How to take your pension lump sum in an unstable economy

The ability to take tax-free cash from your pension pot is a valuable one, but in light of recent events, could it be worth delaying or re-thinking your retirement plans?

The past few years have been volatile to say the least, as coronavirus, the war in Ukraine, and more recently, the fallout from the mini-Budget all affect markets. 

If you’re approaching retirement you might’ve earmarked some of your tax-free cash to fund world travel or to make house renovations. 

But how can you withdraw tax-free cash at retirement, when should you, and how could the current economic climate affect your decision? 

Read on to find out.

The markets are currently unstable

Staying on top of changes to the British economy involves a lot of refreshing your internet browser currently. 

Following the uncertainty of Covid and the war in Ukraine, the new government announced its mini-Budget on 23 September 2022. It was quickly followed by further market turmoil and a weakening of the pound. 

The mini-Budget’s unfunded tax cuts led to investors rapidly selling UK government bonds and the Bank of England (BoE) was forced to step in. It temporarily purchased bonds to calm the markets and protect pension funds from collapsing.

You can read about the mini-Budget in our associated article, as well as some wellbeing tips for staying calm during the current crisis.

The chancellor, Kwasi Kwarteng, has since been removed, in one of the shortest stints as chancellor in British history. Jeremy Hunt has now been appointed to the position. After a series of budget reversals, there are likely to be further changes on the horizon.

How your tax-free entitlement works

According to This is Money, increasing amounts of retirees are taking their tax-free sum in smaller chunks with many using their funds to cover everyday spending as a result of the cost of living crisis. 

So, how does the tax-free sum work and how could market turmoil be affecting your options?

Once you reach the age of 55 (rising to 57 in 2028), you can begin withdrawing funds from your pension. You can usually take up to 25% of your defined contribution (DC) pension fund as a tax-free lump sum. The remaining 75% of your fund is taxed as income, at your Income Tax rate. 

You can take your tax-free lump sum in several ways

There are several tax-free cash options for your DC pension:

• Purchasing an annuity and taking a pension commencement lump sum (PCLS)
• Receiving an adjustable income (known as a “Flexi Access Drawdown”)
• Taking partial or full withdrawals as an Uncrystallised Fund Pension Lump Sum (UFPLS) 
• Opting to mix the above options.

Once you’ve decided on your approach, it is important to be aware of the pros and cons involved.

The tax-free cash pros and cons of taking an annuity, flexi-access drawdown, and UFPLS

An annuity

An annuity is a form of insurance product in which you build a retirement pot through regular contributions and use that pot to purchase an income for life. 

You can usually take up to 25% of your pension pot as tax-free cash. The annuity you receive is classed as income and will be taxed at your Income Tax rate on earnings above the Personal Allowance.

Annuities can come with a variety of added benefits, like spouses’ pensions or an annuity that rises each year to lessen the effects of inflation. 

One disadvantage of annuities is that once you’ve purchased an annuity and chosen your pension basis, it usually can’t be altered. This also means you lock in the full value of your fund at the date of purchase, making your decision especially reliant on market performance. 

Flexi-access drawdown

Flexi-access drawdown is a more flexible means of withdrawing money from your pension pot to provide an income during retirement.

You can take up to 25% of the pot as a tax-free lump sum, while keeping the remainder of the pot invested, leaving it open to further investment growth and potential compound returns. You can withdraw income from it when you need to. As with any investment, the value of the fund can go up or down, potentially leaving you with less to rely on in the future.

Keeping your funds invested can stop your cash from losing value in real terms if you withdraw more than you need and ends up sitting in a savings account. Historically returns on the markets tend to outperform inflation figures. Additionally, the growth on your pension pot is tax-free.

Uncrystallised funds pension lump sum

An uncrystallised funds pension lump sum (UFPLS) is a lump sum, or a series of lump sum payments, 25% of which is tax-free, while the remaining 75% is taxed as income.

An UFPLS is useful if you have large sums earmarked for one-off expenses like world travel or renovations. However, if you take too much from your pension in one go, you could move into a higher Income Tax bracket.

If you opt to take a one-off lump sum for your whole pension amount, recent market turmoil might have lowered the value of your fund and made delaying your retirement prudent, if you can afford to.

Get in touch

The best decision for you will be based on your personal circumstances and how you intend to spend the money. Your first step should be to seek professional advice so get in touch now.

If you’d like help navigating your retirement needs and the possible tax implications of any future withdrawals, please contact us by emailing info@lloydosullivan.co.uk or calling 020 8941 9779.

Please note: 

The value of your investments (and any income from them) can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance. Investments should be considered over the longer term and should fit in with your overall attitude to risk and financial circumstances.