Pros and Cons of taking a Lump Sum

Wyndham

I hope that someone can explain this to me in simple terms. I've reached the age where pensions have started to become of interest to me, but I also know that there is a lot I don't know!

I'd like some advice on lump sums. As I understand it:
If you take one, you get (up to) 25% of your pension tax free. However, your ongoing income in retirement is reduced because you've taken it.
If you don't take one, you have a higher ongoing income, but miss out on the tax free status.

In my head 'tax free' equals 'good'. But I'm sure it's actually more nuanced than that. So, does anyone have any advice of other things I should be considering?

My circumstances are likely to be that I would have no immediate need for a lump sum. I also will be a tax payer in retirement.

BoxerfanUK

depends what you pension is,  DB or DC?

Wyndham

BoxerfanUK said:

depends what you pension is,  DB or DC?

I'm in a very mixed economy! Some work based pensions (both final salary and career average as the world changed). More recently I have a SIPP as I'm now self employed.

I don't really understand why DB or DC makes a difference (as I said I know that there is a lot I don't know). Are you able to explain why you asked the question?

MallyGirl

Assuming it is a DC pot - you don't have to take it all up front. You can draw down from your pension in an ongoing fashion with 25% of every drawdown being tax free and you paying relevant tax on the other 75%. So you could draw £16.6k and pay no tax as the 75% that is taxable falls under the £12k (ish) personal allowance. Assumes no other income for this.

dunstonh

I've reached the age where pensions have started to become of interest to me, but I also know that there is a lot I don't know!

Congratulations on your 18th birthday

If you take one, you get (up to) 25% of your pension tax free. However, your ongoing income in retirement is reduced because you've taken it.

Not necessarily.   If you take the 25% up front then your pot will be lower by 25% but it doesnt mean you need to necessarily change the withdrawal amount.

If you don't take one, you have a higher ongoing income, but miss out on the tax free status.

No.   If you don't take the 25% up front then any withdrawals you make will be taxed on the basis of 75% taxable and 25% tax free.

BoxerfanUK

Wyndham said:

BoxerfanUK said:

depends what you pension is,  DB or DC?

I'm in a very mixed economy! Some work based pensions (both final salary and career average as the world changed). More recently I have a SIPP as I'm now self employed.

I don't really understand why DB or DC makes a difference (as I said I know that there is a lot I don't know). Are you able to explain why you asked the question?

For DC as Mallygirl said, and in addition the 25% lump sum if you don't take straight away stays invested within your pension to potentially grow and also stays outside of your estate for inheritance tax purposes whilst its in your pot.

For DB, it could depend upon what you opt to do!  For some schemes you could opt to take a larger lump sum (meaning more tax free) in exchange for a reduced annual pension.   Or you may opt to forego some or all of what would have been your tax free lump sum to buy a larger annual pension, all depending on the scheme rules of course.

Wyndham

Right, the mist is starting to clear!

I've basically got confused by the various different pensions I've had over the years. Mostly DB, and maybe there the lump sum isn't worth taking in order to get a higher level of ongoing income - but I'll run figures closer to the time. For DC, I may make different decisons and it may be worth taking the lump sum - either at once or ongoing.

Thanks all. Apologies for the basic questions. I'm really good with most things financial, but do find pensions to be hard and confusing!

Phossy

If you are in a final salary scheme (DB) and take the lump sum, then it may keep you in a lower tax bracket (especially when you also get the state pension). It is also money in your hand right now rather than eeeked out over 20 years (if you are lucky).  Down to the individual whether this suits you or not (pay of your debts, blow-out holiday, new car etc)..

Marcon

This might be helpful reading: https://www.moneyhelper.org.uk/en/pensions-and-retirement

Depending on your age (minimum 50), a free appointment with PensionWise https://www.moneyhelper.org.uk/en/pensions-and-retirement/pension-wise could help to further clarify your options/give you a grasp of the basics.

LHW99

Although for DB pensions it is not necessarily a "25%" lump sum, as a DB pension is not actually a pot of money.

Its called a pension commencement lump sum (PCLS) and is defined by the pension Ts & Cs, eg 3 x annual income.

You can often decide whether to take more lump sum (which would reduce your annual pension) or less and increase the annual pension paid.

So there are quite a lot of differences between DB and DC pensions, and it's good you are looking into it early, as it gives plenty of time for the details to be mulled over and understood. It's taken me at least 40 years!

Sarahspangles

Depending on the DB scheme, the rate at which you ‘buy’ extra lump sum may not be generous. LGPS for example is 1:12 which is pretty low.