Downside of taking the 25% lump sum from a pension early?

RiskyScientist

Hello - I am 65 years old and have several direct contribution type pensions.
I am still working, though only for another 2-4 years.
Assuming I am allowed to take the 25% tax free lump sum now instead of later, what is the downside of doing this?
I am concerned that the current government might remove the 25% tax free lump sum rule.
Thanks!

Stubod

...unlikely they will remove this...IMHO??

Dazed_and_C0nfused

RiskyScientist said:

Hello - I am 65 years old and have several direct contribution type pensions.
I am still working, though only for another 2-4 years.
Assuming I am allowed to take the 25% tax free lump sum now instead of later, what is the downside of doing this?
I am concerned that the current government might remove the 25% tax free lump sum rule.
Thanks!

What has made you think that be a possibility?  

One downside of taking the 25% now is that whatever the remaining 75% subsequently grows to them 100% of that is taxable when you take it out of the pension.

Say your total defined contribution pension are currently worth £200k.  You take £50k TFLS leaving £150k in the pension.

If that £150k has become say £200k a few years later the whole £200k is taxable when taken out of the pension.  Obviously what other taxable income (and the types of income) you have when taking money out of the pension will determine how much of an issue this is.

westv

Depends what you do with it.
If you keep it invested that's ok - but if you keep it invested why take it out anyway?
If you keep it as cash then you could be losing out on investment gain.
If you want/need to spend it on something then that's your choice.

RiskyScientist

Dazed_and_C0nfused said:

RiskyScientist said:

Hello - I am 65 years old and have several direct contribution type pensions.
I am still working, though only for another 2-4 years.
Assuming I am allowed to take the 25% tax free lump sum now instead of later, what is the downside of doing this?
I am concerned that the current government might remove the 25% tax free lump sum rule.
Thanks!

What has made you think that be a possibility?  

One downside of taking the 25% now is that whatever the remaining 75% subsequently grows to them 100% of that is taxable when you take it out of the pension.

Say your total defined contribution pension are currently worth £200k.  You take £50k TFLS leaving £150k in the pension.

If that £150k has become say £200k a few years later the whole £200k is taxable when taken out of the pension.  Obviously what other taxable income (and the types of income) you have when taking money out of the pension will determine how much of an issue this is.

Maybe I'm not understanding something.  In general, when you take money out of your pension, that money is taxed as income at your then-prevailing tax rate right?

So in your example, if I left the entire amount of money in the pension, then when I withdraw money I will pay income tax on what I withdraw.

The point of the 25% tax free lump sum is that you can take money out of your pension without paying income tax on it, no?

In which case how is it a downside that the money left in the pension fund will be taxed when taken out?

Doing the sums it seems like you pay less overall tax by taking the 25% lump sum - wasn't that the point of the 25% tax free lump sum?

Maybe I am wrong...

molerat

That 25% would continue to grow and still be tax free.  If you take it now without a real reason for doing so you lose that tax free growth.  In the future you may need to withdraw say £50K.  All of that would be subject to tax.  If you had left the tax free amount in the pension then you could withdraw that £50K with only £37.5K subject to tax.  The real question here is why do you want to take that tax free sum now ?

dunstonh

Assuming I am allowed to take the 25% tax free lump sum now instead of later, what is the downside of doing this?

a) you won't be able to use UFPLS in retirement (a popular and efficient income method)
b) your retirement fund will be a quarter lower.

I am concerned that the current government might remove the 25% tax free lump sum rule.

Even though they said they are not?

Doing the sums it seems like you pay less overall tax by taking the 25% lump sum - wasn't that the point of the 25% tax free lump sum?

Yes.   So, if you started to draw an income in retirement using monthly UFPLS, and it was £400pm, then £100pm. would be tax free, and the remaining £300pm would be taxable.

p00hsticks

RiskyScientist said:

Dazed_and_C0nfused said:

RiskyScientist said:

Hello - I am 65 years old and have several direct contribution type pensions.
I am still working, though only for another 2-4 years.
Assuming I am allowed to take the 25% tax free lump sum now instead of later, what is the downside of doing this?
I am concerned that the current government might remove the 25% tax free lump sum rule.
Thanks!

What has made you think that be a possibility?  

One downside of taking the 25% now is that whatever the remaining 75% subsequently grows to them 100% of that is taxable when you take it out of the pension.

Say your total defined contribution pension are currently worth £200k.  You take £50k TFLS leaving £150k in the pension.

If that £150k has become say £200k a few years later the whole £200k is taxable when taken out of the pension.  Obviously what other taxable income (and the types of income) you have when taking money out of the pension will determine how much of an issue this is.

Maybe I'm not understanding something.  In general, when you take money out of your pension, that money is taxed as income at your then-prevailing tax rate right?

So in your example, if I left the entire amount of money in the pension, then when I withdraw money I will pay income tax on what I withdraw.

The point of the 25% tax free lump sum is that you can take money out of your pension without paying income tax on it, no?

In which case how is it a downside that the money left in the pension fund will be taxed when taken out?

Doing the sums it seems like you pay less overall tax by taking the 25% lump sum - wasn't that the point of the 25% tax free lump sum?

Maybe I am wrong...

You don't necessarily need to take that 25% as a one-off lump sum at first though - you could instead (assuming your particular pension scheme caters for it) do what is called UFPLS, where every individual withdrawal you make from the pension consists of 25% tax free and 75% is taxed. 

Albermarle

RiskyScientist said:

Hello - I am 65 years old and have several direct contribution type pensions.
I am still working, though only for another 2-4 years.
Assuming I am allowed to take the 25% tax free lump sum now instead of later, what is the downside of doing this?
I am concerned that the current government might remove the 25% tax free lump sum rule.
Thanks!

Just scaremongering by the usual suspects in the media.
There probably will be some changes to pension regulation, possibly around higher rate tax relief and inheritance tax advantages. However the 25% tax free is safe as it can be.

RiskyScientist

Thanks all - I missed the statement about not removing the 25% lump sum rule.

xylophone

Even though they said they are not?

Well............

https://www.thisismoney.co.uk/money/comment/article-13706981/Reeves-regret-winter-fuel-payment-raid-pensioners-says-JEFF-PRESTRIDGE.html

I spent five hours on the phone to readers who will lose the benefit. For some, its loss will put more pressure on already fragile finances. For others, it will make little difference, but they feel betrayed after Labour had vehemently denied, pre-election, that the payment would be means-tested.