflation, your savings are falling in value in real terms. 

In contrast, your pension is usually invested with the aim to deliver long-term growth. While returns cannot be guaranteed, leaving your money invested through your pension could lead to the value increasing in real terms. 

So, if you don’t have short-term plans for using your tax-free lump sum, it may be worth considering if your money would be working harder if it remained in your pension. 

You don’t have to take your tax-free cash in a single lump sum. Instead, you can spread it across smaller withdrawals that may better suit your needs and goals. 

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 is a long-term investment not normally accessible until 55 (57 from April 2028). The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available. Past performance is not a reliable indicator of future results. 

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.  


Share: