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Your practical guide to pension tax-free cash

Category: News

Your pension is incredibly tax-efficient. Not only do you receive tax relief on the contributions you make, but at retirement, you’ll likely have the option to take 25% of your pension fund as tax-free cash.

The minimum retirement age in the UK currently stands at 55 (rising to 57 in 2028). And yet, a recent survey from Standard Life found that nearly half (43%) of over-55s don’t know that tax-free cash is an option.

The choices you make at retirement can have long-lasting implications so being fully aware of your options, and making an informed choice, is key. 

Keep reading for your practical and indispensable guide to pension tax-free cash.

Defined contribution (DC) schemes usually allow you to take up to 25% of your pension pot as tax-free cash

A pension commencement lump sum (PCLS) 

If you opt to take an annuity at retirement, you’ll usually be able to receive up to 25% of your fund as a one-off lump sum, known as a “pension commencement lump sum (PCLS)”.

While the popularity of the traditional annuity has declined in recent years, thanks to a mixture of low rates and Pension Freedoms legislation, the tables are turning. 

FTAdviser reports that between January and October 2022, rates increased by 52%, reaching their highest point in 14 years.

Higher rates and a guaranteed, stable income might be very attractive in the current climate. You’ll need to weigh up the pros and cons carefully so speak to us before you decide.

Flexi-access drawdown

Pension Freedoms introduced several flexible options including flexi-access drawdown. You can take as much, or as little income as you want, only when you need it. And you can be flexible with your tax-free entitlement too.

You can take the full 25% in one go or split it between each payment you receive.

Remember, unlike an annuity, flexi-access drawdown doesn’t guarantee an income for life so your money can run out. You’ll need to budget carefully as the onus is on you.

Uncrystallised funds pension lump sum (UFPLS)

An UFPLS is a lump sum – or a series of lump sums – that are paid as 25% tax-free cash and 75% is taxed as income. 

As with drawdown, once you exhaust your pension fund through UFPLS payments, it will have run out so you’ll need to budget carefully.

Tax-free cash can be great for covering one-off expenses or even clearing debt

If you have one-off big-ticket items planned for the start of your retirement, a tax-free cash lump sum can be a great way to pay for these. World travel or house renovations in the early, active years of retirement can set you up for later life when your retirement expenditure might start to dip.

You might also use your tax-free cash to pay off debt or add to your investment portfolio. 

These can be especially useful options post-Pension Freedoms.

This is because you can take tax-free cash without drawing from the taxable element of your pension fund, which remains invested. You can continue to contribute – up to the Annual Allowance (£60,000 for the 2023/24 tax year) – and hopefully see further investment gains.

Paying off debt, meanwhile, has the benefit that when you do start to receive an income, the whole amount can go towards helping you live your dream lifestyle.

Your maximum tax-free cash entitlement remains the same despite Budget changes

The chancellor, Jeremy Hunt, used his spring Budget to announce the abolition of the Lifetime Allowance (LTA). This is the amount you can withdraw from your pensions during your lifetime without paying an additional charge. This charge has now been removed.

The threshold itself is important though. Because it was this amount that set the maximum tax-free you could take. 

Currently, the level of the LTA for tax-free cash calculation purposes is £1,073,100 – its 2022/23 amount – and it is likely to remain frozen at this level. Your maximum tax-free cash entitlement is currently £268,275, or 25% of the LTA.

This could be different if you have any form of HMRC protection or you have a DB scheme (and future governments might look to reintroduce the LTA or make threshold changes) so speak to us if you are unsure.

Get in touch

If you would like help setting up a pension or JISA for your child, or you have any questions about providing financial education to your children, speak to us now. Get in touch by emailing or calling 03452 100 100

Please note

The value of investments (and any income from them) can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance. Investments should be considered over the longer term and should fit in with your overall attitude to risk and financial circumstances.

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