This content is for information and inspiration purposes only. It should not be taken as financial or investment advice. To receive personalised, regulated financial advice please consult us here at Elmfield Financial Planning in Padiham, Burnley, Lancashire.
The question of what to do with your 25% tax-free pension lump sum has come into sharper focus in 2020. In stable times, this is a big decision given the vast sums involved and the impact upon your nest egg. Yet since the COVID-19 pandemic and subsequent volatility in the stocks markets, many pensions across the UK (which are typically invested in them) have taken a big hit too. What should you do, therefore, if you are over 55 and looking to retire soon?
On the one hand, accessing some of your 25% tax-free lump sum from your pension could be a tempting way to plug an income gap. Many people have lost hours and employment from the pandemic and pension savings may seem an easy way to boost your income in the short term. Yet, on the other hand, withdrawing large sums from your pension in a volatile market risks disproportionately reducing the size of your pot. In the worst case scenario, this could lead to you running out of money in retirement.
Here at Elmfield, our financial planners in Padiham, Burnley, Lancashire do not want to see that happen. Nobody deserves to be impoverished in retirement. Here, we offer some thoughts on how to navigate this important (yet complex) topic. We hope you find this content useful. If you’d like to speak to an independent financial adviser you can reach us via:
T: 01282 772938
The 25% lump sum: a brief overview
For those unfamiliar with these pension rules, in 2020-21 you are allowed to withdraw up to 25% of the value of your pension pot as a lump sum once you are over 55 years of age. There is not usually a tax charge involved. Your scheme’s “commutation factor” will largely determine how much you can take in one go.
Bear in mind that you cannot withdraw money from your pension before the age of 55. Anyone who claims that they can help you do so is likely a scammer. Also, be aware that it is possible to withdraw money in this manner from your state pension, but this will hinge upon when you reached your state pension age and if you decide to delay when collecting it.
The rules are also more complicated regarding final salary (or “defined benefit”) pensions, since these pensions do not have a “pot” for you to withdraw money from. Rather, withdrawing from a pension like this usually involves a complex process whereby your scheme will need to convert some of your promised retirement income into a lump sum. How this works, exactly, varies from scheme to scheme and so it is usually best to seek professional financial advice, to ensure you get the best deal out of this process.
Taking your lump sum during a pandemic
Every individual’s financial goals and situation are different. So it would be unwise to say that no one should take their 25% lump sum following the events so far in 2020. Yet, for most people, it is likely that this decision will be a poor decision at this time, due to the disproportionate damage this could inflict upon your pension pot.
Suppose you have a pension pot which stood at £300,000 in January 2020 (before the markets started reacting negatively to coronavirus). Taking 25% from this pot would have reduced this to £225,000. Now, however, suppose this pot is down by 20% following the lockdown and market turmoil we have witnessed this year. This would reduce the pre-withdrawal pot to £240,000, and taking 25% from these shrunken savings leaves you with £180,000. This remaining amount is £45,000 smaller than the post-withdrawal pot in January, and would, therefore, likely radically reduce the comfort and quality of your lifestyle in retirement.
However, this is not to say that taking some of your 25% in the present environment is always a bad idea. It might be, for instance, that your financial adviser recommends that taking some of this money could help provide you with a much-needed sum for an emergency. Yet taking from your 25% lump sum allowance at this time for non-essential spending (e.g. a new car or house extension) may not be the wisest choice if your pension is still recovering from a market shock.
With all of this said, it is possible that your pension has not been dramatically reduced following the pandemic in 2020. Those with retirement savings held primarily in “safe” assets (e.g. cash and UK government bonds), for instance, may still be in a strong position to consider accessing some of their 25% lump sum. The same is likely to be true for those with a final salary pension, since their employer is required to make up for any investment shortfalls. Here, we recommend speaking with your financial adviser about your options. It might be, for instance, that taking a small portion of your 25% lump sum might be acceptable at this time. Be careful, however, not to rush into any big decisions which could affect your future retirement prospects.
Conclusion & invitation
If you are interested in starting a conversation about your financial plan then we’d love to hear from you. Get in touch to arrange a free, no-commitment consultation with a member of our team here at Elmfield Financial Planning in Padiham, Burnley, Lancashire.
Reach us via:
T: 01282 772938