In our weekly series, readers can email any questions about their finances to be answered by our expert, Rosie Hooper. Rosie is a chartered financial planner at Quilter Cheviot and has worked in financial services for 25 years. If you have a question for her, email us at money@inews.co.uk.
Question: I am 63 and I have three pension pots with £300,000, £150,000 and £20,000 respectively in them. What is the best way for me to take my lump sums from each if I want to retire at 65?
Answer: In simple terms, when you access pension funds for the first time, you can usually take up to 25 per cent of the amount as tax-free cash, up to the value of £268,275 for most people. When you take money from a specific pension, it moves from being what’s called “uncrystallised” to “crystallised” in industry jargon.
But you don’t have to crystallise all your different pensions at once (more on that later.)
What you can do is take tax-free cash from one pension now and access your other pensions at different times, rather than having to take benefits from all three pensions, or the full £470,000, in one go.
The more important question isn’t whether the pension rules allow it, but whether it’s the most effective way to meet your income needs throughout retirement.
One factor to consider is the gap between retiring at 65 and receiving your state pension at 67 and how much money you’ll need to plug this gap.
During those two years, your private pensions will need to do more of the heavy lifting. Once your state pension starts, it will provide a valuable foundation of guaranteed income, potentially reducing the amount you need to withdraw from your pension pots each year.
It’s also worth remembering that retirement spending rarely follows a straight line. In fact, many people find their income needs are highest in the early years of retirement when they’re healthy, active and keen to travel, pursue hobbies or tick items off their bucket list.
Spending patterns often evolve over time, which is why mapping out your expected lifestyle can be just as important as deciding which pension to access first.
In that sense, the pensions themselves are really just funding tools. Without understanding your wider financial picture – including other savings, spending plans, health, family circumstances and inheritance goals – it’s impossible to say whether taking tax-free cash at 64 is better than waiting until 65 or phasing withdrawals over a longer period.
One area that often causes confusion is what actually happens when you access a pension.
Many people worry that moving into drawdown means they’ve somehow “taken” the pension. In reality, drawdown simply allows you to access the pension while keeping the money invested. So if you decided to access a £300,000 pension, you could normally take 25 per cent tax-free and leave the remaining 75 per cent invested in drawdown.
You don’t have to start taking an income immediately, and the money remains within the pension.
This is where the industry term “crystallisation” comes from. In simple terms, it just means accessing pension benefits for the first time. The portion you’ve accessed becomes “crystallised”. It sounds far more complicated than it really is.
It’s also a myth that you must take all of your tax-free cash at once. Some people do, but others access their pensions gradually, taking tax-free cash in stages and leaving more money invested for longer.
There is one final consideration that is becoming increasingly relevant. Historically, many people viewed their pension as the last asset they would spend because it could be a very tax-efficient way to pass wealth on. However, with unused pension funds expected to become subject to inheritance tax from April 2027, some retirees are revisiting that approach.
For those who are already likely to face an inheritance tax charge, there may be circumstances where taking tax-free cash sooner and sheltering it inside ISAs becomes more attractive for children who inherit it later.
If a pension fund remains in an estate subject to inheritance tax and is then inherited by beneficiaries (other than spouse), they will pay income tax when they draw from it at their marginal rate. The eventual tax cost can be significant. By contrast, ISA assets can generally be accessed free of further income tax, but still inheritance tax to pay in this scenario.
That won’t be relevant for everyone. Much depends on the value of your estate, who you intend to leave assets to and whether inheritance tax is likely to be an issue in the first place. It’s also important to consider the potential impact on valuable reliefs such as the residence nil-rate band.
Ultimately, the pension mechanics are relatively straightforward. The harder part is working out what you want your retirement to look like, how much income you’ll need before and after your state pension starts, and what role you want your wealth to play for both yourself and the next generation. Once those pieces are clear, the decisions around tax-free cash, drawdown and crystallisation often become much easier.
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