Posted on: 12th October 2017
The tax free “lump sum” that savers can withdraw from a pension has always been a major selling point. For many holders, including most Final Salary members, the amount that can be withdrawn without paying any tax is a healthy 25% of their pension.
However, under the new pension freedoms, it is possible to obtain far greater sums – as much as twice the original offer – depending on which type of pension you make the withdrawal from.
Defined Benefit Pension Cash Withdrawal
If you have a final salary pension, also known as a defined benefit pension, the cash sum that can be withdrawn is calculated as approximately a quarter of 20 times the starting income.
That means that a pension that will pay £10,000 a year is valued at £200,000. Which means that you can withdraw £50,000 of cash tax-free.
Final Salary Pension Transfer
For those who have swapped their final salary pension for a “defined contribution” pension, the figure they can withdraw could be boosted even further.
This is because of the current, historically high pension transfer values that have been seen in the last year. This is known as the Cash Equivalent Transfer Value (CETV) and relates to the amount of cash a pension scheme will give you to exit the scheme.
Pension providers have found recently that it is in their interest to offer high value, as the cost of funding a final salary pension has spiralled in recent years.
In this last week, Tesco announced its first dividend in three years. It seems this was possible, in part, because its pension obligations have fallen.
Transfer Value High Leads to Higher Tax Free Cash Withdrawal
As the transfer values today can be as much as multiples of 30, 35 or even 40 times the starting income from a final salary scheme, a scheme of £10,000 might be valued at £400,000, if transferred out, which would in turn produce £100,000 of tax-free cash.
Although this sounds too good to be true, it is currently happening. However, as always with a defined contribution pension there is more risk involved which is why talking to a qualified Chartered Financial Advisor is always the safest option.
Want to take early?
For those who need to take cash from theirearly, there is a risk that they can lose out. Most final salary schemes apply discounts for taking a pension before what is classed as normal retirement age. From our analysis, retiring early, say at 55 instead of 60, could potentially take 20% off the starting pension. This effectively lowers the amount of tax free cash that can be withdrawn.
Alternatively, a defined contribution pension is freely accessible from the age of 55 onwards.
Is it all that easy?
There are some possible issues that are coming up. The Financial Conduct Authority reviewed 88 cases and found 53% were badly advised in recommending a transfer.
Our view is that this should never take place, savers have to take regulated financial advice if transferring a pension worth £30,000 or more, and this advice should always be in the best interests of the saver.
If you’d like more advice on how to make the most of tax free cash from your pension drawdown. Contact us at secure your future through sound financial advice.and let us