THE BIG QUESTION
ACASH LUMP SUM
THE RICHER RETIREMENT SPECIALISTS
The recent changes in pension legislation
have raised a hugely important question
for many people approaching retirement
age. With the option of taking up to 100%
of their pension fund in cash, how much, if
any, should be withdrawn?
In talking about the new pension freedoms, the
pension minister recently confirmed that someone
really could cash in their pension and buy a
Lamborghini! That caught the imagination of many,
and resulted in a ripple of concern.
The government is now worried that people may
not understand all the issues involved in making a
decision to withdraw cash from their pension. So a
national support network has been created to provide
‘guidance’ for everyone who wants it. Since this
‘guidance’ is going to be generic and not delivered by
professional financial advisors, it remains to be seen
how valuable it is.
This article covers my personal views on the important
question of whether to draw cash, and if so how
much, from your pension fund. It is not personal
advice since everyone’s circumstances are different.
However, with the information I’m sharing, you will be
better prepared to consider this choice. I recommend
that you take financial advice from an approved
advisor before making any final decisions.
From what pensions can a 100%
withdrawal be made?
PENSIONS FALL INTO TWO MAIN CATEGORIES.
Defined contribution (DC), also called Money
These pensions have a final value that is determined
by market forces. Your pension managers have built
up a fund during your years of contribution, the value
of which is determined by the total contributions and
the investment performance of the fund.
Historically, most DC schemes (which could be
personal or works pensions) have allowed a 25% tax
free lump sum, with the balance taken as an annuity
(or income for life). More recently many people
have decided to keep their fund invested (going into
‘drawdown’) and not buying an annuity.
Any pension holders who have a DC scheme will be
able to take advantage of the new pension freedoms
and withdraw up to 100% of their fund. This is true
whether it is a personal or a company pension
These pensions have a value that is determined by a
set of rules that usually relate to your salary in the last
few years of employment. DB schemes usually allow
you to take 25% tax free cash on retirement, then
provide a pension for life.
A DB scheme does not allow you to take the rest of
your pension as a fund to keep for investment, or to
take the rest of your scheme in cash despite the new
Therefore those people with DB schemes, now
wanting to benefit from the new pension freedoms
and withdraw more than 25% from their fund, need to
transfer their DB scheme to a different DC scheme.
The Government has decided that there is a
considerable risk to the public finances if too many
government employees with DB schemes decided
to transfer to DC schemes. This would require
the payment over of the full cash funds – possibly
amounting to hundreds of millions of pounds!
Therefore there is no opportunity for government
employees to benefit from cash withdrawals above
what is already allowed in their existing scheme. And
government employees are banned from switching
from a DB to a DC scheme.
Employees in the private sector are still be able to
switch from a DB to a DC scheme, subject to getting
advice from an IFA.
What are the new rules about
withdrawal of cash from your
• From April 2015, many people reaching
retirement age (minimum age 55) who have
an appropriate pension, are able to withdraw
up to 100% of the value of the fund.
• The first 25% of the fund can be withdrawn
free of tax. (This is the existing position).
• Any further withdrawals will be taxed at your
marginal tax rate, at the time the withdrawal
• You do not need to make one big withdrawal,
but can spread them over a period.
• It is worth remembering that you do not
have to make any withdrawals at all!
Seven basic principles to bear in mind
1. Before we start our discussion of the pro’s and
con’s of taking cash from your pension, it’s
worth keeping in mind a handful of fundamental
principles that underlie the concept of pension
provision. Pension provision can be considered in
two parts. The first part, up to retirement, consists
of building the largest pension fund possible. The
second part, after retirement, consists of turning
this fund into the largest income possible.
2. Any cash withdrawal from the fund, at any time,
has a negative impact on your ability to generate
3. The larger the amount of cash you take, the
greater the negative impact on your income.
4. Taking money from your fund sooner rather than
later also has a negative impact, because you
don’t allow the fund to continue growing through
investment performance. Therefore taking cash at
age 55 is far worse than taking cash at 65!
5. Money accumulating inside a pension grows tax
free. Money growing outside a pension is mostly
taxed at your marginal rate (with few exceptions
like ISA’s). Therefore there is an underlying benefit
to keeping your fund inside a pension wrapper
unless other factors override this advantage.
6. Since the first 25% of cash is tax free, but
everything further is taxed, a distinction needs to
be made between what part of the fund is being
7. if you need money for any purpose, it is almost
always advantageous to find it from tax paid
money outside your pension than from tax free
money inside your pension.
To take or not to take, that is the question!
With core principles and understandings covered, let’s
consider the key decision points about taking cash
from your pension.
WHAT DO YOU WANT THE MONEY FOR?
Perhaps the most fundamental question to ask. There
are six key categories that your cash withdrawal may
1. Payment of pressing debt
I’d say this category is sad but necessary. If you are in
the unfortunate position of being in financial difficulty
and only a cash payment will sort it out, you may have
to make a short term decision that takes precedence
over longer term retirement plans.
However, I’d still be looking for ways to reduce the
debt – definitely take professional advice – and only
use your pension fund as a last resort.
2. Purchase of non-essential goods or services
One of the largest categories of reasons to withdraw
cash, including everything from cars to holidays to
house improvements to cosmetic procedures! The list
I’ve got dreams and plans for my retirement. I deeply
understand the urge to fulfil them when your pension
fund can unlock what you have wanted for, perhaps,
However, in the cold light of day, we have to balance
the benefit of indulging ourselves with the potential
long term consequences to our future income.
It’s a matter of balance. If we have £500,000 in our
pension fund and we take £25,000 for non-essential
expenditure, it frankly matters little.
But if we have £100,000 in our pension and we want to
take £50,000 to indulge ourselves I’d start to raise the
Consider carefully any expenditure in this category
and balance it against the loss of income that will
3. Investment outside the pension scheme
This is probably the single biggest reason that people
consider withdrawing capital from their pension fund.
And generally it is the most mistaken!
This is such a big point I’ve given it a whole section
later in this article. However as a brief introduction it is
worth keeping in mind these two key points:
• If an investment provides the same top level
return inside and outside a pension scheme, the
benefit of tax relief always means that it is always
better to invest inside the pension.
• If you aren’t getting 7%-15% annual return inside
your pension, change your pension investments so
that you ARE getting the best possible income and/
or growth. Ask my company, Avantis Wealth, for a
no-obligation pension review!
4. Business support
Maybe your business needs a cash injection for
growth that will improve profitability. I’d say that’s a
good call. Alternatively we may need a cash injection
to rescue a business that has been struggling. That
seems more challenging to me.
The difficulty is this. We may have an emotional
attachment to our business which means that we
inject more capital, only for it to be lost in years to
come. That would be a very bad thing to do with a
pension fund that we have carefully developed over
our lifetime, and where there is no time to do it again.
Perhaps the best suggestion is to say that if you are
considering supporting your own business, if you have
the slightest doubt about the safety of the investment
get an accountant to give you an independent view.
5. Paying off the mortgage on your own house
This is a common reason for wanting to draw cash
from your pension. There are two aspects to the
decision – the purely financial one and the emotional
From a financial perspective it rarely makes sense
to take pension fund money to pay off a mortgage.
Typically you will be paying between 2% and 5% p.a.
interest. And your pension fund could – if invested
wisely, be used to generate income of circa 10%
net annually. Perhaps three times the level of your
An alternative to paying off your mortgage using a
capital sum would be to make sure you are getting
maximum income from your pension fund, then use
that money to pay off your mortgage far more quickly
than you are currently doing.
The second perspective is an emotional one. I fully
understand the security we can feel of knowing that
our house is owned outright. This could be particularly
important if our income sources are somewhat
The third aspect of this decision is the scale of the
mortgage, in relation to the size of the pension fund
and other investments. If we have a huge mortgage,
and modest investments, then it probably makes
more sense to trade down to a smaller property than
to deplete our retirement income by withdrawing a
high percentage of our pension fund.
Alternatively, if we have a small remaining mortgage
and a large pension fund, paying off the mortgage
is more like a ‘tidying up’ exercise than a major life
As with all other reasons for withdrawing cash from
the mortgage, there is no black and white answer.
However, consideration of the points raised in this
section will help you make the right decision for your
6. Medical emergencies
A medical emergency is just that. An emergency.
And life and health come before anything else. So
if you are in the situation when money is called for
– somewhat rare in the UK – then it clearly takes
precedence over any other future use of the money.
But again I counsel you to use your pension fund as
a last resort, and look to fund this from any other
Your marginal tax rate
Once you get beyond the first 25% tax free cash
withdrawal, you will pay tax on capital withdrawals at
your highest tax rate. If you are a zero or even 20% tax
payer the impact is relatively minor. If you pay tax at
40% or 45%, a considerable part of the cash you take
is going to disappear back to the Government.
Therefore it follows that higher rate taxpayers should
consider cash withdrawals with greater care to ensure
that the planned benefit will outweigh the significant
tax bill that will arrive.
It may be that your income in retirement is not
regular, and therefore you have years where your
taxable income is lower and your tax rate falls. You
may be able to arrange your affairs to take lump sums
from your pension in years where your tax rate is
Investment performance inside the
One of the most common discussions I have is with
clients whose pension is performing badly. Perhaps
there has been no real growth for years, or even
losses. They plan to withdraw funds to invest outside
This could be a really good move, or maybe not! There
are important aspects to weigh up:
Can you do better with investments inside your
pension? If you can, then it is very questionable
whether it makes sense to take money out of a tax
free environment and invest it in a fully taxed one.
This goes to the core function of what my company,
Avantis Wealth, offers clients. We focus on investment
that deliver 7% to 15% net annual return and for most
clients are transformational in terms of on-going
income and/or growth.
Let’s consider an example, where the investment
returns are the same inside and outside a pension. We
will assume that you are a 40% taxpayer. You wish to
invest £100,000, and your investment produces 10%
annually before tax.
Inside your pension the full £100,000 is invested, and
produces £10,000 annually. This is not taxed. This
has two potential benefits. Firstly, if you don’t actually
want to take the income, then none of it will be taxed
and it can all be left to grow your fund. Secondly, if you
only want to take part of it, then you will only be taxed
on the part which you decide to withdraw as income.
Contrast this with taking £100,000 from the pension.
With tax at 40% you can only invest £60,000. This
reduced capital creates income of £6,000 which is
subject to tax at 40%. Therefore the net income is
£3,600 a year. Even if you don’t want to take the
income, only £3,600 is available for reinvestment – a
massively lower amount than if the £100,000 had been
invested inside your pension.
My experience is that many people make a
fundamental mistake in thinking that investment
outside a pension is automatically better. Absolutely
not the case.
Of course there are situations where it makes good
sense to withdraw cash from the pension fund and
invest outside. Here’s a scenario where you would be
better off withdrawing cash:
1. You have little income and pay tax at 20%
2. You need to live on the income that is created
from your fund
3. You can generate a much greater investment
income outside your pension than you can inside
the pension (unlikely!)
4. You have a relatively small fund (say less than
£30,000) where the benefit of transferring your
pension to an alternative scheme that enables
more productive investment is doubtful because
the costs are too high in proportion to the value of
And here’s a scenario where it makes no sense to
withdraw cash from the fund – even the 25% tax free
1. You pay tax at 40%
2. You don’t want to take the income yet, preferring
to let the fund grow
3. You can achieve similar investment returns inside
your pension as you can outside it
My company, Avantis Wealth, specialises in offering
property investments with an 7%-15% net annual
return, most of which can be included within a
pension scheme. So if your pension scheme is not
achieving, year after year, this kind of regular income
we should be talking. Of course all pension transfers
must be fully advised by an IFA and our clients are
Health and lifespan
If you suffer from impaired health, or a statistically
reduced lifespan due to certain lifestyle choices (like
smoking for example), you may make the decision that
your pension fund does not need to provide for so
many future years of income.
In these circumstances you may choose to withdraw
greater amounts from your fund to enjoy life for the
shorter period available to you.
Of course the opposite is also true. If you come from
a long lived family and can expect to survive into your
80’s or 90’s, any lump sum withdrawal now could
prejudice the life you want to live perhaps 20 or more
years into the future.
Your income needs have an immediate and critical
bearing on whether you should be withdrawing cash
from your pension fund or not. You can’t have it both
ways – either you have the biggest possible pension
fund and therefore the highest level of income. Or you
And in the worst case, withdraw and spend all your
capital and you have zero income from your pension.
Of course, if you have income from elsewhere this
might not matter, but this is an area that repays
In simple terms, take away 50% of your fund and you
take away 50% of your income. That could mean an
income of £2,000 a month becoming £1,000 a month.
Let’s say you have other direct investments outside
your pension scheme. And these other investments
provide most of your income.
Then the importance of your pension scheme is
diminished, in the grand scheme of things. And as
such you can be more relaxed about taking capital
from your fund. If the impact of what you propose to
do, on your whole retirement plan, is relatively minor –
then you may only need a cursory check before going
On the other hand, if you have little or nothing in the
way of other investments, and your pension scheme
accounts for all or most of your income, then taking
out capital sums from the fund could be critical to
your future income.
There is no right or wrong. Just a question of balance
and what’s right for you.
Five simple guidelines
This has turned out to be a far longer article
that I anticipated, but there was a lot of
important ground to cover. I hope it has been
helpful. Here’s a quick summary condensed
into five key guidelines:
1. Start from the basis that it’s better for your
retirement income not to take any cash
lump sum at all.
2. If you think you have to take cash, weigh up
what you will gain against what you lose.
3. If you are a higher rate taxpayer, restrict
the cash to the 25% tax free element.
4. If you are planning to withdraw cash to
invest outside the pension, review whether
you can make the same return through
better investments inside your pension (ask
for examples from Avantis Wealth).
5. Always take a holistic view of your
retirement planning. Consider the impact
of taking cash from your pension fund on
your total retirement income, the reduction
in available capital, and the benefits that
using the cash elsewhere will bring.
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THE RICHER RETIREMENT SPECIALISTS