If you have more than one pension pot, you can take the whole amount from one and continue to pay into others.
If you take anything other than your tax free lump sum, you will have to pay tax on contributions (employer and your own combined) to defined contribution pensions over £4,000 a year. This is known as the ‘Money Purchase Annual Allowance (MPAA)’ and is based on your gross contributions (ie. it includes your tax relief ).If you’re a member of a defined contribution pension scheme, you may be facing the dilemma of whether to stay put or cash out.
What is a Defined Contribution Pension?
A Defined Contribution Pension consolidates both yours and your employer’s pension contributions into one pot. Whilst you work, the money in your defined contribution pension pot is invested, usually in a mix of cash, stocks and shares, property and fixed interest securities, available for you to access in retirement.
Things to consider before cashing in your defined contribution pension
According to the Office for National Statistics, the number of people cashing in their defined contribution pension has soared since radical pension freedoms were introduced in 2015, but for many it still makes sense to stick.
You don’t have to start taking money from your pension pot when you reach your chosen retirement age (currently any time from age 55 onwards). You can leave your cash invested until you need it. But, if you are thinking of defined contribution pension plan withdrawal, here are some options to consider.
Taking your defined contribution pension pot as a lump sum
You can choose to completely cash out and take your whole defined contribution pension pot as a lump sum. If you do, 25% will be tax-free, the other 75% will be taxed. Your pension provider will deduct the tax owed before they pay you the cash lump sum.
Taking a large sum from your pot can mean you pay a higher amount of tax on any other income such as salary and savings. It could also affect your entitlement to any benefits you may be receiving.
Many people decide to cash in their defined contribution pension then reinvest the money elsewhere. Ensure you consider all the options available to you by seeking independent financial advice.
Taking cash in smaller chunks
You can opt to take smaller sums of cash from your defined contribution pension pot until it runs out. With this approach, you can decide how much you take and when you want to take it. Each time you take a lump sum of money, 25% is tax-free and the rest is taxable. Not all pension providers offer this option, and some may charge a fee to take cash out.
The money you withdraw will be added to any other income you receive for that year, such as State Pension payments, benefits and interest from savings or salary. Taking a large amount of cash in one go could result in you moving into a higher tax rate. Spreading the cash amounts across more than one tax year, could help keep your tax bill down.
Adjustable income (flexi-access drawdown)
You can receive an income from your pension pot that’s adjustable. This option, also known as ‘flexi-access drawdown’, means you get a regular income but can change it, or take out cash sums if you need to.
You get 25% of your pot either as a single, tax-free cash sum or each time you move some funds into flexi-access drawdown. The remaining 75% of each amount is invested to provide a regular, taxable income.
An independent financial adviser can help create an investment plan for your money, advising on how much to take out and the likely tax implications.
Guaranteed income (annuity)
You can use your pension pot to buy an insurance policy that gives you a guaranteed income for the rest of your life, no matter how long you live.
You take 25% of your pot as a tax-free lump sum and buy what is referred to as an annuity with the remaining 75%. You then pay tax on your annuity income.
If you’re currently receiving a pension income, it’s likely that you’ve already bought an annuity or are taking an income from a final salary or defined benefit pension.
How much income you get each year from an annuity depends on factors such as how much you had in your pension pot when you bought the annuity; your age, health and lifestyle; whether you want the income to increase each year; and whether you want the annuity to pay out to someone after you die.
Mix your pension options
You can choose to mix the ways you take your defined contribution pension pot, such as using some of it to get an adjustable income and some to buy an annuity.
Multiple pension pots
If you have multiple pension pots, you can use different options for each, such as leaving one untouched and taking cash in chunks from the other.
Mixing your options can be complicated and you will benefit from independent financial advice to ensure this works favourably for you.
To speak to a Chase de Vere adviser, request your initial consultation here or call 0345 300 6256.
This article is for general information only and is not intended to be individual advice.
This represents our understanding of law and HM Revenue & Customs practice as at 06.04.2019.