Too often it’s the default decision to take tax-free cash from accumulated pension funds. It’s almost a case of ‘Well, it’s there to be taken, so I’ll take it’. Remember that one quarter of your accumulated DC pension fund can be taken as a tax-free cash lump sum when you choose to crystallise your pensions.
There are occasions where more than 25% can be taken, often from old pensions where the rules were slightly different. Often this tax-free cash is used to fund the big holidays or other purchases that people often make when they first retire. That’s fine of course, but like all things, the decision to take your tax-free cash should be made intentionally, and not by default.
Why might you consider NOT automatically taking your full tax-free cash? Well firstly, if you have an inheritance tax issue, you might want to consider not adding to that problem by shifting money from your pension, which is almost always NOT subject to inheritance tax, into your bank account where it IS taxable. This isn’t the time to go into the IHT rules, but if you have an estate that is potentially liable to IHT, you’ll probably know it.
Also, while that money is inside your pension, it is growing free of all taxes, whereas if you pull it out then it’s in your bank account, and hence potentially taxable. You may of course reinvest it into an ISA, but that might take you a few years, depending on the amounts involved.
And taking all your tax-free cash in one go is a very broad-brush action which might not be the best choice. Remember that whenever you move any money over the imaginary line which advisers call crystallisation, it’s at that point only when you get to decide if you take the tax-free cash or not. If you shift all your fund over and take all the tax-free cash at that time, it’s job done; once-for-all.
Maybe instead you could draw from your pension in a series of withdrawals over time, with part of each withdrawal being made as tax-free cash and part of it taxable. If you have no other income, you could be taking £16,666 out per year tax-free, by utilising your personal allowance and also your tax-free cash on top of that.
This might be particularly useful if you’re looking to retire before state pension age but after the point at which you can draw from pensions or maybe from other DB schemes you might have. All I’m saying is to think it through, and not default into the thinking of ‘well, I’m 55 and I can take my tax-free cash, so I will!’ – I see that all the time and it makes me sad…
Isn’t £16,666 last years number? (though it is way easier to remember)
In the case of being close to the LTA isn’t it better to take out the PCLS and invest elsewhere to avoid bigger tax bills later? Even if that means managing a GIA.
Though the inheritance tax conundrum is real though especially in the LTA case.
Be great if you could show this with various calcs to demonstrate how it would work and why it could be beneficial I’m trying to get my head around this very topic as I’ll have up to 3 individuals tax free pots to potentially draw but realise it may well not be the right thing to do and not really sure what I’d do with potentially 90k in tax free cash albeit I’ll need it to live off until state pension age but don’t see point in taking it to leave it in a bank account doing nothing except being eroded in real terms – I’d luv to see various options on how best to deal with tax free benefits