How to take tax-free cash from a pension


There used to be something frustrating about a large pension pot. You might have had ample funds, but the only way you could access them was through an annuity.
Whether you wanted a holiday of a lifetime, or simply to pay off the mortgage, the money you had spent so long building up was simply not available.
This all changed with the pension reforms of 2015, which allowed those approaching retirement to access any amount of money from their pension pots. This meant that paying off the mortgage, or even buying investment property could be possible, and made retirement planning a lot easier – and enjoyable – for many.
However, you need to be careful if you want to convert your pension pot into hard cash – because if you get things wrong, the taxman will be helping himself to your pension.

Tax-free cash

Fortunately, you can take a proportion of your pension as tax free cash to spend as you want. This is known by regulators as the pension commencement lump sum.

But despite this name, you don’t have to take it straight away. You can leave the money where it is until you have made some clear financial plans about how you want to spend your golden years. You can leave the rest invested until you need it, or start using it to provide an income.

How it works

How exactly you access your tax-free lump sum depends on the type of pension scheme you have. Most modern personal pensions include a drawdown option. That means you can simply choose to take your tax free cash and your policy will become a drawdown policy which you can access as you wish while the rest remains invested.

Older plans usually don’t include drawdown and so you need to convert your pension to a drawdown policy first.

You may be able to transfer to a different policy with the same provider. Most workplace pensions and especially final salary pension schemes require that you turn your pension into an income when you take the tax-free cash, so again, you would need to switch to a drawdown plan if you want a more flexible approach.

The ‘small pot rule’

If your pension pot is £10,000 or less, it may be classed as a ‘small pension pot’, and some special rules apply.

These mean that you can take the whole of your pension as cash, whether your pension is defined contribution or final salary. With personal pensions there is also the option of taking up to three small pots of £10,000 or less.

But remember, only the first 25% of the cash will be tax-free. You will pay income tax on the rest of it.

What should you do?

A key principle when it comes to accessing your pension is to minimise your tax. As long as your money stays in your pension pot you won’t pay tax on it and you’ll get tax relief on any more contributions you make. If you take out your 25% lump sum and put it in the bank, you lose the tax advantages. The interest the money earns could be subject to income tax, so if you don’t have an immediate purpose for your tax-free cash it is usually better to leave it in your pension.

Leaving your money invested also means it can continue to grow. You need your pension to last as long as you do.

When it’s your pension, you won’t have the chance to put things right if you make the wrong decision. Expert advice is essential, and at Continuum, we will be happy to provide it.

The value of pensions and investments, and the income from them, can fall as well as rise and you may get back less than you invested.

Tax treatment varies according to individual circumstances and is subject to change.

Book a free initial consultation

Book an initial consultation with one of our independent financial advisers or call us on 0345 643 0770 if you would like to discuss further.

Sources:

gov.uk – Tax when you get a pension

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