Tax free lump sum pension query
Discussion
There are tax considerations both ways, but it depends on how much we are talking about.
Keep it in and you could become subject to the lifetime allowance and any future changes to tax treatment on pension.
Take it out and you move it from tax-free growth to potentially taxable growth (income tax and CGT). Not an issue if you intend to spend the funds.
I assume you’re not referring to a DB scheme because there are different considerations there.
Keep it in and you could become subject to the lifetime allowance and any future changes to tax treatment on pension.
Take it out and you move it from tax-free growth to potentially taxable growth (income tax and CGT). Not an issue if you intend to spend the funds.
I assume you’re not referring to a DB scheme because there are different considerations there.
I am referring to a final salary type DB scheme. The 25% amount is to be my holiday fund.
I'd like to spend approx £15K on holidays straight away and had thought of the rest in premium bonds and spend as and when needed. I have other DC type pensions that come into effect 5 years later and the state pendion 6 years later.
I'm a self employed dog walker/house sitter and will carry on house sitting with some dog walking.
I'd like to spend approx £15K on holidays straight away and had thought of the rest in premium bonds and spend as and when needed. I have other DC type pensions that come into effect 5 years later and the state pendion 6 years later.
I'm a self employed dog walker/house sitter and will carry on house sitting with some dog walking.
Edited by condor on Friday 5th April 11:14
condor said:
I will be surrendering annual pension but I would need to live over 20 years longer to break even if I didn't take the lump sum.
How long you think you are going to live then? 
If the residual is sufficient to live on, take the tax free cash and enjoy yourself. You only live once and are a long time dead.
xeny said:
depends on your goals - I'd probably like to keep such invested, so I'd rather keep it in the pension wrapper than withdraw it and give myself ISA allowance problems.
I've spoken to a few ex colleagues, one who took the 25% lump sum and then afterwards wished she hadn't as she spent it on helping her children buy homes and still needs to do some extra work, even though she gets the state pension and another pension too. Another who only took £25K lump sum and had a bigger pension as a result - but presumably is paying tax on his overall pension income. Another who took the full lump sum and spends it on travelling/holidays.condor said:
Another who only took £25K lump sum and had a bigger pension as a result - but presumably is paying tax on his overall pension income.
They'll be paying tax on it, yes, but not on the proportion corresponding to the 25% tax free (less £25K). The tax free part of the pension is tax free regardless of if you take it as a lump sum or as monthly payments.xeny said:
They'll be paying tax on it, yes, but not on the proportion corresponding to the 25% tax free (less £25K). The tax free part of the pension is tax free regardless of if you take it as a lump sum or as monthly payments.
Do you understand how defined benefit pension schemes work?my understanding is that 25% of the value is tax free. If you take a 25% lump sum, that is tax free, and the rest is taxed at your current income tax rate. AIUI, if you took no lump sum then obviously your pension payments would be larger but the 25% tax free would apply to those payments.
excuse the clumsy wording, but is that not the case?
excuse the clumsy wording, but is that not the case?
xeny said:
my understanding is that 25% of the value is tax free. If you take a 25% lump sum, that is tax free, and the rest is taxed at your current income tax rate. AIUI, if you took no lump sum then obviously your pension payments would be larger but the 25% tax free would apply to those payments.
excuse the clumsy wording, but is that not the case?
No it is not the case.excuse the clumsy wording, but is that not the case?
Tax free cash under a defined benefit pension scheme is usually ascertained via surrendering part of the pension entitlement. If you chose not to do so the whole pension will be assessed for income tax. I acknowledge there are some defined benefit schemes where the tax free cash is assessed independently to the pension, eg local government schemes, but this is not the same as 25% of the pension value.
You are referring to defined contribution pension schemes. However, while a 25% tax free lump sum of the fund crystallised will be available (or more in certain circumstances) if you chose not to take it, the resulting pension you receive will all be assessed for income tax.
I suspect you are confusing taking the tax free cash and buying a purchase life annuity with it. There, the original capital will be returned over time tax free.
A big factor in your decision is the "commutation factor" used by your pension scheme. The factor varies by age, over time, and by pension scheme.
Some pension schemes will use generous factors which make taking the lump sum almost a no brainer; some pension schemes will use quite penal factors which could well mean it is better to stick with the pension even after taking into account the tax-free status of the lump sum.
For example, if you gave up ("commuted") £1,000 of annual pension, some pension schemes might give you a lump sum of just £12,000 (quite penal) whereas others might give a lump sum of more than £25,000 (quite generous).
Plus, as you alluded to, think about what you want to do with the money. If you have credit card debt, say, it might make sense to take a lump sum to pay down that debt and save paying high rates of interest. Similarly, you might want to clear any outstanding mortgage.
Conversely, you might be quite risk averse and prefer the certainty of a regular income for the rest of your life. If you've never invested large sums of money, you might be understandably nervous about what to do with it (although a good financial advisor is worth their fee in that situation).
Some pension schemes will use generous factors which make taking the lump sum almost a no brainer; some pension schemes will use quite penal factors which could well mean it is better to stick with the pension even after taking into account the tax-free status of the lump sum.
For example, if you gave up ("commuted") £1,000 of annual pension, some pension schemes might give you a lump sum of just £12,000 (quite penal) whereas others might give a lump sum of more than £25,000 (quite generous).
Plus, as you alluded to, think about what you want to do with the money. If you have credit card debt, say, it might make sense to take a lump sum to pay down that debt and save paying high rates of interest. Similarly, you might want to clear any outstanding mortgage.
Conversely, you might be quite risk averse and prefer the certainty of a regular income for the rest of your life. If you've never invested large sums of money, you might be understandably nervous about what to do with it (although a good financial advisor is worth their fee in that situation).
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