Should you take a 25% lump sum from your pension fund?

If you’re approaching retirement, think twice before exercising your right to take 25% of your pension fund savings as a tax-free cash lump sum.

Man serving cake slices to waiting people © Getty Images

535082912

If you're approaching retirement, think twice before exercising your right to take 25% of your pension fund savings as a tax-free cash lump sum.

If you're a member of a final-salary scheme, the tax-free lump sum available to you on retirement depends on a "commutation factor". This is the formula that determines how much cash you qualify for and, just as critically, how much annual pension income you'll forgo by taking the money. The higher the commutation factor your scheme offers, the more generous it is.

But the factor also gives you a rough idea of how long you have to live to miss out overall by taking the cash. A commutation factor of 12 broadly means that 12 years into your retirement you'll have given up more in regular pension income than you received as your lump sum.

Men and women aged 65 today can expect to live for another 19 and 21 years respectively. So for many people, a higher annual pension with no lump sum paid upfront will be a better bet.

In defined-contribution schemes, the calculation is more difficult. You can take a straight 25% of the fund upfront, but this will mean less annual annuity income or a smaller fund to invest if you're opting to draw cash down directly from your pension scheme. If the former, you can do some quick calculations by getting annuity quotes with and without taking the lump sum; if the latter, you'll have to make a judgement about the investment returns you're missing out on.

Recommended

Make sure you max out your pension contributions this year
Pensions

Make sure you max out your pension contributions this year

If you're saving for retirement, make sure that you have used up all their allowances before the tax year ends, and contributed as much to your pensio…
31 Mar 2021
Make sure you don't go over the pensions lifetime allowance
Pensions

Make sure you don't go over the pensions lifetime allowance

Breaching the lifetime allowance for pension savings could prove very costly, says David Prosser.
15 Mar 2021
Women could be compensated for state-pension shortfall
State pensions

Women could be compensated for state-pension shortfall

A government inquiry has said that up to 200,000 women could be owed a collective £1.7bn in compensation, with the average woman being owed £13,500 in…
12 Mar 2021
What is the pensions lifetime allowance and should you be worried about hitting it?
Pensions

What is the pensions lifetime allowance and should you be worried about hitting it?

In his recent Budget the chancellor froze the pensions lifetime allowance at £1,073,100. That may sound like a lot to have in your pot, but you could …
11 Mar 2021

Most Popular

Central banks are rushing to build digital currencies. What are they, and what do they mean for you?
Bitcoin

Central banks are rushing to build digital currencies. What are they, and what do they mean for you?

As bitcoin continues to soar in value, many of the world’s central banks are looking to emulate it by issuing their own digital currencies. But centra…
8 Apr 2021
Nuclear power might never be popular – but now looks a good time to invest
Commodities

Nuclear power might never be popular – but now looks a good time to invest

Nuclear power gets a very bad press, but it is the ultimate renewable energy source. Interest in it is perking up again, says John Stepek. Which means…
9 Apr 2021
How to find companies that can thrive in the post-Covid world
Advertisement Feature

How to find companies that can thrive in the post-Covid world

Many sectors of the global economy will return to something resembling pre-pandemic status, but others will take far longer to recover.
8 Apr 2021