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Question: I am 62 and plan to retire next year. I am going to receive a pension from my employer but I also have a separate self-employed personal pension (SIPP) which I want to take money from as well.
Can you tell me what I need to think about. I understand I can take 25 per cent of my pension and not pay any tax on it. Is that right? Should I take it all at once or can I stagger it? I want to use it to repay some debt and would probably put the remainder in an ISA.
Answer: From the age of 55 (rising to 57 from April 2028) you can take a quarter of your pension pot as a tax-free lump sum and either take the rest as a taxed lump sum, move the remainder to drawdown, or buy an annuity (which gives a set out guaranteed income for life). If you decide on drawdown, you can withdraw a taxable amount any time you want and how much you want.
You must have enough ‘lump sum allowance’ (LSA) left to take a tax-free lump sum – this is usually initially set at £268,275 and will include any tax-free cash sums you take from other pensions, such as your workplace pension.
Your income options don’t have to be a binary choice. You can choose to use part of your pension to buy an annuity, move part into drawdown, and take part as a taxed lump sum. The choice is yours – you can mix and match however you want.
You don’t have to access your whole pension pot either. You can decide to just access a small portion of it and keep the rest invested. Taking this approach offers an interesting way of getting a tax-efficient income.
For example, if someone took £16,760 from their pension pot, they could take a tax-free lump sum of £4,190 and a drawdown income of £12,570. If they have no other taxable income, then this falls within their personal allowance, meaning no income tax to pay.
Staggering taking your tax-free cash can offer advantages. It means you can leave a greater part of your money invested in the pension, which hopefully will grow in value, and means you can take a greater amount of tax-free cash out overall.
If you take out all your tax-free cash in one go, then you would lose this opportunity to benefit from further growth.
Taking all the tax-free lump sum in one go may be a good solution if you have something you specifically need the money for. But if not, then you may be left with a sizeable sum languishing in your bank account. The money can be moved into an ISA, but as you can only pay up to £20,000 a year into ISAs, then a larger lump sum would have to be moved over gradually which could take several years.
It’s also worth noting that the rules for ISAs are due to change next April. The allowance for a Cash ISA will fall to £12,000 for those under 65, although you can still invest the other £8,000 (of your £20,000 allowance) in a Stocks and Shares ISA. There will also be a 22 per cent charge on interest paid on cash held in a Stocks and Shares ISA, and you won’t be allowed to hold 100 per cent of your investment portfolio in money market funds.
Nor can you transfer from a Stocks and Shares ISA to a Cash ISA if you are under 65 years of age.
One final point. When someone takes their first ad-hoc payment from drawdown, emergency tax is applied, and they will end up overpaying tax. They can easily ask for a refund from HMRC, but it’s worth bearing this in mind.
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