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How to Withdraw from a Pension

Information on the different ways a pension can be accessed

Leaf Financial Advisers Ltd. - Independent Pension Advisers from Bristol

You save into your pension for decades, building up a pot to sustain you through your retirement years.  Currently, from age 55 (due to increase to 57 in April 2028) you can begin to withdraw from your Defined Contribution pension pot.

Thanks to Pension Freedoms there are now several choices when it comes to deciding how to access your pension pot.  This allows you to tailor your withdrawals to suit your situation, and hopefully help you get more out, when you need it, with lower costs and taxes.

 There are now a number of choices when it comes to withdrawing from your pension. These are:

  • Take out an Annuity
  • Use Drawdown
  • Take your pension as several lump sums
  • Take your whole pension in one go
  • Leave your pension where it is
  • A mixture of the above

Not all pension plans may offer all of the above options.  For example, workplace pension schemes may only offer a choice of an annuity.  However, you are able to transfer to a different pension provider that offers all the options, with a transfer generally a straightforward process.

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Annuity - Guaranteed income for life

Once a popular option when withdrawing from a pension, annuities have become less common but can still be a good option for many.

You withdraw some or all of your money from your pension pot and use it to purchase an annuity, giving you a guaranteed income for an agreed period of time, usually for life.

The withdrawal here is essentially the buying of the annuity. 

When you purchase an annuity, you may be liable to pay income tax depending on your earnings in the tax year you take them.

  • You can take up to 25% as a tax-free lump sum straight away.
  • The remaining money is given to an insurance company in return for an agreed income (usually for life).
  • There are numerous features that you can include such as annual increases to the income, a pension for a spouse or dependant and a guarantee period.
  • If you have any health problems you might be able to get a higher income in return for the same lump sum cost.  This is called an ‘enhanced annuity’.
  • Due to the income you receive from an annuity being partly based on interest rates, the income the annuity company offers may be lower than expected, especially if interest rates are low.
  • You may be able to pass something on to your loved ones, if you select the right features.
  • Once you take out/buy an annuity, you can’t usually change your mind.

Using Drawdown

Pension drawdown, or pension income drawdown as it is also called, is a flexible way of withdrawing the money in your pension pot while it remains invested.

This allows you to withdraw money for your retirement expenses whilst giving your remaining pension the chance to benefit from investment growth over a longer period.  This opportunity would be lost if you purchased an annuity with the pension pot or took all of your pension savings in one go as cash.

  • You are able to take up to 25% of your pension as a tax-free lump sum.  This can be taken straight away if you wish.
  • The rest of the money in your pension pot remains invested and you can then take a regular income or ad-hoc lump sums as and when you please.
  • As your pension savings are remaining invested, they have the chance to continue to grow.
  • However, if you take too much, or your investments underperform, you may run out of money sooner than planned.
  • You can leave any pension fund you don’t withdraw to your family or any other beneficiaries of your choice.

Please be aware that if you take more than 25% as a lump sum in one go, you’re usually liable to pay income tax on it as earned income.  You may fall into a higher tax bracket if you withdraw large amounts from your pension pot.

If you would like to know more about Pension Drawdown then please read our dedicated article – Pension Drawdown.  Alternatively, you can get in touch with us and we’d be happy to help with any questions you may have.

One or several Lump Sums (UFPLS)

An alternative way of accessing your pension is to leave all the money within the pension pot and take lump sums from it as and when you need, until your money runs out or you choose another option.

You can decide how much to take out each time, when to take it out and how often.

Each time you take a lump sum from your pension, a quarter (25%) of it is usually tax free, with the rest being taxed as earnings.  This means that if you take a large sum you could move up a tax band.

The money remaining in your pension pot can stay invested, which may give your pension savings a chance to grow, although it’s important to understand that it could go down in value too.

If you take too much out of your pension, or your investments underperform you may run out of money sooner than planned.  Any money that is not withdrawn can be left to your family, other beneficiaries or charities of your choice.

Do nothing, and leave your pension where it is

Just because you have reached the minimum pension age or the age you agreed with your pension provider to retire, does not mean that you are forced to take action.  The current minimum pension age is currently 55, and is due to rise to 57 on 6 April 2028 (and to remain 10 years below the State Pension age).

If you can delay taking money from your pension savings, this can allow you more time to consider your options.

Delaying taking your money may also give your pension savings a chance to grow, but it is important to note that it could fall in value as well.  Any money left in your family or other beneficiaries of your choice.

How much can I withdraw from my pension?

If you have a defined contribution pension, then you can take as much as you want when you turn 55  (to rise to 57 in 2028).

In most cases, 25% of your pension can be taken tax-free.  Some older pensions may have a protected allowance for a higher lump sum.  The remaining 75% will be subject to income tax as earned income.  Depending on how much you withdraw this could add up to a chunky tax bill and may also push you into a higher income tax bracket.  If you are planning to cash in all or most of your pension, you should think very carefully about how you will use that money to fund your retirement, particularly if it’s your only pension.

Although you can withdraw from age 55, and can take the 25% tax free lump sum at this point, it may make more sense to leave your pension invested.  Leaving it will give it a chance for further growth (including your tax free lump sum), can help with inheritance tax liability and other general benefits of having your money in a pension wrapper.

What tax will I pay on my pension withdrawals?

If you’re at least 55 you can take up to 25% of your overall pension pots as a tax-free lump sum.  Some older pensions may have protected rights to a higher amount of tax free lump sum.   If you make use of this allowance in one go, the income you then take through an annuity or pension drawdown will be subject to income tax at your marginal rate.

If you don’t want to draw a regular income, then you can draw ad-hoc lump sums (these are known as ‘uncrystallized funds pension lump sums’ (UFPLS)).  25% of each ad-hoc withdrawal made this way will be tax-free, and the remainder will be taxed as income at your marginal rate.

You may also face a tax charge if your combined pension benefits exceed the pension lifetime allowance. This is currently £1,073,100 for the 2022/23 tax year and is due to remain at the same level until 2025/26. Any benefits you hold above the allowance will be subject to a 25% tax charge if they are taken as income, or 55% if you take them as a lump sum.

It’s important to be aware that the first time you make a taxable withdrawal from a defined contribution pension, you are likely to be charged using an emergency tax rate. This is because, unless you have an up-to-date tax code or P45, your pension provider won’t know the correct amount to deduct, and so will use the emergency code.  Although you will overpay tax you can claim the overpayment back from HMRC.  Once your tax position has been clarified, you will then be issued with a new tax code.

Final Thoughts

There are currently many different options for how you can access your retirement savings.  They all have different pros and cons, and which is the most suitable will depend on your own unique situation, including not only the type of pension you currently have but also your own goals and plans for the future.

It’s important to remember that you don’t need to pick just one.  You can use as many or as few as you need, in whatever combination is right for you and at the right time for you.  In many cases, you’ll be free to change your mind later on as well.

As well as understanding the strengths and weaknesses of each, and how they may be suited to each situation, it’s important to note that they call come with slightly different tax implications as well.  So it’s important to understand how
much tax you may have to pay before going ahead.

If you’d like a friendly chat to discuss the options you have for withdrawing from your pension, then please get in touch.  We’re Bristol based Independent Financial Advisers who offer a free consultation and can visit you in the comfort of your own home.