Pension benefits – taking a tax-free lump sum

You can start taking pension benefits at the age of 55, and that includes a tax-free lump sum. So what to do: spend, save or invest?

How much of the lump sum can I take?

You can normally take up to 25% of your pension pot as a tax-free lump sum, provided it's less than 25% of the lifetime allowance for that tax year. For the 2014-15 tax year, the allowance is £1.25 million.

If you built up your pension pot through payments to an occupational pension scheme prior to 6 April 2006, you might be entitled to take a bigger tax-free lump sum. To find out if this applies to you, check with your scheme administrator.

What can I do with the lump sum?

In a nutshell, what you choose to do with your lump sum is entirely up to you!

You could save or invest it, or use it to fund that trip of a lifetime – or a mix of these options.

Bear in mind that by taking a lump sum you'll have less left in your pension pot with which to buy an annuity. If you have a Self Invested Personal Pension (SIPP) and want to draw down an income from your pension pot, the smaller the pot, the smaller your income is going to be. So you might prefer to leave your money where it is.

Alternatively, you may choose to take a smaller lump sum or ‘phase in' taking the lump sum over a number of years.

Spending a lump sum

If you have debts, loans or an outstanding mortgage, you might want to consider prioritising paying these off using a lump sum. Getting rid of debts that are accruing interest will help lessen the financial burden during your retirement.

Alternatively, you might simply want to use a lump sum to fund a major purchase like a new car, make home improvements – or both. The choice is yours!

If, on the other hand, you would like to secure additional retirement income, a tax efficient way of doing this can often be to use your lump sum to buy a purchased life annuity - we can help you with this.

Put your lump sum in a savings account

If you need instant access to your money, you have the option of putting it in a savings account. Bear in mind, though, that inflation can eat away at the value of your cash, especially when interest rates are low.

You might also consider placing the money in fixed-term savings, though this usually means locking up your money for a set period. You may have to pay a penalty if you need to access your money before the fixed term ends.

Put your lump sum in an ISA

There are a number of ways of saving tax efficiently. One way is via an Individual Savings Account (ISA). For the 2014-15 tax year, the annual allowance for cash ISAs is £5,940 and for stocks and shares ISAs it's £11,880*. So if your lump sum is bigger than the annual allowance for either of these, you might consider drip feeding it in over a number of years.

Our guides to savings can offer you more help and information on ISAs and other ways to invest your lump sum.

More information on short-term savings

More information on medium-term savings

Investing a lump sum

Over the long term, choosing to invest a lump sum gives your money the potential to grow or generate a higher rate of return than cash. The price of units depends on the value of the underlying assets after charges. As with any investment, the value of your fund can go up or down, and may be worth less than you paid in.

You can select your own funds to invest in or pick a fund like MyFolio

Assess your appetite for risk

Remember that different funds have different levels of risk, so before you make any decisions you may want to reassess where your risk threshold lies. Our Risk questionnaire can help with this.

Ultimately your choice of investment will depend on how much risk you're comfortable with and how long you want to invest your money for. Find out more in our section Savings and investments explained

Tax-efficient investing

There are ways of protecting your investments from the taxman. You may want to consider Offshore Bonds. Investments have the potential to grow tax efficiently and you can take withdrawals of up to 5% of your initial investment without an immediate tax liability.

Tax is a complex issue, but the more knowledge you have about it, the easier it is to manage your investments. Please take a look at our Tax help guide for more information.

*Allowance applies from 6 April 2014 to 30 June 2014. From 1 July 2014 the allowance will be £15,000.

Retirement income - making the most of your pension

It’s always tempting to take your full 25% tax free lump sum, but it’s also useful to stop for a minute and decide what you need the money for. Will you save it, spend it or invest it? Remember the less cash you take, the more you’ll have left to buy an annuity. It’s all about finding the balance that’s right for you.

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