I have been having numerous conversations with clients’ in the weeks since the budget who are proposing to withdraw their entire pension fund as cash (as per the new budget announcements) and simply invest the proceeds in the bank or another form of taxable investment.
While I did write about this very topic a few weeks ago, I thought it sensible to mention it again so that people are aware of the consequences of such actions. As such I have prepared a simple worked example to compare the difference between withdrawing a 100k pension fund as one lump sum in cash and investing this in the bank and taking the income gradually from the pension over a number of years. This example is for illustrative purposes only and should not be construed as advice to act. If you are unsure about your own pension provision, you should seek advice from a chartered financial planner.
For the purpose of this exercise I am making a few assumptions:
– The client has £20k per annum in other retirement income from final salary and state pensions.
– The client would like to take a further 10k per year of income to make a total of £30k
Option 1 – Take the whole pension as cash on retirement
£25,000 will be paid tax free
£75,000 will be subject to income tax as follows
£21,865 @ 20% = £4373 tax
£53,135 @ 40% = £21,254 tax
The client would receive £74,373 in cash and pay £25,627 in tax
Any income that the money generated would possibly be subject to further income tax or capital gains tax.
Option 2 – Take the tax free lump sum and then £10k per annum as required
£25,000 will be paid tax free
£10,000 per annum will be taxed at £20% = £2000 tax
The total tax paid on the original £75,000 remaining fund will only be £15,000
The client would receive £85,000 – a difference of £10,627!
Of course the money would also continue to be invested in a tax efficient environment and could well make substantial further gains over the time period in question.
The above is clearly a very simple example, however it illustrates the taxation implications of taking large pension pots in one lump sum.
The point I am trying to make is that the full withdrawal of a pension fund will generally be very tax inefficient and should only really be considered if the fund is very small or there are specific spending plans for the money.
If you would like to find out more about the options available to you at retirement please get in touch to request your discovery meeting.
