This year’s Budget in March changed the entire landscape for retirement and saving. Taking the whole of your pension pot in one go is now a much more viable option than before. But not everyone will want to take the whole lot.
I’m going to look at what your options are for taking a lump sum out of your pension pot.
A lump sum under the new rules
As we’ve said already, from April 2015, you’ll almost certainly be able to withdraw as much as you want from your pot at any time – as long as you’re 55 or over.
This new option was perhaps the biggest element in George Osborne’s pension reforms, and it’s a very exciting change.
The attraction is that it gives you freedom. You can take all your money from your pension pot and do whatever you want with it. And that’s fair enough, given that it’s money you earned in the first place.
Be careful though. The temptation to spend all your pot on a Lamborghini or a super-expensive holiday may be high. Remember that you could end up living for another 30 or 40 years, and you don’t want to be in a situation where you have to rely on the state pension for most of that time.
The best approach could be to take some of your money out now, and take more out when you’re older – possibly using income drawdown.
You could also end up paying a high tax bill if you take all the money in one go. You’ll be charged income tax at your highest rate. This is especially true if you take the lump sum from your pot when you’re still earning money from your job.
We’ll look at the issue of tax in more detail in a later chapter.
25% tax-free lump sum
There’s one lump sum that all retirees should take. That’s the 25% tax-free lump sum.
So if you have a £100,000 pension pot, you can take out £25,000 tax-free once you reach 55. You can then keep the rest of the pot invested or withdraw money via an annuity or drawdown if you wish.
Or you could just pull out the remaining £75,000 in one go – from April 2015, anyway.
But remember, if you pull out the remaining £75,000 in one go, you’ll have to pay income tax. The same is true for any annuity or drawdown income.
You see, the idea with pensions is that you get tax relief when you pay the money into your pot, so therefore you should pay some tax when you take the money out.
That’s apart from the 25% tax-free lump sum, where you get tax relief when you pay in, and more relief when you withdraw the lump sum. So really, you’d be mad not to take this tax-free cash at some point. Many retirees take the lump sum when they start taking an income from the rest of their pot.
Make sure you take advantage of the pensions revolution
The entire landscape of retirement and saving has changed radically.
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If you have a small pension pot, it’s easy to take your money out in one go. This is known as ‘trivial commutation’.
From the age of 60, if your total pension pot or pots are worth £30,000 or less, you can take the whole lot in one go.
Even if your total pension savings are worth more than £30,000, you can still withdraw all the money from any pots that are worth £10,000 or less. That’s as long as you don’t withdraw money from more than three pots.
There are two further catches here. Firstly, some pension providers don’t allow you to withdraw money under the trivial commutation rules.
Secondly, although you won’t have to pay any tax on the first 25% you withdraw, the rest of your withdrawal will be subject to income tax.
If you’re not planning to withdraw money from your pension before April 2015, you won’t need to worry about trivial commutation.
Under the new rules coming in next year, you’ll be able to withdraw as much money as you like.
But if your pension savings are small, and you’d like to get all the money out now, trivial commutation could be the way to go.
Investing your lump sum
If you take out a lump sum, you may want to invest it and generate an income. If you want advice on how to build a balanced investment portfolio, take a look at The Lifetime Wealth newsletter for information and advice on how to do that. Click here to find out more.