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Should I take a 25% tax-free lump sum from my final salary pension?

I am about to retire and I am keeping my final salary pension as I do not like risk.

But I was just wondering, is it more financially viable to take the 25 per cent lump sum (it would be around £100,000) and just put it in a bank account to gain the tax-free element of this?

Or, would the annual rises if it remains part of a pension eradicate this? I do not really need the lump sum.

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Money dilemma: Should I take 25% from my final salary pension, or leave it and get a bigger income during retirement?

Steve Webb replies: When it comes to final salary pensions most of the discussion has been about the merits of staying put or transferring out completely.

But there is much less discussion and support around the important decision you (and many others) are facing.

Like many people in your situation, you can choose between simply having a regular pension from your scheme, subject to tax in the usual way, or having a smaller regular pension plus a one-off lump sum which is free of tax.

Although this is a big and important decision, and raises many of the same issues as the decision about transferring out completely, there is no obligation in this case to take financial advice.

Steve Webb: Find out how to ask the former Pensions Minister a question about your retirement savings in the box below

Steve Webb: Find out how to ask the former Pensions Minister a question about your retirement savings in the box below

Whilst I cannot advise you on the right thing to do without knowing your full circumstances, there are a few key things to be aware of.

First, as you appreciate, the fact that you can take part of your pension tax free is one of the big advantages of saving in a pension in the first place.

You have suggested that the lump sum in your case would be around £100,000, and if you took this as taxable income instead you might end up paying basic rate tax of £20,000 over your retirement.

Taking part of your pension as a tax free lump sum could save you a lot of money.

However, by taking this lump sum you will lock in a lower regular pension and a key question is how much pension you are being asked to sacrifice in order to receive a lump sum.

Perhaps surprisingly, pension schemes differ hugely in the amount they knock off your pension when you take a lump sum.

Some are relatively generous, making only a modest deduction to your regular pension. But others take a huge chunk out of your pension when you take the lump sum option.

Obviously, the bigger hit you take on your pension, the more you would want to think twice about taking a lump sum.

There are also several other factors to bear in mind. One is how long you are likely to live.

Why is my wife’s 25% tax-free pension lump sum deal more miserly than mine? 

Steve Webb replies to another reader about why some final salary pension lump sum offers are more generous than others here.

For example, if you were in poor health then taking an immediate lump sum rather than a higher pension could be more attractive, especially if you have heirs who you would like to benefit.

Another is your overall tax position. If, for example, your state pension, remaining company pension, any earnings and other taxable income took you into the higher tax bands then making the most of tax-free cash could look like a good deal.

You rightly mention your attitude to risk and this is also a relevant factor.

If you decline the lump sum you are giving up on a tax break, but you are locking in to a pension which is guaranteed to last as long as you do (as long as your former employer doesn’t go bust, and even then it will be largely covered by the Pension Protection Fund).

In addition, it will usually pay a pension to any surviving spouse, will rise each year to reflect inflation and will not be affected by the ups and downs of the stock market.

By contrast, your transferred lump sum would be up to you to manage.

Simply leaving it in a bank account would mean that your spending power could decline each year because of inflation, whilst investing it for growth would give you some uncertainty which you are not keen on.

Finally, although you personally say that you do not really need the lump sum, for some people it is possible that they could put the lump sum to good use and this would make this option more attractive.

Obvious examples could include clearing any outstanding mortgage or other debts, or perhaps helping another family member with a house deposit.

There are no doubt other things to bear in mind, but I hope I have given you a flavour of some of the reasons why taking a lump sum might be right for some people but not others.

Although you are under no obligation to do so, one option would be to approach a financial adviser on a fixed-fee basis to give you some advice, which could include advice on how best to use your lump sum if you did decide to take it.

He or she could take account of the full range of your circumstances as well as raising issues you might not have thought of.

It might be worth checking if your scheme has a suggested financial adviser and/or if they would be willing to help you with advice costs.

Ask Steve Webb a pension question

Former Pensions Minister Steve Webb is This Is Money’s Agony Uncle.

He is ready to answer your questions, whether you are still saving, in the process of stopping work, or juggling your finances in retirement.

Steve left the Department of Work and Pensions after the May 2015 election. He is now a partner at actuary and consulting firm Lane Clark & Peacock.

If you would like to ask Steve a question about pensions, please email him at pensionquestions@thisismoney.co.uk.

Steve will do his best to reply to your message in a forthcoming column, but he won’t be able to answer everyone or correspond privately with readers. Nothing in his replies constitutes regulated financial advice. Published questions are sometimes edited for brevity or other reasons.

Please include a daytime contact number with your message – this will be kept confidential and not used for marketing purposes.

If Steve is unable to answer your question, you can also contact The Pensions Advisory Service, a Government-backed organisation which gives free help to the public. TPAS can be found here and its number is 0800 011 3797.

Steve receives many questions about state pension forecasts and COPE – the Contracted Out Pension Equivalent. If you are writing to Steve on this topic, he responds to a typical reader question here. It includes links to Steve’s several earlier columns about state pension forecasts and contracting out, which might be helpful.  

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