Investing, Pensions, Personal Finance

How to do more with your Pension’s 25% tax free cash

How to do more with your Pension’s 25% tax free cash

Understanding how much your money could be worth if you don’t take it out

Smart investors know that setting a goal for their Pension and maintaining a disciplined approach with regular investments over a long-term period is the best way to build wealth for retirement.

Many Pension investors don’t know how to handle potentially large sums of money when they reach 55 and become eligible to withdraw 25% tax-free. In fact, many don’t realise that they don’t have to take the tax-free cash out at once and that their money could be worth a lot more if they don’t take it out.

For example, let’s say your goal is retirement and you’ve hit 55, the age you can withdraw from your Pension. At this point, you will typically be able to access 25% of the value of your Pension pot tax free. The rest is subject to Income Tax rules at the time of withdrawal. 25% tax-free sounds tempting, so why not enjoy that money?

Simply put, this could cost you a lot more than you realise:

  • If you have a pot worth £100,000, you can take out £25,000 tax free at 55.
  • If you leave the money invested until you reach 65, your £100,000 pot could be worth £145,000 (based on an 5% annual growth and fees of 1.2%).
  • Your 25% tax free withdrawal is now worth £36,250 (an £11,250 increase)
  • The longer you leave your money, the more you could benefit from the tax-free allowance.

If you do need some money from your Pension, you can withdraw just what you need. You don’t need to take the full tax free 25% in one go.

  • You could take just 10% from your £100,000, giving you a £10,000 withdrawal.
  • This will leave you with £30,000 in flexible access drawdown (from which you cannot withdraw any more tax-free cash) and £60,000 which you have not yet accessed.
  • You could then leave the £60,000 which you have not yet accessed in your Pension for another ten years, letting it grow to £87,000 (based on an 5% annual growth and fees of 1.2%).
  • You could then take 25% tax-free from the £87,000, for a withdrawal of £21,750.
  • Overall, you’ll have now withdrawn £31,750 (an increase of £6,750).
  • You’ll also still have £65,250 in your Pension, plus the original £30,000 (which could have grown to £43,500 based on 5% growth and fees of 1.2%) which would be taxed at your marginal rate upon withdrawal.

Keep in mind that when you’ve used up your 25% tax-free allowance, the remainder of your Pension withdrawals will then be subject to Income Tax rules at the time of withdrawal. You could do more with your money by leaving your money invested for as long as possible, making sure you really get the most out of your 25% allowance.

With investing, your capital is at risk. Investments can fluctuate in value and you may get back less than you invest. Past performance is not a guide to future performance. Tax rules can change at any time. This blog is not personal financial advice. The calculations take into account our average annual fee of 1.16%, they don’t take into account the impact of inflation, which will reduce returns, and assumes you only make the contributions as set out.