This week, I was asked to write an article about how to cash in pensions, and mainly I just wanted to scream ‘DON’T’.
Seems like I’m in the minority though. Also out this week were figures from the financial watchdog, about what people did when they got hold of their pensions for the first time.
During the last financial year, 55% of pension pots were cashed in completely. More than half! Wham, bang, thank you ma’am – let’s take the money and run.
Yup in the brave new world of pension flexibility, if you want to cash out the whole of your pension pot as soon as you turn 55 – you can.
Previous post: What is a pension and why you should care
Now, I get that a pot of pension money can be oh-so-tempting.
Maybe you’ve been eyeing up a kitchen or a cruise, want to clear debt or help your kids with the deposit on a home.
Maybe you are not happy with the performance of an old pension, with charges going out but no new money coming in.
Maybe you’re just keen to stash the money safely in a savings account, in case the government moves the pension goal posts yet again.
But erm – hello? Those retirement savings are meant to provide an income in retirement, given the state pension doesn’t cover much. (It’s just under £8,770 a year at last count. Fancy living on that?).
Previous post: How much will I get from my pension?
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I can stand here wagging my finger, lecturing people not to go crazy like a kid in a sweetshop. A sugar binge now could leave you toothless by the end of retirement. Cashing in your pensions pronto is like buying Easter eggs early, eating them all and having to buy them all over again. Worse – take out too much money too soon, and your pension could run out before you do, with nothing left to rebuy more chocolate. Blah blah blah don’t do that thing you really want to do right now! Be sensible!
But I also wonder if everyone cashing in a pension is aware of the consequences?
Because if you take a big chunk out of a pension, Bad Things Happen. You can lose money right, left and centre, and create irreversible problems. Take a dekko at my checklist at the end of this post.
So, to quote the well-known financial commentator Aretha Franklin, think think THINK about the consequences of snatching pension cash.
Think about why you are cashing in a pension
Cashing in for a big ticket item
The trouble with money is that you can’t spend it twice. Spaffing your pension pot on an exotic holiday at 55 is cold comfort when you’re still alive 33 years later. Bear in mind 33 years isn’t unrealistic, it’s actually the average life expectancy for a 55-year-old woman, so there’s plenty of chance you’ll actually live longer. Have a play with the ONS life expectancy calculator if you don’t believe me.
Cashing in because you only live once, baby!
Yeah, yeah, spend the money now so you can enjoy it! And be spontaneous! Because you might go under a bus tomorrow!
I refer you back to the point above, when it’s 30+ years after your once-in-a-lifetime spending spree, and you’re shivering under a blanket with some cold baked beans.
Cashing in to clear debts
Debt can be distressing and destructive of mental health, so pension money can be a lifesaver in lifting a crushing burden.
But unless you’re in extreme circumstances, do think through the implications of raiding your pension to pay debts. Will it fix the problem long term, or are you leading a life you can’t afford? Say you use the money to clear your mortgage. Looking ahead, would you actually be better off selling up, moving somewhere less expensive, and keeping your pension cash to avoid more debt in retirement?
You may vow to plough way more money into your pension after clearing debts. But if you cash in more than 25% of a pension worth more than £10,000, the amount you can pay into a pension in future gets cut right back. All of sudden, you can’t pay max £40K a year into a pension, but only £4,000, and that’s including your pension contributions, any employer contributions and tax relief.
Cashing in to help your children
As for doling out money to offspring, to help with homes, cars or uni fees – check your own financial future first. Think of it as putting on your own oxygen mask before helping anyone else. Don’t hand out huge sums from the Bank of Mum and Dad if you might become a financial burden for your family in later life.
I’ve also written about the Bank of Mum and Dad recently, based on figures showing parents contribute so much towards deposits, they’ve effectively become the 11th largest mortgage lender in the UK. When I asked financial advisers for comment, they actively warned against giving away money you can ill afford, or being bullied into handing out cash. So take a long hard think about what you can actually afford, long term.
Plus, if you give money expecting to get it back, make sure it’s all down in writing, and beware of issues if your child’s relationship breaks down, and any home has to be sold.
Cashing in because your pension performance is rubbish
Performance on old pensions doesn’t always look great, with charges going out and no new money going in. Rather than taking the money out, you could always transfer to a sparkling new pension, with lower fees and perhaps racier investments in the hope of higher returns. That way, your retirement savings can still grow tax-free within a pension.
Cashing in for the safety of a savings account
Taking pension cash just to put it in a savings account makes me want to bang my head against a wall even harder than spending the lot.
Tucking money in a bank account may seem super safe. No chance the balance will fall if the stock market drops. But when interest rates are so low, your savings won’t keep up with inflation. The value of your money will be eaten away, year after year, as prices go up and up.
Previous post: Are you losing money on your savings?
Instead, if you keep your money invested inside a pension, you’ve got way more chance of it growing above and beyond inflation, even if yes, there is a risk the value could bounce up and down.
And if you really are terrified about risk, and determined to stick to cash, you can always choose cash-like options INSIDE a pension scheme.
The consequences of cashing in a pension
Maybe my doom-mongering warnings about running out of money in retirement don’t strike a chord.
But are you aware of the financial consequences of taking a large chunk of pension cash? Quite how much money you could be giving up? It can prove a seriously expensive choice.
Here’s my handy dandy checklist of the Bad Things That Can Happen, with more detail afterwards:
- Bigger tax bill if you become a higher rate taxpayer over £50K a year.
- Which also means:
- No money just for being married (Marriage Allowance)
- Less tax-free interest (lower Personal Savings Allowance)
- Less money just for having children (Child Benefit)
- Less tax-free income, if you earn over £100K a year so your Personal Allowance is cut
- Too much money in the bank?
- Lose out on means-tested and income-related benefits, such as Universal Credit
- Lose out on help with long term care fees
- Cuts the maximum you can pay into a pension in future, from max £40K a year to just £4K
- Miss out on valuable benefits if you cash in a defined benefit / final salary scheme
- Could face paying inheritance tax
- Could lose all your money to pension scammers
A bigger tax bill
I cannot emphasise this enough. Pension money can be taxed! According to Legal & General, one in four over-55s don’t realise they have to pay tax on their pension savings.
Only the first 25% of your pension pot is tax free. The other 75% gets taxed as income. Whip out a big chunk of pension cash, and money above the 25% tax free gets added to your other earnings. Remember, you don’t have to stop work to take money out of your pension, and many of us will still be earning some kind of salary at 55.
So even if you were a basic-rate taxpayer at 20% before, if that pension money pushes you into a higher tax bracket, you’ll pay 40% tax on part of it. Right now, 40% tax kicks in on income over £50,000 a year.
Yet if you took smaller pension payments over several years, to stay below the 40% threshold, you could pay a lot less tax and hang on to much more of your own money.
Plus there’s a whole bunch of stuff where you might end up overpaying tax because you get stiffed with an emergency tax code, and have to wait till putting in your tax return to get it back, or go through the faff of claiming a tax refund.
Bad things if you’re now a higher rate taxpayer
Becoming a higher-rate taxpayer doesn’t just land you with a bigger tax bill. Oh no. It can hit you much harder in the wallet.
No money just for being married
You can’t claim Marriage Allowance if you’re a higher rate taxpayer, which can save up to £250 a year where one spouse is a basic rate taxpayer and the other doesn’t pay any tax at all.
Less tax-free interest
You can’t earn as much interest on savings before paying tax if you’re a higher rate taxpayer, as your Personal Savings Allowance gets halved from £1,000 a year to £500. Wave goodbye to £200 in tax if you previously earned max interest.
Less money just for having children
At 55, you may well still have dependent children. But once you earn over £50,000 a year, you have to start paying back Child Benefit. Once you earn over £60,000 a year – you aren’t entitled to any.
So now you’re losing out on up to £1,076.40 a year for one child, and nearly £1,790 for two.
Less tax free income
OK, so this one only kicks in once your income goes over £100,000 a year, which is a nice problem to have! But currently, most people can earn £12,500 a year without paying tax, known as the Personal Allowance. However, your Personal Allowance goes down by £1 for every £2 in income you earn over £100,000. If a big chunk of pension cash takes your income over £125K that year, your allowance gets cut to zero, and you’ll face even bigger tax bills.
Bad things if you’ve now got more money in the bank
Moved money out of your pension into a savings account? You could be waving goodbye to income and benefits if your savings balance is too big.
Lose out on means-tested and income related benefits
For example, Universal Credit is reduced once you have more than £6,000 in savings, and you can’t claim at all if you have more than £16,000 savings. In contrast, money inside a pension doesn’t affect Universal Credit.
Lose out on help with long term care costs
Again if you have savings above £23,250, you won’t get help with long term care costs
Slashes how much you can pay into a pension in future.
As mentioned above, if you take a penny more than your 25% tax-free lump sum out of a pension, the maximum you can plough into a pension gets slashed from 100% of earnings up to £40,000 a year (the annual allowance) to just £4,000 a year (the money purchase annual allowance or MPAA).
The exception is cashing in up to three ‘small pots’ each worth less than £10,000, which doesn’t trigger the MPAA.
Miss out on valuable benefits
If you are lucky enough to have a defined benefit pension, often known as a final salary pension, don’t underestimate how much that is worth! Buying the same regular income, rising with inflation, would cost a ton of money elsewhere. Plus, some defined benefit pensions are even more valuable, with goodies such as generous guaranteed income rates, life cover and decent provision for your spouse or dependents after you die. Some companies offer huge handouts if you’ll give up your final salary pension, but you could be giving up even more. Defined benefit pensions can be so valuable that you have to get financial advice before cashing in scheme worth more than £30,000.
Liable for inheritance tax
If you cash in your pension, any money left when you die becomes part of your estate, and could be liable for inheritance tax (IHT).
But if you leave the money in your pension instead, it passes to your nearest and dearest free from IHT. Die before 75, and your beneficiaries don’t even have to pay income tax, if they whip out the money within two years. That’s why financial advisers normally suggest using other money first, such as Isas or other savings, and leaving your pension invested for as long as possible.
Lose all your money to pension scammers
This is the worst one – if you take money out of your pension only to hand it over to crooks for a too-good-to-be-true investment scam. Be careful with your cash or you could lose the lot!
More on how to avoid a pension scam from PensionWise.
If this sounds confusing – good. If I could get one message across in this blog post, it’s to get expert advice about your pensions. Yes, you have to pay for proper, personal advice. But if you make the wrong choices, it can hit your financial future much harder. At least book a free appointment for guidance from the government’s PensionWise, available for over 50s.
Last year, nearly half of the pension pots accessed for the first time were accessed by people who hadn’t taken any guidance or regulated advice. I wonder how many of them will live to regret their decisions?
Now – over to you. Have you ever cashed in a pension pot? Do you intend to? And have you discovered anything you didn’t know about pension cash?