If you're approaching retirement, you've probably started to think about how you'll make the most of your pension savings. Withdrawing the tax-fee lump sum could well prove tempting, but if you were to go down that route, just what would you spend it on?
Well, according to research from MGM Advantage, paying off debt could be a possibility. According to a survey of retirees who took free the tax-free lump sum at retirement, 28% saw paying off debt as a priority: 13% paid off all or some of their mortgage with the proceeds, 8% used some of it to pay off credit cards and 7% paid off other loans.
But, there are other possibilities, too. Around 12% of retirees surveyed used some or all of their tax-free cash to renovate or decorate their existing home, while 9% used some cash to buy a new car, the same number as those who decided to treat themselves to a holiday. However, some were more prudent in their choices, with 15% choosing to invest some of their lump sum in stocks, shares or investment trusts, while 27% put some of their tax-free cash in the bank for a rainy day.
The figures show that there are wide-ranging views regarding the best way to spend the cash, often depending on personal need, and they also provide some indication of what retirees might do when the reforms come into play next year. However, there's a big difference between taking the tax-free lump sum and withdrawing the full amount, and the research also highlighted a worrying lack of understanding around the tax implications of such a move.
The survey found that 59% of people aged over 55 said they didn't understand the tax implications of withdrawing their pot. Furthermore, when the tax implications were explained, people were far more likely (83%) to leave their money in a pension wrapper and draw an income as needed, rather than taking the entire pot as cash in one go. Just 17% said they are happy to pay tax on any withdrawal, suggesting that the majority won't be rushing out to buy sports cars with their cash.
Andrew Tully, pensions technical director at MGM Advantage, commented on the findings: "This research helps paint a picture of the likely behaviours of people who might take advantage of the new pension freedoms [next year]. Debt is a clear priority for many people who have spent a portion of their tax-free cash paying off loans, credit cards or their mortgage.
"[But], it is important to remember that, from April, accessing more than 25% of your pension in one go will mean you pay income tax on any withdrawals. Treating yourself with your tax-free cash is one thing, but paying the tax man to access your cash is another thing altogether. Unfortunately, we know from our research there is a lack of understanding of the tax implications of taking lump sum withdrawals. It is vital that people receive professional financial advice to help them navigate the retirement maze and decide what is best for their personal circumstances."
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