A “spend, spend, spend” attitude has taken hold, but millions risk leaving themselves short of money in later life after blowing their tax-free cash. Too many are driven by the idea that “everyone is doing it” and face disaster as a result, a top pensions expert has warned.
Savers can usually take up to 25 percent of the amount built up in any of their pension pots as a tax-free lump sum.
This is not subject to income tax and doesn’t affect your personal allowance. Withdrawals from the remaining 75 percent of pension will be taxed before you receive them.
This means that somebody with, say, a £60,000 pension could take £15,000 free of tax, while their pension company would automatically deduct tax from the remaining £45,000.
Most people are free to make pension withdrawals from age 55, although it varies according to the scheme.
Stephen Lowe, director of retirement specialist Just Group, fears many will squander this money by treating it as a windfall.
He warned: “Taking your pension tax-free cash at age 55 is an option, not a requirement. Don’t treat it like a lottery win because it is likely to represent a hefty chunk of all the money you’ve saved to see you through your life after work.”
Yet figures suggest the spend, spend, spend mentality has taken hold.
The over-55s are racing to cash in pensions early, which City regulator the Financial Conduct Authority has described as “the new norm”.
Its research found that many consider it a ‘windfall’ and are motivated by a perception that “everyone is doing it”.
Nearly two in three savers who put their pension into drawdown in the 2021 tax year, did so purely to take the tax-free cash.
Drawdown involves leaving your pension invested in later life, rather than buying an annuity, and taking cash lump sums as required.
Tax-free cash is sometimes called the Pension Commencement Lump Sum. It is available on all workplace and personal defined contribution schemes, and some final salary defined benefit schemes as well.
“This is a valuable perk so it is important not to squander it,” Lowe said.
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Lowe urged savers to resist the urge to cash in. “You don’t have to take all your tax-free cash at once, just take what you need. Leave the rest to benefit from future investment growth.”
Ignore friends or family who claim that taking the money is a “no-brainer”, because it isn’t. “If you need money, consider tapping other cash reserves instead.”
The worst thing you can do is to put the money into an easy access cash account, where you are likely to get lower returns and the money becomes taxable, too.
Splashing the cash on a new car a holiday of a lifetime can also backfire.
Lowe said there are some instances when you should take the tax-free cash. “It could make sense if you need to clear expensive debt, generate emergency income, or raise cash to see you through until the State Pension kicks in.”
Always check your eligibility to state benefits first, though. “Take free, impartial and independent guidance from the government’s Pension Wise service at MoneyHelper.org.uk to help understand your choices, and consider independent financial advice, too.”
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