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Can I take a lump sum when I retire?
When you can start drawing benefits from your pension scheme, you may be able to take part of your pension benefits as a tax-free cash lump sum and you might be able to take the whole amount within certain limits.
However, you could be hit with a big tax bill if you go over those limits so you need think carefully and also check the rules of your scheme. The government's Pension Wise web site explains the options.
If you are at least 55 you may be able to take a small pension as a cash lump sum. If you are in a defined benefit pension scheme and the value of all your pension benefits when added together does not exceed £30,000 in total, you may be able to take the whole of your pension as cash. This is known as a 'trivial commutation lump sum'.
If you are in a defined contribution scheme you may be able to take the whole of your pension as a small pot if the value of your pension arrangement does not exceed £10,000 (with the option of taking up to three small pots of £10,000 or less). The Pensions Advisory Service describes these choices in more detail.
If you have a 'money purchase' scheme pension, then you can take up to 25% as a lump sum. Most salary-related pensions let you take a lump sum when you retire in return for a reduction in your annual pension. In other words you exchange ('commute') part of your pension for cash up front. Tax rules prevent this being more than 25% of the total value of your pension, using factors set by HMRC.
The key question is how much pension you should have to give up in return for your lump sum. This will depend on your age when you retire, and sometimes on your gender, as men and women have different life expectancies (it is at present legal to discriminate in this way). It can be hard to make direct comparisons between schemes as the pension you are giving up may be different.
For example, if annual increases are generous, then you would expect a bigger lump sum for giving them up. For every £1 of pension you give up at age 65, a lump sum of between £15 and £18 might be considered reasonable.
If you are offered less than that, you should consider if it is good value. The question to ask is whether an actuary has worked out fair rates for your scheme. It is possible to work these out so the pension fund is not making a profit from people taking lump sums. This needs to be done every so often, and with people living longer, you should expect a better deal.
Some suggest that many schemes have not increased the value of their lump sums to reflect longer life expectancy. If this is the case – and you have no reason to think that you do not have long to live – then it makes sense to think very hard before succumbing to the immediate attraction of a lump sum.