Should I Cash In My Pension?

Beware Pension Liberation Scams

The new pension freedoms allowed more direct access to your pension pot and provided more choice for your retirement income. However, fraudsters have exploited the public’s awareness of the new pension freedom rules.

People have been targeted with cold calls and emails, promising to use non-existent loopholes to release or unlock their pensions before the age of 55. The so-called pension liberators may also charge steep fees, seriously denting the total value of your retirement pot.

It is important to know that unless you’ve been diagnosed as seriously ill or have an early protected retirement age, it’s never possible to release your pension before the age of 55 without facing a stiff penalty. Make sure you don’t fall for the fraudsters.

Jonathan Cooper
Senior Paraplanner at Drewberry

Can I Cash Out My Defined Benefit Pension?

You can’t usually cash in your final salary or defined benefit (DB) pension in the same way you can for a money purchase scheme. An exception is if your pension provisions are worth less than £30,000. This is known as a ‘trivial commutation’ lump sum and the first 25% is tax-free, providing you meet strict conditions.

The trustees may not allow you access to the pension fund to do so, however. Moreover, while those with money purchase schemes can access their savings from 55, the rules of many final salary schemes usually have a much higher retirement age.

However, if you do want to pursue this route, you should consider getting pension transfer advice to see if transferring your final salary pension to a money purchase scheme is right for you.

If your pension provisions are worth more than £30,000 and you’re considering transferring out, then getting pension advice from an appropriately-qualified expert is a regulatory requirement.

HMRC’s Tax Rules For Cashing In A Pension

If you do decide to cash in your pension for a lump sum, only the first 25% will be tax-free. The rest of the money you withdraw will be taxed as income at your marginal rate of income tax during the tax year you make the withdrawal.

That means if you have pension savings, you could end up paying a higher rate of tax on the sum that you’ve taken. In the table below, imagine you have a pension pot of £50,000 and you want to take the entirety as a cash lump sum, but you’re still working and earning £30,000 per year.

By taking the entire £50,000 pension pot in one cash lump sum and also drawing their salary, this individual has pushed themselves into the higher tax bracket and is therefore required to pay 40% tax on some of their earnings that year.

You can avoid being hit such a bill by spreading your withdrawals over a period of several years rather than taking it out in one big lump sum.

Can You Afford To Cash In Your Pension?

If you’re considering cashing in your pension, it’s not just tax you need to think about. It’s important to consider how you’ll fund your retirement if you take your pension pot now as one cash lump sum.

Keep in mind that you might spend 30 or more years in retirement, so you’ll need to make sure you have funds available to cover your living costs.

According to the Office for National Statistics, people aged 55 today will on average live to their mid-to-late 80s. About 1 in every 10 men and 1 in every 5 women will live until they are 100.

That means that when you’re considering taking your entire pension as a cash lump sum at age 55, you could only be just over halfway through your life. You should consider how you’ll manage financially if you were to survive for another 45 years after withdrawing your pension cash.

Cashing in your retirement savings will reduce the pension you have left — if it leaves any at all. Always seek financial advice before you act and think carefully about how you much money you’ll need for the rest of your life.

Don’t assume that you can spend your pension cash and then rely on the state to look after you. The maximum New State Pension for a man born on or after 6 April 1951 or a woman born on or after 6 April 1953 is £203.85 per week in the 2023/24 tax year.

You’ll only get this full amount if you’ve made the full 35 years of qualifying National Insurance contributions; you might get less depending on your work history. In total, the state pension is worth £10,600.20 per year in 2023/24, hardly enough for a comfortable retirement.

Should I Cash in My Pension?

If you do decide to cash in a pension despite the risk of running out of money in your old age, make sure you think carefully about what you’ll do with the lump sum.

Having the cash suddenly at hand might mean it’s tempting to spend it on home improvements or a holiday, but remember that for every pound of your pension you spend today, you’ll have less to live on in your old age.

In a pension, your cash can continue growing tax free. You can also continue adding to it and getting income tax relief for doing so.

If you decide to cash in your pension and put it into a savings account, for instance, current low interest rates mean it’s unlikely you’ll see much of a return. The spending power of the lump sum could gradually be eroded by inflation. Moreover, there’s no tax relief on savings in a savings account.

Leaving money in your pension means it will continue to grow tax-efficiently and won’t form part of your estate for inheritance tax purposes. The longer you leave your pension savings invested, the greater the income you could achieve when you eventually decide to take it.

Cashing in Your Pension to Repay Debts or Buy a House

You might be tempted to cash in your pension in order to pay off any debts you have, such as your mortgage, personal loans or credit cards.

However, your pension is there to fund your retirement, so although paying off your debts might give you peace of mind now, you must be certain that you are left with sufficient funds for you to live off in later life.

It’s worth bearing in mind too that thanks to low interest rates, mortgage costs are lower than they’ve ever been, so you may be better off leaving your money invested rather than paying off the mortgage.

Some parents may also see their pension fund as a way to help get their children on the property ladder. Once again, you have to consider that although that might feel good today, it won’t provide you with an income when you’re older.

Cashing In Your Pension For A Buy-To-Let

Similarly, some are considering using pension funds to purchase buy-to-let properties. While you might feel comfortable being a landlord at age 55, will the same be true at 75? Or 85?

You might then want to sell a buy-to-let property in the future and the price you’ll get will be determined by the market at the time you want to sell. You may also have to pay capital gains tax on the proceeds of the sale.

If you are making plans for cashing in your pension, you should consider talking through your options with an expert first, who can recommend the best options for you.

Your Financial Plan – Build A Better Future

A good financial plan can help you make the right decisions when it comes to your finances. Make the right decisions today to build a more prosperous future.

Good financial planning with clear goals can increase your retirement income by as much as 53%. Old Mutual Redefining Retirement Survey

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