Lump Sum or Pension

This article discusses general concepts and ideas, rather than any specific policy or plan. This website does not contain personal advice based on your circumstances.

By Bob Cook

One of the most common searches on our Best Pension Annuity website is by customers who are uncertain whether they should take a lump sum from the pension or just an income. Perhaps the most important thing to say at outset is that they can have both.

In fact pension rules dictate that typically only 25% of the pension value can be taken as a pension lump sum. The reason for this restriction is that the lump sum paid to you is not subject to income or any other form of tax, it is a pure Tax Free Cash lump sum.

Depending on your circumstances you either have to convert the remaining 75% of your fund into a regular income known as a pension annuity or you can leave it invested to take an annuity later, it you are not retiring yet.

Many people who want to realise Tax Free Cash and are not yet planning to retire, tend to leave the remaining 75% of the fund invested. There are two main reasons for doing this. The first is that all annuity income is taxed. Therefore if you are working and paying tax on your income, this additional income would also be subject to tax and possible high rate tax at 40% or even 50%.

The other thing is that the amount of income you will receive from an annuity will be higher the older you are. Therefore taking an income from your pension before you retire or before you need to, is generally not a good idea.

The issues about whether you should take your tax free cash or use it all to purchase an annuity is more complex and will largely depend on your circumstances and your needs at the time. The obvious thing to say at this point is that in my experience the vast majority of people will take a lump sum from their pension, the key being those magic words ‘tax free’. If the lump sum is not taken and is used to purchase a pension annuity all of the income paid to you is eligible for tax.

Even if you do not have an immediate need for a pension lump sum. By keeping the money invested on deposit, it can provide a useful emergency fund to pay for those unexpected bills that might occur in the future.

Of course we do have customers who elect not to take Tax Free Cash and instead convert their entire pension fund into an income. In the main these tend to be people who heed to maximise their income and  would rather see their annuity income increase by a third.

Ultimately only you will know what is the right decision for you, if you are however unsure you should consider taking financial advice.