Since the introduction of the 25% tax-free pension lump sum under the Pension Freedoms legislation in 2015, individuals have had even greater choice over how they use the funds they’ve built up over the course of their working lives.

Many people have been able to achieve their retirement goals with ease thanks to the ability to access a portion of their retirement savings from age 55 (rising to 57 in 2028) ahead of fully finishing work forever.

But did you know that rather than drawing your entire lump sum in one go, you are also free to take it in multiple instalments over the course of many years? 

So, continue reading to find out about these options and the various pros and cons that come with choosing one or another.

Achieve your goals with a single lump sum

In the current tax year, you can start accessing your defined contribution (DC) pension and the entire tax-free lump sum from age 55. This is then set to rise to 57 in 2028. It’s worth noting here that if you have a defined benefit (DB) or “final salary” pension, the rules may be different. 

The enormous benefit of being able to access this money is the ability to instantly achieve some of your retirement goals early on. You can use your pension savings for whatever you’d like, but ambitions that it could help you fulfil might include:

– Moving to your dream home

– Going on an expensive holiday

– Buying something you’ve always wanted, such as a luxury sports car

– Retiring early.

Additionally, you’ll be able to access your pot without having to buy an annuity – one of the most common ways to do so in the past – and you’ll face no Income Tax on that first 25% of your funds.

However, it’s important to note that any money you draw over your 25% lump sum will typically be subject to Income Tax. 

You may also be subject to the Money Purchase Annual Allowance (MPAA). This can reduce your tax-efficient savings under the pension Annual Allowance to just £4,000 a year.

Under certain circumstances, you might not trigger the MPAA when taking your lump sum. This includes using it to buy an annuity or going into flexi-access drawdown without actually drawing any income from your pot.

But otherwise, you may be subject to the MPAA. Be sure to keep an eye out for this if you’re still working and contributing to your pension when you take your lump sum.

Taking smaller chunks over time

While you’re able to take 25% of your pot in a single lump sum, you also have the option of taking it across multiple smaller sums.

In doing so, 25% of each withdrawal is free from tax, with the remaining 75% taxed at your marginal rate of Income Tax. So, for example, if you took £1,000 out of your pot this way then £250 would be entirely tax-free. Meanwhile, the remaining £750 would count towards your income and be taxed accordingly. 

There are many reasons that this may be a preferable choice, especially in the current climate. As stock markets have been particularly volatile in 2022, it’s possible that your pension savings have temporarily fallen in value.

As a result, taking a smaller sum may be preferable, as it might mean you’re able to use your pension savings for whatever you need in the short term, while also giving the remainder of your funds time to potentially recover any losses in value you’ve incurred over the past few months.

Crucially, by taking your 25% sum piecemeal like this, it means more of your pot stays invested in the future. Thanks to compounding returns – essentially growth on growth – that means investment returns could be magnified by your larger pot more than they might be if you had taken the entire lot as a lump sum.

On the other hand, this method can understandably become complicated as there are considerations to take into account. This includes:

– Your pension funds must remain “uncrystallised” – that is, within a pension wrapper, rather than as an annuity, or in a flexi-access drawdown arrangement that you’ve started to draw income from

– The taxable portion of your pension income could push you into a higher tax bracket, meaning you end up paying a larger Income Tax bill

– You’ll need to keep track of how much you’ve taken out over time as, once you start taking money above the 25% threshold, you’ll be subject to tax. You may also be subject to the MPAA, reducing your pension Annual Allowance to just £4,000.

It may be sensible to speak to an expert before you decide what to do with your lump sum to ensure that you don’t end up falling foul of any of these issues. 

It depends on your financial goals

Ultimately, the right option of these two will come down to you, your lifestyle, and your financial goals.

If you want to access your pot early to achieve a life target, taking your entire lump sum could be the right choice for you.

Meanwhile, if you’re only doing so to provide yourself with additional income during the cost of living crisis, taking smaller sums could be a more suitable strategy.

Crucially, this underlines the importance of good financial planning. By having a clear, comprehensive plan for what you want to achieve in the future, you can make incisive, informed decisions with your tax-free lump sum.

Speak to us

If you’d like help working out the best way for you to draw your pension in retirement, please do get in touch with us at Cordiner Wealth.

We’ll create a personalised financial plan for you that takes you and your goals into account.

Email or call 0113 262 1242 to find out how we can help you.

Please note

A pension is a long-term investment. The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available. Your pension income could also be affected by the interest rates at the time you take your benefits. The tax implications of pension withdrawals will be based on your individual circumstances, tax legislation and regulation, which are subject to change in the future.