Withdrawing lump sums from your pension pot will become much easier in April, and you could benefit from a new tax cut while doing so. You could even withdraw 100% of your pot as cash. However, there are major risks to bear in mind.
Anyone with a defined contribution pension can withdraw up to 25% tax free upon retirement. It’s a cash payment known as the Pension Commencement Lump Sum (PCLS) and it will continue to be available after the new pension rules come into force in April.
However, it has traditionally been difficult to access the remaining 75% of your pension pot without incurring a 55% tax charge or using income drawdown – something that can require you to meet certain eligibility criteria, or limit the amount you can withdraw.
If you’re retiring after 6 April 2015, however, you’ll have much greater freedom. Once the new pension rules come into force, you’ll be able to take lump sums of any size from your pension whenever you like, while leaving the rest invested. And you can even withdraw the lot as a single cash payment.
How the lump sum rules changed in April
From 6 April 2015, anyone aged 55 or over (or earlier if in ill-health) has the flexibility to withdraw lump sums from their pensions as and when they like, while leaving the rest invested. As a result, the trivial commutation and small pots rules become redundant –you’ll be able to withdraw 100% of your pension pot, no matter how big it is.
If you have a defined contributions pension then, as before, you’ll be able to take a tax-free lump sum upon retirement, worth up to 25% of your pot. Any lump sum you withdraw after that will be subject to income tax.
You’ll also be eligible for flex-access drawdown automatically, without having to prove you have a guaranteed retirement income of £12,000 from other sources, as was previously the case. Flexi-access drawdown allows you to withdraw as much as you like from your pension. However, not all pension schemes offer the option of transferring your pot into drawdown – and this is especially likely to be the case with workplace pensions.
To take advantage of flexi-access drawdown, you may therefore have to transfer your pension to another scheme. There may be fees involved, and you need to be aware that, since drawdown products involve investments, they must be monitored and managed on a regular basis. You may wish to consult a financial adviser before making a transfer decision.
How a lump sum can affect your future pension contributions
If you choose to withdraw a lump sum flexibly from your pension, you should be aware that this could reduce your annual allowance for pension contributions.
This allowance is a limit on the amount that you can contribute to a defined contribution pension each year, while still receiving tax relief. It’s based on your earnings for the year and is capped at £40,000. However, from 6 April 2015, the annual allowance is reduced to £10,000 if you have withdrawn more than the first 25% from your pension pot.
You can read more about the potential pitfalls raised by all the new pension rules in the section of this site entitled “Retirement pitfalls and how to avoid them”.
Why the new lump sum rules present new risks
The greater flexibility on offer from April will be welcomed by many. However, opting to take lump sums from your pension fund is not a decision to take lightly. Your pension fund needs to last you the duration of your retirement, which could be several decades.
In particular, you should think very carefully before withdrawing more than 25% from your pension if you decide to take a tax-free lump sum upon retirement. Any money you withdraw over that share of the pot will be taxed at your marginal rate, and even if you’re not a higher or additional rate taxpayer when you retire, you may find that the lump sum pushes you into a higher tax band for that year.
Tax planning is a complex business and everyone’s circumstances are different. You may therefore wish to consult a financial adviser, who can recommend a strategy that will help you achieve your particular goals while remaining as tax-efficient as possible. If you don’t yet have a financial adviser but are interested in finding one then you can find out more here.
For basic pension guidance you also have the option of using the Pension Wise service, introduced by the Government. It’s available free of charge to anyone who is aged 55 or over, and who has a defined contribution pension, via The Pensions Advisory Service.