Navigating pension options can feel like a maze.
Whether you’re eyeing retirement or simply planning ahead, understanding how to efficiently access your pension tax-free cash is crucial.
Here’s a straightforward guide to why you might not want to withdraw your pension commencement lump sum all at once and how doing it in phases could benefit you and your family.
Understanding Your Tax-Free Cash Options
Usually, you can take out 25% of your UK pension value without paying a penny in taxes (*) —this is known as the Pension Commencement Lump Sum (PCLS).
But did you know you don’t have to take your PCLS in one big chunk?
Instead, spreading out your withdrawals over time could be a smart financial move.to
* This is the rule in the UK. However, it is not always the case when you are living overseas.
There are many countries, e.g. France, Spain and the US, where your PCLS will be taxed locally in the same way as your pension income would be.
This is one of the main pitfalls that catches Brits who are retiring overseas.
If you are considering retiring outside the UK, or have already done so, and are not sure on what to do with your pensions then please get in touch for a free no no-obligation 20-minute call.
I would be happy to review your position, and explain where you stand and what you need to do to get the most out of your retirement.
The Flexibility of Modern Pensions
Not all pensions are created equal, especially when it comes to withdrawing your tax-free cash.
Traditional defined benefit/final salary pensions don’t offer the flexibility to take your tax-free cash in instalments.
With these schemes, at retirement you are given the choice between a larger lump sum or a higher regular income, and that’s that—once you decide there are no take-backs.
On the flip side, defined contribution pensions (also known as money purchase pensions) can be much more flexible.
These setups can allow for phased withdrawals, giving you greater control over your finances in retirement.
However, to be able to do so, you need to make sure that your pension offers Flexi-Access Drawdown or Uncrystallised Funds Pension Lump Sum (UFPLS) options.
If it doesn’t, then you should shop around to find one that does.
The Drawbacks of Withdrawing Your PCLS All at Once
While grabbing all your tax-free cash in one go might be tempting, it’s not always the wisest financial decision.
Here’s why:
💡Growth Potential: Money left invested in your pension can continue to grow over time. Withdrawing a large sum to sit in a low-interest bank account could mean missing out on significant investment returns.
💡Maximising Your Tax-Free Cash: By taking smaller withdrawals over time, you might benefit from a larger tax-free sum in the future as your pension pot grows.
💡Tax Planning: Phased withdrawals offer the chance to strategically manage your tax liabilities, potentially reducing your overall tax bill.
💡Inheritance Benefits: Keeping funds within your pension might offer tax advantages when it comes to passing on your wealth, as money within pensions is usually outside the scope of Inheritance Tax.
Real-Life Scenarios: Why taking your tax-free cash in stages might make sense
Case Study 1: Meet Susan
Susan is 62 and ready to stop work, but her spouse wants to keep on for a few more years before they retire to Spain.
She doesn’t need a large income right away, so instead of taking a big lump sum from her £600,000 pension, she opts for smaller, mixed withdrawals that partly count as taxable income and partly as tax-free cash.
This strategy lets her utilise her Personal Allowance (the amount you can earn tax-free each year) to effectively draw funds without paying income tax, while also benefiting from her tax-free cash allowance.
Case Study 2: Pete’s Plan
Pete is 58. He is gradually transitioning to full retirement by working part-time as a non-executive director (NED).
With a £800,000 pension pot, he is entitled to a significant tax-free sum but chooses to withdraw only £20,000 yearly as a tax-free lump sum.
This smart move avoids increasing his taxable income, allowing him to enjoy his earnings and pension withdrawals without handing over a chunk to the taxman.
The Bottom Line
When it comes to deciding how to take your pension benefits, the key is flexibility.
With careful planning, phased withdrawals can provide a steady income, minimise taxes, and ensure that your retirement savings continue to work hard for you.
Further Reading
New Pension Rules 2024: How to Prepare for the Abolition of the Lifetime Allowance
How do I apply for an NT Code for pension income?
Should I take a lump sum from my pension? 4 reasons why you should think twice
