Pension tax-free cash: a practical guide
This content is for information purposes only and should not be taken as financial advice. Every effort has been made to ensure the information is correct and up-to-date at the time of writing. For personalised and regulated advice regarding your situation, please consult an independent financial adviser here at Castlegate in Grantham, Lincolnshire or other local offices.
Pensions are still a powerful vehicle for saving towards retirement in 2023-24, particularly due to their tax advantages. One of these advantages is the freedom to withdraw up to 25% of the value of your pension pots without income tax after the age of 55 (the Normal Minimum Pension Age, or NMPA). Yet how does this work, exactly? Is it a good idea to take your tax-free cash?
Below, our Lincolnshire financial planners offer a short guide about this important topic to help readers gain more clarity about their retirement options. We hope this summary is helpful to you. To discuss your financial plan with us, please get in touch to arrange a no-obligation financial consultation, at our expense:
01476 855 585
info@casfin.co.uk
Pensions & the PCLS
The tax-free lump sum is sometimes called the commencement lump sum (PCLS). This refers to the total amount that most people can take, in cash, from their pension once they start accessing their benefits.
Confusion often occurs, however, over some jargon-heavy pension language – in particular, “uncrystallised funds” and “crystallised funds”. The important thing to know about these terms is that they refer to different parts of a pension, determining their treatment for tax purposes.
Uncrystallised funds, in simple terms, are the funds in your pension which have not yet been accessed. If you are aged under 55 in 2023-24, for instance, then all of your pension funds will fall into this category because you cannot typically start accessing benefits before the NMPA.
Conversely, crystallised funds are those which have been formally assigned to provide pension benefits. For example, if £100,000 in your pension has been committed to income drawdown (i.e. keeping the funds invested whilst gradually taking an income from them), then these will be classed as “crystallised”.
The distinction between these two categories was very important before April 2023 because crystallised funds were tested against the Lifetime Allowance (the maximum value that an individual could have stored in their pensions, which was £1,073,100). However, in 2023-24 the Lifetime Allowance charge has been abolished.
How does the PCLS work?
If an individual turns 55 in 2023-24, they will typically have the choice of taking up to 25% of their pension as a PCLS (a tax-free lump sum) – using the rest to provide an income which is subject to their marginal rate.
Let’s take an example. Suppose you have £400,000 in your pensions in 2023-24 and you have just turned 55. You could take up to £100,000 as a PCLS. £300,000 is then put into flexi-access drawdown, providing a regular income which would be subject to income tax (assuming your earnings take you over your tax-free Personal Allowance).
You are not legally obliged to take your PCLS, however. Indeed, choosing not to take it could be the right decision for some people. It all depends on your financial goals and circumstances.
Please note that the NMPA will be rising to 57 in 2028. Therefore, some readers may need to wait an extra 2 years before they can access their PCLS.
The pros & cons of the PCLS
One benefit of the PCLS rules is that an individual does not have to take their full 25% tax-free lump sum all at once. Assuming it has not been fully used up, an individual has the option to use their PCLS each time they access pension benefits.
This can be helpful for tax planning and income planning. For instance, suppose you have £600,000 in your pension. You could theoretically take £150,000 as a PCLS all at once. However, imagine you decide to crystallise only £300,000.
This means you could take up to £75,000 as a PCLS. Later, you could take more when you decide to crystallise the remaining £300,000. Following an approach like this could help certain individuals to manage their marginal rate in a more efficient way.
However, one drawback to taking your full PCLS is that it takes away a large portion of your pension value. This could lead to you having a lower pension income, possibly leading to a reduced standard of living. In worst-case scenarios, without careful planning, an individual could even erode the sustainability of their pension – running out of money in retirement.
Speaking with a financial adviser (such as one of ours in Grantham!) can help you navigate complex PCLS issues like this – giving you more information, clarity and peace of mind as you move forward in your decisions.
One key issue to consider before taking pension benefits is the Money Purchase Annual Allowance (MPAA). When triggered, these rules restrict the individual’s annual allowance (i.e. their yearly limit to make pension contributions and benefit from tax relief) to £10,000. This could severely restrict your ability to keep contributing to your pension.
So, make sure you have all of the relevant information about the MPAA ahead of time. Again, seek professional advice to gain the insight and guidance required to navigate this nuanced aspect of the UK tax system for pensions.
Invitation
If you are interested in discussing your own financial plan or investment strategy with us, please get in touch to arrange a no-commitment financial consultation at our expense:
01476 855 585
info@casfin.co.uk
