All your questions about cashing in a pension answered

Few subjects generate quite so many questions as the topic of cashing in a pension. Since the Pension Freedoms came into effect in 2015, retirees have had the unprecedented ability to cash in their pensions in one lump sum. Tempting as that may seem if you harbour dreams of exotic holidays or extensive renovations, the reality is that this should almost always be viewed as a last resort to ensure your savings last throughout retirement.

With massive risks involved with these kinds of life-changing decisions, it’s little wonder that there is so much intrigue and confusion swirling around this topic. To help you make more informed choices, we’ve decided to answer as many of your burning questions about cashing in a pension as we can here in this blog. Keep reading to find out (virtually) everything you need to know about the rules and ramifications of cashing in a pension. 

Can I close my pension and take the money out?

In theory, yes. If you’re aged 55 or over, you have the option to cash out a defined contribution pension as one lump sum. The first 25% of this will be tax-free, while the remaining amount will be taxable. As such, it’s worth remembering that this could push you into a higher tax bracket depending on the size of your pension pot. 

You can cash in any number of smaller workplace pensions and up to three personal or stakeholder pensions worth up to £10,000 under the “small pots” rules. If your provider allows it, you might also be able to take a defined benefit pension as a lump sum if the total of your pension savings amounts to £30,000 or less. 

Over and above this amount, you would need to transfer your benefits into a defined contribution pension scheme to access your funds as a lump sum, which by law requires financial advice before you commit to such a move.

What are the rules for cashing in your pension? 

You have several options if you’re considering cashing in your pension. 

You can either choose to take your whole pension as a one-off lump sum, take several smaller lump sums, receive regular income payments for a predetermined period (often for life) by purchasing a pension annuity, or you can dip into your funds on an ad-hoc basis using pension drawdown, which keeps the remainder of your pension savings invested.

How many pension pots can you cash in?

Overall, there isn’t a specific limit on the number of pension pots you can cash in. However, it’s important to carefully consider the tax implications (more on this later) and explore all the available options before making any decisions about cashing in your pensions. The last thing you want is to be faced with a hefty tax bill.

Of course, the other option is to combine multiple pensions by way of a pension consolidation. This option can make it easier to keep track of several disparate pension funds and potentially streamline, and even reduce, the management fees you pay across the various schemes. However, it’s important to do your research to ensure you won’t lose out on valuable protections or benefits if you were to consolidate your pensions.

How many small pension pots can I cash in?

Under the “small pots” rules, you can cash in an unlimited number of smaller workplace pensions (subject to provider terms and conditions) and up to three personal or stakeholder pensions worth up to £10,000. 

Taken as a whole lump sum, these encashments won’t trigger the Money Purchase Annual Allowance. That means you can continue contributing your full annual allowance and still enjoy tax relief on your pension savings.

Check out his blog for more information about cashing in a pension from an old employer or a small pension pot.

How much would I get if I cashed in my pension? 

The amount you would receive if you cashed in your pension will depend on the size of your pension pot. 

However, it’s worth bearing in mind that there may be exit fees associated with cashing in a pension, which could reduce the overall value of your funds. Be sure to check your provider’s terms and conditions first. Beyond the tax-free portion, the remainder of your funds will be taxable. This can also erode your hard-earned savings.  

How much tax will I pay if I cash in my pension?

That’s a good question and one that has no straightforward answer, unfortunately. When you cash in your pension, up to 25% of the lump sum can be taken tax-free, known as the Pension Commencement Lump Sum (PCLS). The remaining 75% is subject to income tax at your marginal rate. 

This taxable portion is then added to your other taxable income for the tax year, potentially pushing you into a higher tax bracket and increasing your overall tax liability. It’s also worth bearing in mind that HM Revenue & Customs (HMRC) may apply emergency tax initially. Although, you can claim a refund for any overpaid tax later.

Is pension transfer value the same as cash value?

No, pension transfer value and cash value are not necessarily the same. The pension transfer value represents the amount of money that a pension provider is willing to pay a new provider if you decide to transfer your pension. 

For a defined contribution pension, you might hear the phrase “pension fund value” used, and that essentially relates to the current value of the pension fund at any given time. In theory, this should be the same as the transfer value. However, bear in mind that the transfer value may need to take into account exit fees and potential market fluctuations. As such, you might find that the transfer value doesn’t tally exactly with the fund value.

In the case of defined benefit pensions, you’re more likely to hear the phrase “cash value” used. In this context, pension benefits are calculated based on salary and length of service, so you don’t have a final pension pot that can be valued. Therefore, your provider will provide a cash equivalent transfer value (CETV) instead, which is an estimate of how much they would pay to a new provider should you transfer to a defined contribution pension.

It’s important to note that the CETV is not a guarantee. When you transfer from a defined benefit pension to a defined contribution pension, you stand to lose the inherent protection from stock market fluctuations that a defined benefit scheme offers, not to mention various other benefits and protections. 

Is it a good idea to cash in your pension? 

In the majority of cases, it isn’t wise to cash in a pension. You run the risk of exhausting your pension savings early, which could make later life a struggle – especially if you need to cover unforeseen costs, such as care home fees. 

Cashing in your pension also removes your right to valuable tax reliefs and the potential to grow your savings by keeping them invested. The only exception is a pension annuity, which can give you a guaranteed income for life.

Do I need a financial adviser to cash in my pension?

Given all the permutations and complexities associated with pensions in general, but particularly cashing in a pension, we would always advise consulting with a financial adviser before making any concrete decisions. 

In some cases, such as transferring a £30k+ defined benefit pension to a defined contribution scheme, FCA rules mean it is compulsory to discuss your options with a pension transfer specialist for your protection and to ensure you have all the information you need.

Overall, it’s a sensible course of action to discuss these kinds of life-changing decisions with a qualified financial adviser. The last thing you want is to make a rash decision that could end up costing you and your family dearly later in life. 

Therefore, be sure to contact Hilltop Financial Planning to discuss your options if you’re thinking about cashing in a pension. Our experienced advisers are here to provide tailored pension advice when you need it. 

For pension advice made personal, contact us today on 0161 413 7051 to speak to one of our advisers.