nigel woollsey

Nigel Woollsey

Online Writer
Published: 19/03/2019

At a glance

  • Since April 2015 you have the option of cashing in your pension for a lump sum at retirement.
  • However, doing so is a risky strategy and shouldn’t be entered into without a lot of consideration or without professional advice.
  • Taking your whole pension or just part of it may result in a hefty tax bill.

The pension freedoms introduced in April 2015 gave retirees a whole host of new options and cashing in your pension is one of them. This means you can, if you wish, take your pension pot in one lump sum. But before you take the plunge and withdraw all that cash, there are several risks to be aware of.

The key considerations to think about

Risk 1 – Running out of money

Your pension pot is designed to provide enough money to give you a life-long income when you stop work. If you take the money in one go (and are not very sensible about how you use it) you could quickly use up all that hard-earned cash and have nothing left to live on. Of course, you could use it to buy another investment to generate an income, such as a buy-to-let property, but returns aren't guaranteed. Whatever you choose to do with it, you'll need to be aware of the taxman.

Risk 2 – Income tax

If you take your pension pot as a single lump sum, you could be in for a big tax bill. Essentially, it's equivalent to taking your entire retirement income in one go, so the tax implications could be huge. Even though 25% of your pot can be withdrawn tax-free, 75% of the sum will be taxable. While you could remain in the basic rate (20%) tax bracket, if you have a sizeable pot it could tip you into the 40% or even the 45% tax band.

Say you have an annual income from an old company pension of £10,000 and have a separate pension pot of £120,000. If you cashed in the whole pension but chose to take £30,000 as tax-free cash, it essentially means you'd have a taxable income of £100,000 in that tax year. Assuming a personal tax allowance of £12,500, this equates to a tax bill of £27,500. Would you want to give that amount of lifelong savings to the taxman?

Taking that same pension pot but spreading the withdrawals over several years – and therefore reducing your income in any one tax year – could significantly reduce your tax bill. Remember, too, that if you take anything over £100,000 as an income, you start to lose your personal allowance, making it even more tax-unfriendly.

Risk 3 – Where do you put the money?

If you cash in your whole pension pot, you need to put the money somewhere. Pension funds grow pretty much tax-free, but if you put the money anywhere other than an ISA, it'll be taxed. If you invested in other investment funds like unit trusts or investment trusts, tax is paid in the fund. If you put the money in the bank, any non-ISA interest you earn over £1,000 per year will be taxable income. If you are a higher rate taxpayer this amount is £500, and if you pay tax at 45%, you get no tax-free interest allowance. Either way, the investment growth is likely to be worse, because more tax is payable. The only caveat to this is if you had a small pension fund and chose to put the proceeds in a tax-free ISA.

Risk 4 – Inheritance tax/debts

Any money held in pension funds is generally outside of the person's estate when they die, so doesn't count towards any Inheritance Tax (IHT) charge. But, as soon as you take the money out of the pension, it would become part of your estate, and so is potentially subject to IHT – depending on your other assets and who you leave it to.

Similarly, if you have debts on death, any money taken out of the pension can be called upon by creditors to repay the debt.

Pros and cons of cashing in your pension

  • You can use the money from your pension any way you see fit.
  • If you don’t invest the money wisely you could end up with nothing to support you in your retirement.
  • Taking a lump sum can make you liable for a hefty tax bill.
  • Money held in a pension is generally not liable for inheritance tax – however, lump sums you have withdrawn from the pot will be, so if you cash in the full amount, it could significantly add to your estate and potential inheritance tax bill.

Moneyfacts tip

Moneyfacts tip nigel woollsey

If you are considering cashing in your pension for a lump sum make sure you take independent professional advice and ensure that you know the amount of tax you’ll be paying.

What next?

The pension flexibilities have given retirees more options, but they're also very complicated, so it's vital to think carefully before making any choices that you can't undo in the future. The Government's Pension Wise Service should be the first port of call for most people, and you may also want to seek independent financial advice to ensure you make the right decision.

Disclaimer: This information is intended solely to provide guidance and is not financial advice. Moneyfacts will not be liable for any loss arising from your use or reliance on this information. If you are in any doubt, Moneyfacts recommends you obtain independent financial advice.

happy couple holding up a key

At a glance

  • Since April 2015 you have the option of cashing in your pension for a lump sum at retirement.
  • However, doing so is a risky strategy and shouldn’t be entered into without a lot of consideration or without professional advice.
  • Taking your whole pension or just part of it may result in a hefty tax bill.

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