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Should I take my 25% tax free lump sum out of my pension now or leave it?

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To take or not to take, this is a question that most pension holders begin to ponder as their retirement begins to approach

Of course, the attraction of obtaining £25,000 tax-free on a pension of say £100,000 is obvious and not to be sniffed at. It could be particularly handy if you wish to access a big pot of cash and use it to settle long-standing debts, like paying off the mortgage, taking that dream holiday or treating a loved one. However, whilst this has become the default option of choice for many over 55’s or those close to retirement age, it should not be automatically assumed that this is the right option for everyone and it deserves closer consideration and analysis.

Things to consider

The key thing to consider is -Do you need the money in your pension right now? If not, the rules introduced as part of wider “pension freedoms” in 2015 also allow you to grow your pension pot increasing its value, ultimately leaving you with more money to fund your retirement at least for longer and with a higher standard of living.

If you choose to take advantage of these reforms and decide to raid the piggy bank, the options are clear, especially when one looks at a pension pot worth, for example, £100,000.  Here, you can either take £25,000 tax-free in one lump sum leaving you with a pension pot of £75,000 and the rest of the pension fund is taxed at whatever your normal rate of tax is  – ie 20%, 40% or 45%.

Alternative options

Alternatively, a more sensible option for others might be to take 25% tax-free on every withdrawal you make, so on a £10,000 withdrawal – the first £2,500 of this would be tax-free and on the rest of £7,500, you would pay tax on whatever income tax band you are currently taxed at. The main advantage of this is that you would be able to build up a much greater pension fund and from this get greater returns over the longer term. You will have more money in your pension by having more funds in it rather than reducing it by taking out a large lump sum.

Unfortunately, if you take a 25% lump sum at the start of your pension you lose the option to take that 25% tax-free on every withdrawal you make thereafter. It is clear that whilst these reforms (now in their fourth year) offer over 55’s greater powers on how they spend, save or invest, it is imperative that any decisions they make are carefully considered and that the decision made now suits them at this juncture of their life and more importantly into the future.