The latest retirement data from the Financial Conduct Authority (FCA) is out. This shows almost 60% of pension pots are taken in one go as a cash lump sum. In sectors where many people work part-time and therefore have lower savings this can be around 90%.
Everyone has the right to take any pension pot they have in one go. For some, it may be the right thing to do. But for many, there are three key issues which can arise. We explain these below, what you need to think about and how to possibly avoid them.
Paying too much tax
Many people who take a pension pot in one go will be working at the time. Whilst 25% of any pension pot is tax free, 75% is taxable. That means it gets added to your other taxable income (wages for most people) in that tax year.
Currently you pay zero tax on total income up to £12,570. Then 20% on any more income between £12,571 and £50,270, then 40% on any more above that.
There are higher rates and reducing allowances also above this. Plus if you are based in Scotland, like us, we pay a bit more at most levels. We won’t consider any of that here. The principle of over paying tax, when you don’t need to, is the same.
Let’s say you earn £35,000 and have a £30,000 pension pot. Taking the £30,000 all in one go means 75% (£22,500) is taxable. That means your total taxable income is now £57,500. You will now be taxed 40% on £7,230. This is a higher rate of tax than you would usually pay.
Instead of this taking the £30,000 pot in one go, you could take it over, say, three years. This means you will never pay more than 20% tax.
If you had no other earnings, then taking £10,000 a year would mean it could all be paid tax free.
Key takeaway – Adding 75% of the pension pot value to your expected income that tax year may push you into the next tax bracket. It it does then you may need to think if you are better off spreading the payment over 2-3 tax years. This will also mean the money in your pot can stay invested, perhaps earning a bit more return over that time as well.
Losing benefits
Lots of part time and lower paid full time working people are eligible for means tested benefits. This is usually Universal Credit before State Pension Age.
After State Pension Age, if you receive a full State Pension then you are unlikely to receive much in the way of means tested benefits. You may receive Pension Credit if you don’t get a full State Pension.
Benefit entitlement is very complex. If you think you may be entitled to benefits, you should check using a good calculator like this one from Inbest. Also if you want to find out more about Universal Credit check here.
Let’s assume you are working and claiming Universal Credit to top up your income. If you take a £10,000 pension pot in one go, what you then do with the money is key.
If you save it and put it in a bank account, then you now have £10,000 in savings. Pension pots aren’t counted as savings before State Pension Age, but bank accounts or ISA’s are. Universal Credit reduces if you have more than £6,000 in savings and is zero if you have more than £16,000.
If you spend the money straight away by paying off any debts (which then reduces your repayments and income needs), or any outstanding bills, then you won’t have these added savings in the bank. This means any Universal Credit payments should be unaffected.
Key takeaway – If you are going to save the money anyway, why take it from the pension pot in one go in the first place? It seems much better to leave it there until you need it. Again, this may reduce the tax you pay also and perhaps add some additional growth. When you do need it, taking smaller amounts to pay off debts, or making payments you need to at the time is far less likely to affect any benefits.
Having enough to live on in retirement
The Pension and Lifetime Savings Association (PLSA) provide some helpful figures. The PLSA estimate that you currently need around £14,400 a year, after tax, for a minimum single retirement income.
You will need more if you retire in London, have to pay ongoing rent, or if you are still paying off your mortgage for a few more years.
From State Pension Age you can currently get around £11,500 from the State Pension. If you don’t get a full State Pension, then Pension Credits may top up your income to around the full State Pension amount.
By taking a pension pot as a lump sum, does this leave you with enough other things to provide the minimum needed from State Pension Age? This could include other pension and savings pots you have. It could also include any home equity you may have and choose to take. Finally, any other pension and non pension incomes, such as part time work, could be used.
Key takeaway – working this all out yourself will be difficult. You could use Guiide, which is free, to do the calculations for you to see how you may put everything together.
Select you won’t take any tax free cash lump sum at retirement so your whole pension pots are used for an income. Then set a minimum income level, plus any rent payable for life, or remaining mortgage payments needed for a few years until they are paid off.
You can then see if you would expect to have any shortfalls if you retire at your State Pension Age.
We are trying to help more
We are launching an At Retirement Protection service. This allows employers, providers and schemes to help people who say they want to take all their pot in one go. This will help them consider the relevant points to support them in making a choice that they feel is right for them. They can do this by just answering a few simple questions.
If you would like to help your employees to be aware of some of the pitfalls please contact us at contact@guiide.co.uk or philiph@guiide.co.uk
