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When should you take out your 25% tax-free pension lump sum?

According to research from Resolution Foundation, once an adult reaches the age of 50, they start to become happier with their lives. This could be due to multiple reasons, ranging from career satisfaction to a more fulfilling personal life.

Another reason could be the fact that they are nearing the age of 55, which means they are a step closer to tapping into their pension savings, and withdrawing a tax-free lump sum from their pension pot.

This will be an enticing offer for many savers, particularly in the context of COVID-19. After all, the pandemic has driven one in sixteen (6%) of adults over the age of 40 admit to withdrawing part or all of their pension without seeking any form of financial advice, according to a study by My Pension Expert.

However, there are certain rules savers must abide by to access their pension.

The rules of withdrawal

Put simply, once an adult reaches the age of 55, they are legally able to access their pension, as attempting to do so before could result in a huge tax bill. From there, they are able to withdraw 25% of their pension pot completely tax-free.

This essentially crystalises a person’s pension scheme, meaning that it can then be used as a source of income. So, once the 25% lump sum has been withdrawn, any further pension withdrawals are taxed as income.

Following the initial withdrawal, it is up to the retiree to decide what they do with the remaining 75%; they could for example buy an annuity, or a flexible income drawdown.

Many adults are still keen to take advantage of the tax-free lump sum as soon as they reach the age of 55. Whilst some choose to invest the sum in an ISA or stocks and shares to make their money work harder, others may use the money to pay off their mortgage or credit card debt.

However, does this mean that all adults should withdraw cash from their pension as soon as they reach the age of 55?

Potential benefits

Of course, many savers could stand to benefit from withdrawing their tax-free lump sum as soon as they reach the age of 55.

Indeed, it can be incredibly beneficial in funding the early part of an individual’s retirement – particularly for those whose retirement income is likely to sit above the tax-free annual allowance of £12,500.

Taking out the lump sum sooner rather than later could also be useful for people looking to diversify their retirement savings investments. Having the flexibility to invest 25% of a pension pot into promising stocks and shares, for example, whilst the remaining 75% continues to grow in the original pension scheme could certainly help individuals looking to make their retirement savings to work harder.

That said, investments like these will naturally come with risks, so savers should assess their risk appetite and seek advice before making a final decision.

Pause for thought

 Of course, an earlier withdrawal of the 25% lump sum might have inevitable drawbacks for savers.

Primarily, keeping the entirety of one’s pot in a pension scheme means that the saver can continue to enjoy tax-free growth on their savings. What’s more, the pot is protected from inheritance tax, should the saver in question die earlier than expected.

What’s more, accessing funds earlier than necessary could reduce an individual’s ability to make future contributions to their pension savings. So before withdrawing any cash, it is vital to check the details with one’s pension provider.

At the end of the day, everyone has different needs when it comes to their retirement finances. Some savers might benefit from withdrawing their 25% tax-free lump sum as early as possible, whilst others might not, depending on their individual circumstances.

In general, it is advisable for savers not to withdraw any money unless they have devised a retirement strategy with an independent financial adviser. Doing so will ensure the correct management of one’s pension pot, thereby enabling Britons to enjoy a financially secure retirement.