Should You Be Cashing In Pensions At 55?

For most people unlocking or cashing in pensions at 55, in part or in full, is now possible. How you do this will depend on the type of scheme you have and how you want to take your benefits. Under pension freedoms, the rules allow anyone aged 55 and over to take the whole amount of their pension pot as a lump sum, 25% of this will be tax free, but the rest being taxed as earned income in the year it’s taken out. This does provide more choice, but it also means it’s easier to make mistakes resulting in the Government taking a large bite out of your hard earned pension.

Research shows that around one in ten people (10%) planning to retire this year expect to withdraw their entire pension savings as one lump sum, however, concerns have been raised that by doing this you may risk:

• Running out of cash before you die
• Paying a hefty, unnecessary tax bill on drawdown.
• In fact, one in five (20%) retiring this year will risk avoidable tax bills by taking out more than the tax-free 25% limit on withdrawals.
• Investing the cash in less tax efficient ways
• Reducing future retirement income
• Having a less enjoyable and secure retirement

“two thirds planning on retiring early”

Around two thirds (66%) of people are planning on retiring early. Since the launch of pension freedom reforms in April 2015, more than 1.1 million people aged 55-plus have withdrawn around ￡15,744 billion in flexible payments.

Interestingly, they are not necessarily spending all the cash – the main reason given by those taking all their fund in one go was to invest in other areas such as property, a savings account or alternative investment funds (71%).

Don’t Get Penalised By The Tax System

Government estimates show that around ￡2.6 billion was paid in tax by people taking advantage of pension freedoms in the 2015/16 and 2016/17 tax years, with another ￡1.1 billion raised in the 2017/18 tax year. The most popular use of the cash is for holidays, with 34% planning to spend the money on trips. Around (25%) will spend the money on home improvements, while one in five (20%) will gift the money to their children or grandchildren. Other popular uses include buying cars or paying off mortgages.

Instead, Take Advantage Of Pension Freedoms Effectively

Pension freedoms allow you to have the flexibility on how and when you spend your money without being penalised by the tax system, but it is worrying that some retirees may withdraw more than the tax-free lump sum limit. The risk is even greater if you’re taking all your pension fund in cash.

If you are thinking about cashing in pensions at 55, seriously consider limiting what you take out to the 25% tax free amount and the rest spread over several years in a more tax efficient and effective way using income drawdown.

Extra tax Charges or restrictions might also apply if your pensions savings in total exceed the Lifetime Allowance, currently ￡1,030,000 and is likely to increase in line with inflation at the end of the tax year, or if you’ve reached 75 and not yet taken benefits from your pension.

Using Flexi-Access Drawdown

Income drawdown is a way of using your pension pot to provide you with a regular retirement income by reinvesting it in funds specifically designed and managed for this purpose. The income you get will vary depending on the fund’s performance. It isn’t guaranteed for life in the way annuities are. Income drawdown works as follows:

• You can normally choose to take up to 25% (a quarter) of your pension pot as a tax-free lump sum.
• You then move the rest into one or more funds that allow you to take an income at times to suit you.
• Some people use it to take a regular income, whilst others defer taking the income until they might need it later.
• The income you receive might be adjusted up or down periodically depending on the performance of your investments.

Where guaranteed income is required, then Annuities or other products may provide a better solution or a combination of these options.

Flexi-Access drawdown is just one of several options available to you for taking pension your pension, which can be complex and seeking professional advice before committing to one is recommended.

Tax Relief On Pension Contributions

If the value of your pension pot is worth ￡10,000 or more, once you start to take income, the amount of defined pension contributions on which you can get tax relief each year is reduced from ￡40,000 (the Annual Allowance) to a lower amount (called the ‘Money Purchase Annual Allowance’ or MPAA). The MPAA for 2018-19 is ￡4,000. So, if you want to continue to build up your pension pot then taking amounts out of your pension pot in excess of 25% might be unsuitable.

What Happens To Your Pension When You Die?

Any remaining cash or investments from the money that came from your pension pot will form part of your estate for Inheritance Tax purposes.

Whereas any part of your pension pot unused wouldn’t normally be included in your estate for Inheritance Tax purposes. In addition, if you die before age 75 your pension pot will pass tax free to your beneficiaries, provided the money is paid within two years of the pension provider becoming aware of your death. If you die after the age of 75, then the remainder of your pension pot will still pass free of Inheritance Tax, but any benefits withdrawn will be taxed at the beneficiary’s marginal income tax rate.

So, if you have other assets and investments that are sufficient to maintain your standard of living in retirement, then taking income from other non-pension assets first can be a very tax efficient strategy when passing on your estate to loved ones.

What You Need To Ask Yourself Before Cashing In Your Pension Pot

Q1: Have you considered what the tax implications are?

At the heart of any pension transaction you undertake, tax planning is a major consideration. Only the first 25% of the amount that you drawdown from your pension pot is tax-free, and the remaining 75% is taxed as earned income

Q2: Will your money last the duration of your retirement years?

Before taking the cash, it is crucial to think about whether you will have enough money to last the duration of your retirement. It’s not a one-off decision: you should regularly review your choices throughout your retirement, as your needs evolve, and income needs may change.

Q3: Will your pension scheme allow you to cash in your pension pot?

If you’re convinced that cashing in your pension pot is the right move for you, you need to ensure that your pension scheme allows you to do so. If not, it means that you’ll need to transfer your savings into a suitable pension scheme to be able to access your cash.

Q4: Are you aware of the companies running pension scams?

Pension savers getting scammed out of their retirement savings is a real issue. The problem is that many of these scams look perfectly legitimate so are not easy to spot. Others offer investment returns which are too good to be true. You can visit the FCA’s Scam Smart website, which includes a warning list of companies operating without authorisation or running scams – www.fca.org.uk/scamsmart. You can also search the FCA register to check on whether firms or individuals are authorised and registered with the FCA to give that type of advice – https://register.fca.org.uk/

Q5: Have you sought professional financial advice about your plans?

Not seeking professional financial advice can be very risky, especially when it comes to deciding how eventually to take your pension. If you get it wrong, it could be very costly in terms of tax and have a considerable impact on your retirement lifestyle and standard of living. We’ll make sure that the action you take is the right one for you, your family and your needs.

If you are thinking about cashing in pensions at 55, we highly recommend you review your own situation. You can call us to arrange an appointment or ask a question – we look forward to hearing from you.