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Retirees set for average £26k tax-free pension lump sum

Written by: Paloma Kubiak
People approaching retirement are on course to receive a one-off tax-free lump sum of £26,000 from their pension, just shy of the UK’s average salary.

More than half of working age people plan to take advantage of pension freedom rules which allow them to withdraw 25% of their pension as a tax-free lump sum at retirement.

According to Aegon’s UK Readiness Report, on average, those aged 55-65 have £105,496 saved in their pension which could produce a one-off tax-free lump sum of around £26,000, just below the average UK salary.

One in six (17%) people accessing tax-free cash from their pension will put their savings into a cash ISA and 15% plan to put the money into a bank account.

A further 14% plan to use the money to take a holiday, 12% are thinking about purchasing a property and one in 10 will use the savings to clear debts.

Steven Cameron, pensions director at Aegon, said the ability to take up to 25% of pension pots tax-free has always been a popular option with retirees but they need to think carefully when deciding whether to take their maximum tax-free cash lump sum immediately or leave more of their money invested.

“For some people the cash received is vital to clear debts, perhaps pay off a mortgage or clear a credit card. However, not everyone needs it as soon as they retire and money left invested in the pension will continue to grow tax-free while also offering beneficial inheritance tax aspects.

“Cash ISA rates and returns on savings accounts are at all-time lows, with the combination of inflation and low interest rates effectively eating away at spending power from these accounts. Yet, nearly a third of people plan to put the money in a cash ISA or a bank account and this raises a red flag. Savers have worked their whole life to put money away so should be wary of leaving it languishing in bank accounts which aren’t returning the favour. Delaying taking it until they really need it might be a more sensible option.”

Key considerations before taking your tax-free cash lump sum

Here are Cameron’s pointers on what those approaching retirement should consider before taking their 25% tax-free lump sum:

  • Check what kind of scheme your pension savings are held in. The rules for taking a tax-free lump sum are very different for Defined Benefit and Defined Contribution pension schemes.
  • Do you need one large lump sum? If you can keep the money invested in your Defined Contribution pension and take smaller amounts each year, you may be able to opt for 25% of each of these payments to be tax-free and this has the added benefit that the remaining money will gain from any investment returns before you take it. You only have this option before you move your pension into an annuity or income drawdown product.  Retirees thinking about this should check that their scheme or provider offers this and any associated fees.
  • You may be entitled to a higher ‘protected’ percentage tax-free from some older types of pensions – check with your provider or scheme. This may affect how you decide to take your tax-free cash sum.
  • Before you put the money in a bank account, review the current interest rates on savings accounts and cash ISAs and compare them to the potential investment returns on your pension savings. Pensions tend to be invested in stocks and shares. Remember, the value of an investment can fall as well as rise and isn’t guaranteed. You could get back less than you originally invested.
  • Carefully consider inheritance planning in any decisions about your pension savings. As soon as money is accessed it is then subject to inheritance tax as part of a person’s estate but pension savings are treated differently. If death occurs before age 75 pension savings can be passed on tax-free and if over age 75, tax is paid at the income tax rate of whoever inherits the pension pot.
  • This can be a complex area and getting it right can offer real benefits. We recommend seeking professional financial advice.

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