Focus on Pensions: 6 reasons to hold on to your pension

By Rupert Lovesy

In this Focus on Pensions piece, Castlefield’s Head of Client Engagement & Advice Rupert Lovesy offers six reasons why cashing in your pension may not be the most suitable decision.

One of the most common questions I have been asked by existing and prospective clients in the last few months particularly, is whether they should cash in their pensions. In most cases, cashing in your pension is unlikely to be the best move. Here are 6 reasons why cashing in your pension may not be most suitable decision:

  1. Long-Term Financial Security: Pensions are designed to provide a steady income during retirement. Cashing in your pension might give you a lump sum now, but it could leave you with less income in the future. It's important to consider your long-term financial needs and security.
  2. Inflation and Interest Rates: With inflation remaining above target, it's crucial to have a reliable income source. Pensions can provide a stable income that keeps up with inflation, whereas the value of cash savings in real terms is likely to be eroded over time.
  3. Tax-Free Lump Sum Limit: You can currently withdraw 25% of your total pension amount tax-free. As your pension grows, the monetary amount of this tax-free benefit increases up to a maximum of £268,275 - so cashing in early means you won’t benefit from further increases to the amount you could take tax-free as your pension grows. NB: although there have been rumours of a reduction to the tax-free lump sum limit, this was not announced in the Budget – however, we can’t rule out future changes to rules around tax-free lump sums, so keeping your options open would be sensible.
  4. Tax-sheltered Investments: Investments within a pension are not subject to tax on interest and dividends or capital gains realised, which allows them to grow free of tax. Although pension funds will become part of the estate after 2027, and potentially subject to inheritance tax (IHT), those other tax benefits will still be passed on and make a lot of sense if the funds will be left invested for the future rather than withdrawn straight away.
  5. Tax Inefficiency of Large Lump Sums: Taking large lump sums out of your pension can be tax inefficient. When you withdraw a large amount, it can push you into a higher tax bracket, resulting in a significant portion of your withdrawal being taxed at a higher rate. This means you could lose a substantial amount of your pension to taxes, reducing the overall benefit.
  6. Inheritance Tax Changes: Starting in 2027, pensions will be included in the scope of IHT. This means that if your estate, including your pension, exceeds the IHT threshold, it could be subject to a 40% tax. Cashing in your pension now would mean that if you were to die within the next two years (it could happen to anyone), money that could have been passed on tax-free may be subject to IHT unnecessarily. If you cashed in your pension and gifted it to someone, it would usually fall under the 7-year rule before fully leaving your estate (meaning your estate would still need to pay IHT if you died during this period).

In summary, while it might be tempting to cash in your pension, it's important to consider the long-term implications and potential changes in tax laws. Keeping your pension intact could provide more financial security and peace of mind in the future, so remember to keep focused on your long-term plans.

If you’re considering cashing in your pension and would like to speak to an ethical financial adviser about your long-term financial planning needs, please Contact Us. 

Written by Rupert Lovesy. 

 

Please note that this article is intended for information purposes only and it does not constitute a personal recommendation or inducement to invest. Investors must satisfy themselves that any action they take is appropriate in the light of their own personal circumstances. You should seek independent financial advice first if you have any doubt that the financial planning options explained in this article are suitable for you.

This article does not constitute taxation advice. Should you require taxation advice please speak to a taxation specialist or accountant. Any personal advice in respect of taxation is not regulated by the Financial Conduct Authority. Further information about taxation rates, allowances and protections are available at https://www.gov.uk.