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Taking money from your pension as and when you need it

You can use your existing pension pot to take cash as and when you need it and leave the rest untouched where it can continue to grow tax-free. For each cash withdrawal, normally the first 25% (quarter) is tax-free, and the rest counts as taxable income. There might be charges each time you make a cash withdrawal and/or limits on how many withdrawals you can make each year.

With this option, your pension pot isn’t re-invested into new funds specifically chosen to pay you a regular income, and it won’t provide for a dependant after you die. There are also more tax implications to consider with this option.

Your pension pot reduces with each cash withdrawal. The earlier you start taking money out of your pot, the greater the risk your money could run out. What’s left in your pension pot might not grow enough to give you the income you need to last you into old age – most people underestimate how long their retirement will be.

The administration charges for each withdrawal could eat into your remaining pot. Because your pot hasn’t been reinvested to produce an income, its investments could fall in value – so you’ll need to have it reviewed regularly. Charges will apply, and you might need to move or reinvest your pot at a later date.

Once you take money out of your pension pot, any growth in its value is taxable, whereas it will grow tax-free inside the pot – once you take it out, you can’t put it back. Taking cash lump sums could reduce your entitlement to benefits now or as you grow older.

Three quarters of each cash withdrawal counts as taxable income. This is added to the rest of your income – and depending on how much your total income for the tax year is, you could find yourself pushed into a higher tax band.

So if you take lots of large cash sums, or even a single cash sum, you could end up paying a higher rate of tax than you normally do. Your pension scheme or provider will pay the cash through a payslip and take off tax in advance – called ‘PAYE’ (Pay As You Earn). This means you might pay too much tax and have to claim the money back – or you might owe more tax if you have other sources of income.

Extra tax charges or restrictions might apply if your pension savings exceed the lifetime allowance (currently £1,030,000 2018/19 tax year), or if you have less lifetime allowance available than the amount you want to withdraw.

If the value of your pension pot is £10,000 or more, once you start to take income, the amount of defined contribution pension savings on which you can get tax relief each year is reduced from £40,000 (the annual allowance) to a lower amount (the ‘Money Purchase Annual Allowance’, or MPAA). In 2018/19, the MPAA is £4,000. If you want to carry on building up your pension pot, this option might not be suitable.

If you die before the age of 75, any untouched part of your pension pot will pass tax-free to your nominated beneficiary or estate, provided the money is paid within two years of the provider becoming aware of your death. If the two-year limit is missed, it will be added to your beneficiary’s other income and taxed in the normal way.

If you die after the age of 75, any untouched part of your pension pot that you pass on – either as a lump sum or income – will be added to your beneficiary’s other income and taxed in the normal way.

With this flexible retirement income option known as ‘flexi-access drawdown’, you can normally take up to 25% (a quarter) of your pension pot or of the amount you allocate for drawdown as a tax-free lump sum, then re-invest the rest into funds designed to provide you with a regular taxable income. You set the income you want, though this might be adjusted periodically depending on the performance of your investments. Unlike with a lifetime annuity, your income isn’t guaranteed for life – so you need to manage your investments carefully.

Some older policies might allow you to take more in tax-free cash – check with your pension provider. You then move the rest into one or more funds that allow you to take a taxable income at times to suit you. Increasingly, many people are using it to take a regular income. You choose funds to invest in that match your income objectives and attitude to risk, and set the income you want.

The income you receive might be adjusted periodically depending on the performance of your investments. Once you’ve taken your tax-free lump sum, you can start taking the income right away or wait until a later date. You can also move your pension pot gradually into income drawdown.

You can take up to a quarter of each amount you move from your pot tax-free and place the rest into income drawdown.

You can, at any time, use all or part of the funds in your income drawdown to buy an annuity or other type of retirement income product that might offer guarantees about growth and/or income. You need to plan carefully how much income you can afford to take under flexi-access drawdown, otherwise there’s a risk you’ll run out of money.

This could happen if you live longer than you’ve planned for or you take out too much in the early years. It could also be a problem if your investments don’t perform as well as you expect, and you don’t adjust the amount you take accordingly.

If you choose flexi-access drawdown, it’s important to review your investments regularly. Not all pension schemes or providers offer flexi-access drawdown. Even if yours does, it’s important to compare what else is on the market, as charges, the choice of funds and flexibility might vary from one provider to another.

Any money you take from your pension pot using income drawdown will be added to your income for the year and taxed in the normal way. Large withdrawals could take you into a higher tax band, so bear this in mind when deciding how much to take and when. If the value of all your pension savings is above £1,030,000 when you access your pot (2018/19 tax year), further tax charges might apply.

You can normally receive tax relief on pension contributions to a defined contribution pension scheme of up to £40,000 or 100% of taxable salary each year (if lower than £40,000). This is known as your ‘annual allowance’.

However, if you start to draw an income from a flexi-access drawdown scheme, the amount you can pay into a pension and still get tax relief reduces. This is known as the ‘Money Purchase Annual Allowance’ (MPAA). The MPAA for the tax year 2018/19 is £4,000. If you want to carry on building up your pension pot, this might influence when you start taking income. You can nominate who you’d like to get any money left in your drawdown fund when you die.

If you die before the age of 75, any money left in your drawdown fund passes tax-free to your nominated beneficiary, whether they take it as a lump sum or as income. The money must be paid within two years of the provider becoming aware of your death. If the two-year limit is missed, payments will be added to the income of the beneficiary and taxed as normal.

If you die after the age of 75, and your nominated beneficiary takes the money as income or a lump sum, the money will be added to their other income and taxed as normal.

Choosing a taxable income for the rest of your life

You can normally withdraw up to a quarter (25%) of your pot as a one-off tax-free lump sum, then convert the rest into a taxable income for life called an ‘annuity’. There are different lifetime annuity options and features to choose from that affect how much income you would get. You can also choose to provide an income for life for a dependent or other beneficiary after you die.

A lifetime annuity is a type of retirement income product that you buy with some or all of your pension pot. It guarantees a regular retirement income for life. Lifetime annuity options and features vary – what is suitable for you will depend on your personal circumstances, your life expectancy and your attitude to risk.

Lifetime annuities
You can normally choose to take up to 25% (a quarter) of your pension pot – or of the amount you’re allocating to buy an annuity – as a tax-free lump sum. You then use the rest to buy an annuity, which will provide you with a regular income for life. This retirement income is taxed as normal income.

There are two types of lifetime annuity to choose from: basic lifetime annuities, where you set your income in advance; and investment-linked annuities, where your income rises and falls in line with investment performance, but will never fall below a guaranteed minimum

Basic lifetime annuities
Basic lifetime annuities offer a range of income options designed to match different personal circumstances and attitude to risk. You need to decide whether you want one that provides an income for life for you only – a ‘single life’ annuity, or one that also provides an income for life for a dependant or other nominated beneficiary after you die – called a ‘joint life’ annuity.

Payments can continue to a nominated beneficiary for a set number of years (for example, ten years) from the time the annuity starts in case you die unexpectedly early – this is called a ‘guarantee period’.

‘Value protection’ is less commonly used, but is designed to pay your nominated beneficiary the value of the pot used to buy the annuity, less income already paid out when you die. Your choices affect how much income you can get. Where you expect to live when you retire might also affect how much income you get.

If you have a medical condition, are overweight or smoke, you might be able to get a higher income by opting for an ‘enhanced’ or ‘impaired life’ annuity. Not all providers offer these, so be sure to shop around if you think you might benefit from one. If you have a single annuity and no other features, your pension stops when you die.

Investment-linked annuities
Investment-linked annuities also pay you an income for life, but the amount you get can fluctuate depending on how well the underlying investments perform. If the investments do well, they offer the chance of a higher income.

But you have to be comfortable with the risk that your income could fall if the investments don’t do as well as expected. All investment-linked annuities guarantee a minimum income if the fund’s performance is weak.

With investment-linked annuities, you can also opt for a joint or single annuity, guarantee periods, value protection, and higher rates if you have a short life expectancy due to poor health or lifestyle. Not all providers will offer these options.

Open Market Option
If you decide an annuity is right for you, it’s important to shop around. This allows you to turn your pension pot into an annuity rather than accept the rate offered by your pension provider, and is called an ‘Open Market Option’.

Introduced as part of the 1975 Finance Act, the Open Market Option allows someone coming up to retirement to select the best annuity or retirement option from the whole of the market rather than taking the default option from their current pension provider.

By obtaining professional advice and searching the entire market, this could increase a pensioner’s retirement income by as much as 30%. Not automatically choosing your current provider’s option can really make a difference and will help to maximise your income in retirement.

If you die before age 75, any lump sum payment due from a value protected annuity will be paid tax-free. Income from a joint annuity will be paid to your dependant or other nominated beneficiary tax-free for the rest of their life. If you die within a guarantee period, the remaining annuity payments will pass tax-free to your nominated beneficiary, then stop when the guarantee period ends.

If you die age 75 or over, income from a joint annuity or a continuing guarantee period will be added to your beneficiary’s other income and taxed as normal. Joint annuity payments will stop when your dependant or other beneficiary dies. Any guarantee period payments stop when the guarantee period ends. Any lump sum due from a value protected annuity will be added to your beneficiary’s income for that year and taxed as normal.