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Experts Guide to Cashing In Your Pension

Richard Beardsworth Pension Expert

By Richard Beardsworth.

Independent Financial Advisor

More Reading on Cashing In Pensions...

Your pension is the key to your financial future upon retirement. You are depending on that pension to meet your living expenses once you are too old to work. When that time comes, you will be cashing in your pension for the purposes of either investing the money or purchasing an annuity. How you plan to do all of this will go a long way toward determining how much money you have to live on during your retirement years.

In this guide, we will discuss a number of points, including how to utilise a state pension at retirement age or a personal or work place pension at age 55. Please keep in mind that there is a difference between cashing in your pension and taking advantage of a scheme known as 'pension release' or 'pension liberation'. When you cash in a pension, you are accessing funds after age 55 without incurring punitive taxes.

Different Pension Types

Let us start by defining the different kinds of pensions that UK consumers are eligible to participate in. There are four basic pension categories, each with their own subcategories:

  1. State Pension – The state pension is offered to every worker in the UK who has at least 10 years of qualifying work prior to reaching retirement age. Retirement age for men is currently 65. Retirement age for women is 60, but that age will be gradually escalating to 65. The Government will eventually raise the retirement age for both to 68, as explained by This Is Money.
  1. Workplace Pension – The workplace pension is a pension scheme sponsored by your employer. This can be a private employer or a public agency. The advantage of the workplace pension is that the employer contributes a certain amount to be added to worker contributions.
  1. Private Pension – A private pension is one set up with a pension administrator by the individual saver. Employers may contribute to it if their workplace pension programmes allow that option. These are typically group pension schemes with participants from multiple companies.
  1. SIPP – A self-invested private pension (SIPP) is one that is completely independent of employers. It is the kind of pension normally used by self-employed individuals.

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All four kinds of pensions come with specific rules about when they can be accessed. The state pension cannot be utilised until retirement age, while the other three are eligible to be accessed starting at age 55. Also keep in mind that you do not cash in a state pension in the same way you would one of the other three types. Rather, you get monthly payments from the Government for as long as you live.

Reasons for Cashing In

It is generally assumed that most savers will not touch their pension pots until they are ready to retire. So why would someone cash in a pension starting at age 55? There are a number of reasons.

The most common reason is one of being faced with a financial situation requiring extra cash. Paying unforeseen medical expenses is a good example. A 55-year-old man caring for his ageing father may need the extra money to pay for things not covered by the NHS. By accessing a portion of his pension, he can meet those expenses. Other reasons for cashing in a pension at age 55 include:

  • entering retirement early
  • investing the money elsewhere
  • taking an expensive holiday
  • retiring high-interest debts.

You may be wondering when it is a good idea to consider cashing in your pension and when it's not. Unfortunately, there is no easy answer to that question. It depends on your circumstances. The best thing to do is speak with a certified financial planner who can help walk you through your current needs and explain how the different pension options apply to your circumstances.

How to Cash in Your Pension

Should you decide to cash in your pension, there are strict rules regarding how it works. The first thing to understand is the age at which you can access pension monies with minimum tax liabilities. As we said earlier, the state pension cannot be accessed until you reach retirement age. All other pensions – workplace, private, and SIPPs – can be accessed beginning at age 55.

Knowing this, be very cautious about early pension releases schemes. Companies offering to release your pension prior to age 55 may be scammers looking to steal your pension pot. They may offer to unlock pension cash on your behalf but are only unlocking it for their own benefit.

According to the Money Advice Service, accessing a private pension prior to age 55 is only allowable in rare circumstances, such as a chronic or debilitating health condition that would prevent you from working. If you attempt to cash in a pension early, you will be subject to penalties that could wipe out everything you have saved.

Having said that, new pension rules from spring 2015 make it a lot more beneficial to cash in a pension at 55. The new rules stipulate that savers can take an initial lump sum of 25% tax-free. For example, you could take £25,000 out of a £100,000 pension pot without paying a pound in taxes. The remaining money would be taxed at your marginal rate whenever you decide to access it.

A second option, according to The Guardian, is to use your pension pot as a bank account. You would draw it down over a long period. The tax liability would essentially be the same – the first 25% of every withdrawal is tax-free; the remaining 75% is taxed at your marginal rate.

It is important to know the value of your pension in order to determine whether you should to cash it in. Why is this important? Because you might be able to access multiple small pensions without any tax liability being incurred. We discuss this later on in this guide. To learn the value of your pension, all you need do is contact the pension administrator.

Should you decide to cash in a pension, regardless of its size, the pension administrator can handle the details for you. You'll have multiple options including taking the entire pot in cash, taking a partial payment and leaving the rest alone, transferring into a new pension scheme, purchasing an annuity, opening a savings account, or transferring your assets to other qualifying investments.

Lost and Frozen Pensions

There are two circumstances that can cause confusion when it comes to cashing in the pension: lost and frozen pensions. A lost pension is one that was set up through a previous employer you no longer work for. In a day and age in which people switch jobs regularly, having multiple lost pensions is not unusual.

A frozen pension is a state pension with a payment that has been frozen because the pensioner has moved out of the UK to a non-qualifying country. As explained by The Guardian, there are a number of countries UK expatriates can move to and still enjoy their pension payments increasing in line with inflation. The US and Israel are two examples. If an expatriate decides to move to a non-qualifying country, his or her monthly pension payments will be frozen at whatever amount was being received on the date he or she arrived in the new country.

Frozen pensions are completely separate from the idea of cashing in a pension at age 55 because you are not eligible to receive the cash in frozen pensions until retirement age. At that point, you are only receiving monthly payments anyway.

As for lost pensions, these are treated as any other non-state pension. The no cost way to find a lost pension is to use the Government's pension tracing service by visiting their website. You fill out a short form that allows them to search for any pensions in your name. The information they return can be used to contact pension administrators for more details about your money. You can also contact former employers directly if you believe you might have a lost pension with them.

Pension Commutation

There are some savers with one or more small pension pots valued at £30,000 or less. If you are over age 60, you may be able to take the monies from the pensions as a tax-free lump sum under something known as trivial commutation. Unfortunatly this option is now no longer available.

Pensions and Taxes

Whether you cash in a pension at age 55 or wait until retirement age, certain tax liabilities apply. The tax you pay will depend on what you do with the money once you access it. The one exception here is for people who qualify as non-taxpayers because their income is less than the Personal Allowance. In such cases, you need only file the appropriate forms with the pension administrator.

Assuming you are liable for income tax, the most basic scenario would be the one we described earlier. You would take the first 25% of your pension funds tax-free. The remaining 75% is taxed at your marginal rate. This is true whether you take all the cash immediately or you gradually drawn down your account.

Pensioners who decide to retire overseas have the option of avoiding UK taxation by transferring their pension pots to a Qualifying Recognised Overseas Pension Scheme (QROPS). The laws surrounding QROPS are rather complicated, so it is best to seek the advice of a qualified professional if you are interested in going down this route.

Pension Drawdown

Lastly, should you decide to draw down your pension pot in order to invest the money elsewhere, you will likely pay capital gains taxes on the earnings from your other investments along with the income tax charge to your pension monies. For example, someone investing in residential rental property would pay the marginal income tax on 75% of his or her pension funds. Money earned from rental properties would then be subject to income tax and, upon the sale of said properties, capital gains tax. You can read more about drawing down on your pension in our Experts Guide to Pension Drawdown

There are far too many investment opportunities to address them all in this guide. If you plan to cash in a pension and invest the money elsewhere, it is imperative that you work with a financial advisor in order to minimise your tax liability.

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Get Sound Advice

Whether you plan to cash in a pension at age 55 or delay accessing your funds until retirement age, we cannot stress enough the need to get sound advice from a qualified professional. Only an experienced professional can properly guide you in making wise decisions that will secure the best results for your future.

Our panel of FCA regulated pension experts can answer all of your questions regarding cashing in a pension. They can explain the law, advise you about tax liabilities, discuss various investment opportunities, and so on. What's more, our initial advice is free. You will always be advised of any charges that might apply before you commit to doing anything.

Some companies’ make it sound as if it is easy to cash in a pension and be on your way. However, there are many things to consider. You would be wise to get good advice. The last thing you need to do is find yourself in financial trouble because a lack of understanding led you to make unwise choices.

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