Tax free cash is certainly an incentive to save into a pension, but taking that slice of money on retirement is not necessarily the right decision.
Pension rules say anyone with a UK direct contribution pension can take 25% of the fund value on retirement with no tax to pay.
Direct benefit pensions also give a tax-free lump sum, but the final figure is a little more complicated to work out as it is not a percentage of fund value.
For expats with a Qualifying Recognised Overseas Pension Scheme (QROPS), the tax-free lumps sum is even more enticing. QROPS allow up to a 30% tax-free lump sum.
Taking the money is a simple decision for most retirement savers. They have put cash into a pension for most of their working life and the reward is a tax-free lump sum, so why not take the money and run?
Reasons not to tinker with a pension
Well, here are some reasons why not explained:
- Left in the pension, the money still grows tax free and is available for withdrawing at any time. As savings, any interest is subject to tax over certain levels, while in a pension, fund growth is free of tax.
- Any cash in a pension is not part of an estate for inheritance tax, but becomes liable for this tax once shifted into savings
- Money in the bank may be included in state benefit means tests, but in a pension, it’s disregarded
- Pensions are the most tax efficient way to save, so if you must spend savings, take the cash from a bank or ISA first
- Don’t take the full tax free lump sum if you do not need the cash and pension rules allow partial withdrawals
These are good reasons to argue against taking money from a pension, but the financial circumstance of some savers may mean they want or should draw the cash.
Paying down debt with a pension
For over 55s still working and replenishing their savings with earnings, paying down debt with pension cash is worth considering.
Becoming your own bank by ‘borrowing’ from your pension and then paying what you would have paid to lenders back into savings can save a fortune in interest and lender charges.
Don’t forget that once the tax-free cash is withdrawn from retirement savings, the limit on paying more contributions into the scheme is limited at £10,000 a year.
Taking the money will also reduce your available pension money in retirement.
