Is a Lump Sum Pension Withdrawal Right for You?

Whether a lump sum pension withdrawal is right for you depends on your current situation, future needs and investment time horizon. Before considering some of the benefits and potential pitfalls, we will examine how lump sum pension withdrawals work and how they are taxed.

If you have a pension plan and are approaching or in retirement, you may have the option to take a lump sum withdrawal. Taking a lump sum withdrawal can offer a variety of potential benefits, including immediate liquidity and greater control. But taking a lump sum can also mean a reduction of predictable regular income when you retire. After withdrawal, you will also then need to manage those funds.

Determining whether a lump sum pension withdrawal makes sense can be complicated and it depends on your unique financial and retirement situation. Before considering some of the benefits and potential pitfalls in greater depth, we will examine how lump sum withdrawals work and how they are taxed.

Pension Commencement Lump Sum (PCLS) Withdrawals

Whether you have a defined contribution pension or a defined benefit pension, upon retirement you can usually choose to take a Pension Commencement Lump Sum (PCLS) distribution. Typically, you can receive 25% of the total value of your pension as a tax-free PCLS although sometimes the allowed tax-free amount is greater. Check the rules of your particular pension to determine how much you can receive as a PCLS. Defined contribution pensions usually let you take the remainder of your pension at the same time as you withdraw a PCLS. This additional 75% payment will be taxable. You can find more information on the website.

In addition to a PCLS or lump sum withdrawal there are other options for accessing and managing your defined contribution pension. These options include:

  • You can leave all or some of your money in your pension. You don’t have to start taking money from your pension when you reach retirement age.
  • You can use your pension funds (pot) to buy an insurance policy known as an annuity. An annuity guarantees you an annual lifetime income.
  • You could take your PCLS and leave the remainder invested to provide an ongoing income. This is known as “flexi-access drawdown.” Not all pensions provide this option.
  • You can also take tax-free cash on each withdrawal instead of taking a larger initial tax-free payment. If you choose this option, each time you take a withdrawal 25% is tax-free, but the rest is taxable. Not all pensions provide this option.
  • You can mix the options above. For example, you could use some of your pension to buy an annuity, access some in smaller sum withdrawals, and use flexi-access drawdown to obtain monthly income. Mixing options in this way may require a larger pot or balance in your pension.

Potential Benefits of a Lump Sum Withdrawal

Taking a lump sum withdrawal offers a number of potential benefits. First, it gives you immediate liquidity. You have immediate access to your PCLS funds. This can be useful if you have or anticipate any major retirement expenses, such as buying a house or taking that once-in-a-lifetime trip. Or if you’d like to be able to gift assets to heirs or a charity.

Taking a lump sum withdrawal may also give you more options and control over your investments as you near or enter retirement. Whilst your pension likely limits what funds you can invest in, once you take a lump sum withdrawal you are free to reinvest your money however you want. This freedom means you can invest and manage your money in ways that could provide greater flexibility to help you meet your long-term goals. This added flexibility could help you create a more diversified portfolio, possibly lowering your risk. You also may be able to increase your available investment options by transferring your pension pot to another registered pension, without taking a withdrawal.

Many investors overlook inflation’s impact. Keeping this in mind is especially important if you are considering an annuity with no inflation link. Inflation is insidious, in that it reduces your purchasing power over time. If you expect to feel comfortable with your pension payments when you start receiving them, but they aren’t adjusted for inflation, you may not be as comfortable with them further into your retirement. This is especially true if your plan offers survivorship benefits and you have a spouse who may outlive you and rely on your benefits. Over time, inflation may substantially erode the purchasing power of your payments.

Potential Pitfalls of a Lump Sum Withdrawal

If you do decide to take a PCLS withdrawal, this may reduce your predictable monthly or annual income. If you have fairly stable and predictable expenses or you’re able to utilise other income sources, the assured and predictable nature of some pension benefits can be appealing.

If you take a lump sum withdrawal you will also need to invest and manage those funds. Investing takes time and you should think about whether you have the interest and expertise to be a successful investor. Investing—whether on your own or with the help of an investment adviser—can be stressful. Market volatility is normal. A standard disclaimer in any financial ad is “Past performance is no guarantee of future results.” This sums up investing. Whilst markets follow broader trends and price in known information, nobody can be absolutely sure of what will happen next.

Planning Your Future

Whilst deciding whether or not to take a PCLS is complicated and ultimately depends on your individual circumstances, considering your income and cash flow needs can help guide your decision making.

Calculating your income and cash flow needs can be complex, and it goes beyond just understanding your day-to-day expenses or funding a dream trip in the short-term. What are your monthly expenses and what larger, less predictable expenses will you need to be prepared for? Additionally, you should consider anyone else who may depend on income from your pension. Considering these questions and figuring out how much money you’ll need can help you weigh the certainty of monthly or annual payments against the freedom to access a portion of your pension funds through a PCLS. It is also with remembering that if your current pension limits your investment options, you may be able to transfer to a pension that gives you more choices.

Fisher Investments UK may be able to help you decide whether a lump sum withdrawal makes sense for you. And whether you decide on a PCLS or not, we can help you craft an appropriate portfolio and investing strategy based around your cash flow needs and investment goals and objectives. Fisher Investments UK provides financial advice tailored to your specific investor needs and with your individual pension schemes in mind. We can help you retire with confidence and manage your investment portfolio.

To learn more about how Fisher Investments UK can help, contact us today. You can also read the Definitive Guide to Retirement Income for more information about retirement, investing and your pension options.

Investing in financial markets involves the risk of loss and there is no guarantee that all or any capital invested will be repaid. Past performance neither guarantees nor reliably indicates future performance. The value of investments and the income from them will fluctuate with world financial markets and international currency exchange rates.