What are the risks of withdrawing your entire pension at once?
- TBA
- Jul 10, 2024
- 5 min read
When you turn 55, you are free to withdraw and use your private pension.
Some may wonder – if I have an urgent need for the money, can I withdraw everything from my pension pot at once?
In many cases, if you wish, you can actually withdraw the entire pension pot in one lump sum. However, whether you can do so and how depends on the type of pension you have and the specific requirements of your provider. You also need to be aware of a significant risk – paying a large amount in taxes.
Therefore, before making a decision, you need to understand the tax rules and risks associated with withdrawing your entire pension.
1. Withdrawing your entire pension in a lump sum
Back in April 2015, pension withdrawal rules were changed to allow people to withdraw their entire pot in a single lump sum.
Note that not all pension providers offer a lump sum withdrawal option. You need to consult your current pension account provider. If they allow it, they will generally explain the process and require you to provide some documents to apply. If your provider does not offer this option, you may need to transfer your funds to a new provider to withdraw your pension.
In certain cases, you may not be able to use this option, such as:
If you received a portion of your ex-spouse’s or ex-civil partner’s pension due to divorce
If you have certain special features or guaranteed rights, such as a guaranteed minimum pension with an S32 policy
However, different pension companies have different withdrawal rules. Always consult your pension provider before withdrawing your pension.
Note that the withdrawal age will increase to 57 in 2028.
2. Advantages of withdrawing in a single lump sum
Advantage 1: Flexibility
The biggest attraction of withdrawing your entire pension is flexibility.
If you know how you need to use the money, you are not bound by annuities or other investment strategies.
Advantage 2: Invest the way you want
If you want to continue increasing the value of your pension, a lump sum withdrawal allows you to invest in a way that suits you. This method might yield higher returns, but your pension could also depreciate.
Advantage 3: Early retirement
Perhaps you want to travel or pursue new hobbies. In that case, withdrawing funds from your pension in one go can help you achieve these goals earlier.
Or, if you have debts such as a mortgage, you might want to clear them upon retirement. A lump sum withdrawal is one of the simplest methods.
3. Risks of withdrawing in a single lump sum
Risk 1: Tax implications
The main issue when withdrawing your pension in one go is taxation. When you withdraw cash from your pension pot, 25% is typically tax-free, and the remaining 75% is taxed as income. This could push you into a higher tax bracket. For instance, if your pension and other income sources total over £150,000, you will be taxed at the highest rate of 45%.
Additionally, you might have to pay more tax than necessary when you withdraw your pension. Pension companies usually do not know your personal tax code or how much income you earn from other sources.
Without this information, they need to use an emergency tax code to calculate the tax on withdrawals. This means you might lose part or all of your personal tax allowance and end up paying the highest tax rate on most of your pension.
You can reclaim overpaid tax from HMRC, usually within four weeks, but the process can be cumbersome. If you do not use the relevant form to reclaim emergency tax, you can wait until the end of the tax year and use self-assessment to get a refund.
Risk 2: Running out of pension funds
After withdrawing all your pension, unless you have a clear plan, you might run out of funds quickly and lose the ability to receive a stable income.
If you invest the lump sum or use it to pay off debts, your future financial security could be at risk.
Risk 3: Decrease in pension value
If you put the withdrawn cash into a regular savings account, its real value may decrease.
Risk 4: Pension scams
With the increased flexibility to withdraw pensions, pension scams have risen in recent years. Avoid making any major investments without consulting an independent financial advisor.
Most importantly, never respond to unsolicited calls or emails, and only use FCA-regulated financial advisors you have chosen.
4. Advantages of making multiple withdrawals
You can withdraw from your pension pot as needed until it is depleted. The timing and amount of each withdrawal are up to you. Many people choose to withdraw gradually, leaving the remainder invested or using it to buy an annuity.
The main advantage of multiple withdrawals is that you can spread the withdrawn funds over several tax years, helping to reduce your total tax bill.
Additionally, since pension growth is tax-free, the remaining pension can stay invested in a tax-efficient environment.
Note that each lump sum withdrawal might incur fees. Also, the number of withdrawals each year might be limited. Not all pension providers offer this option. If your current provider does not, you can transfer to another provider, though transfer fees may apply.
5. Is withdrawing your pension in a single lump sum suitable for you?
Before making this decision, you should consider that a lump sum withdrawal will not provide regular retirement income for you or your family after your death.
Plan how much you can afford to withdraw, otherwise, you risk running out of money. This could happen if you live longer than expected, withdraw too much early on, or if your remaining investments don’t perform as expected and you don’t adjust your withdrawals accordingly.
Consider how to invest the money from your pension pot and regularly review your investments.
Overall, withdrawing your entire pension might seem more attractive than annuities or drawdown options, but it is a riskier strategy, especially if you don’t have other private funds. You might face unexpected costs, such as large tax bills.
TB Accountants believes you should analyse your situation before making a decision. Consider withdrawing your entire pension if:
You need the money urgently
Your health is poor, and guaranteed lifetime income may not be the best option
You want to reinvest or quickly use the funds
You have multiple pension accounts and want to cash in one or two to provide more initial retirement income