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Tax-free cash and pension commencement lump sum
Most people who have a pension
want to take the lump sum from it - this is sometimes known
as the tax-free cash, but strictly speaking is now the
pension commencement lump sum. This lump can be used for
almost any purpose, such as:
Practically all pension
contracts now offer the facility to take a tax-free lump
sum. Changes introduced in April 2006 to pension legislation
now mean that contracts which previously did not allow any
tax-free to be taken can now allow some money to be taken as
a lump sum. These changes affect contracts which contain
protected rights, freestanding AVCs, in-house AVCs. These
changes also allow at least 25% of the fund value of
Occupational Schemes to be taken as a tax-free lump sum,
although many schemes will require the scheme rules to be changed
to allow this.
However if you have a contract
which has an element of Guaranteed Minimum Pension (GMP),
you need to be aware that you can't take any tax-free cash
from this element. It seems that this type of pension was
overlooked in the changes in the rules. (You could however
transfer it to a personal pension which would convert it to
protected rights and allow you to take 25% of the fund as a
lump sum, but there are some disadvantages to doing this.)
You do need to be aware that if
you have an occupational pension that you might have a
protected amount of tax-free cash, which could be greater
than 25% of the fund value. If this is the case, then you
would probably want to take as much tax-free cash as
possible.
Should you take the lump sum from your pension? The answer to this question depends on your circumstances, and the type of contract you have. But there are some important points you need to consider: Money Purchase Pension Schemes (personal pensions and defined contribution schemes)Generally speaking it does make more sense to take the tax-free cash from these types of schemes. The reason is that the tax-free cash is of course tax-free, and it is possible to invest the funds in a tax-efficient environment to provide an income. If you buy an annuity the income is taxable at your highest rate, and for most people this means at least 22%. However there are some instances when it you need to consider perhaps not taking any tax-free cash, and that is if your existing contract has guaranteed annuity rates. If the guaranteed annuity rates are high it may mean that even after tax it provides a better income than that available elsewhere, with no risk to your income. Final Salary Pension SchemesWith some schemes it is compulsory to take the tax-free lump sum, whereas some other schemes give the option to take a reduced pension and a tax-free lump sum, or a higher pension. This needs some careful consideration. In many instances it does not make sense mathematically to take the lump sum, because the income you give up is worth more than the lump sum you receive. This is because the income they provide has to have some inflation proofing and also usually provide an income for a spouse. Very often the tax-free lump sum they provide does not reflect the true value of this income given up. Legislation now also permits 25% of the notional fund to be taken as a lump sum from a final salary scheme. This can be higher than under the old rules. However the scheme rules also need to be changed to enable this to happen. If you have a question about your pension and taking the lump sum, or just want to discuss your pension in more detail then phone us on 0800 011 2713 or contact us online . Don't take any chances with your pension, your retirement will depend upon it, talk to an independent pension specialist now
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