Tax free lump sum, or not!

[loveawineloveacrisp]

I'm retiring at the end of this year and am undecided as to whether I want to take my full tax free lump sum from my DC pot. I originally planned to take it phased over a few years and live tax free for 3-4 years, but I have a niggling thought that the rules might be changed at some point. The other consideration is that I'm going to be moving to a country where the tax free lump sum isn't recognised in the next 2-3 years so I need to get it out before then.

If you're due to retire soon, what are your thoughts on this?

I took the tax-free lump as I felt the Govenment could withdraw that 'offer' at any time. I think it is even more likely now.

Are we talking a DC or DB scheme?
DC: I did not and left the pot to grow, taking each draw as 25% tax free instead. The growth has meant that the tax free amount available is bigger.
DB: it depends on the commutation rate

Also depends if you have any big one off spends you need it for or if you are going to save it to provide a bigger income later on. I didn't have the former and wanted the latter.

DC. I need about £25k to pay off the mortgage but could live off the rest for probably 4 years and leave the remaining pot untouched to grow.

Also, what's a commutation rate? I do have a small DB which will pay out at 60 as well.

I’d take it out.

A commutation rate measures the amount of monthly pension you have to give up in return for an increased lump sum. The higher the commutation rate the better value the lump sum is - typically government ones have a commutation rate of 12 which is viewed as poor, around 20 is seen as good .

I plan to take mine out at drip it into ISA’s so it can still grow tax free

A commutation rate is the ratio a DB scheme uses to calculate how much annual income you could exchange for a cash lump sum at retirement.

For example, my civil service pension scheme has a commutation rate of 12:1, meaning I could receive £12 of tax free cash for every £1 of annual income up to a certain limit. For myself, I chose to have 0 TFC and the maximum annual income.

For your DC pot, if you are planning on living off the TFC for 2-4 years, I would take the full amount at the beginning. You would have less uncertainty and less exposure to the ups and downs of the market.

Personally i would take the max lump sum.

I have seen so many elderly relatives get to around 80 and they can hardly even spend their State Pension income due to frailty and being stuck in the house so their work pensions effectively just go to waste and build up in their current accounts. (And, then the vultures start circling aka the kids and grandkids!)

Better to take the lump sum, enjoy spending it over a decade or so while you still can and then you should still have enough income for very old age when you're stuck at home.

Further context, I'm retiring fairly early at 57. Pension pot is around £450k. The full amount won't last me a decade! I plan to live off it for 4 years.

What are your expected annual outgoings?
And do you have any other savings / investments?
Any other income?

Basically I would do a spreadsheet with each year your expected annual income (with DB kicking in, SP kicking in + any other income), your outgoings and what the shortfall each year is.

The whole commutation rate thing is only relevant to DB pensions btw.

I plan to take my pension a few months after you.

Full lump sum and annuity for rest … assuming rates stay where they are today.

I don’t need the money right now, but as I would probably hold the funds in short dated gilts then there is limited advantage for me keeping it in the pension wrapper. It does not offset the risk of loosing the allowance for me anyway

For most people it can be beneficial not to take it as a lump sum but to take 25% of every amount you draw tax free. That means it continues to grow (assuming your total pot grows) so you get more tax free overall.

In your shoes I'd probably just take it. You need to have taken it in the next 2-3 years anyway and over that timeframe you can't be sure that it will grow.

Have you other income for those first 4 years? You may be best to take a drawdown pension (instead of, or alongside a partial tax free lump sum) to use your annual tax free allowance (£12,570 p.a.). Otherwise, those years' worth of allowances go to waste. You could take an annual draw down pension of £12.5k per year alongside regularly tax free lump sum withdrawals each year, to give you a "tax free" income for several years to come, never paying any tax. Far better than taking a TFLS now, and delaying draw down pension for 4 years, then needing more than £12.5k p.a. thus suffering paying income tax on higher pension draw downs from year 4 onwards.

Yeah have done all that. Need £25k pa after tax, index linked. Also have about 120k in ISAs. I'm comfortable I have enough, it's just the question of how to take the money.

I have to get all my TFLS out of the pension before I move abroad, as I said in OP.

You really want to draw down some of the taxable part too, to make use of your annual personal allowance. £16,760 being the optimal.

It’s generally considered best practice to leave as much in your DC pot to continue to grow tax free.

I might do a bit of casual work. Plus surely it's a balance between getting all tax free lump sum out within 3 years and leaving enough in pot for growth? Is it really the end of the world if whole personal allowance isn't used every year?

It's daft not to draw your personal allowance, yes. You would be paying more (lifetime) income tax as a result.
So the next step on the spreadsheet that shows your annual shortfall is where you work out where you take the draw from and how much. First take off any income (earned, DB, SP, dividends), then your draw up to the tax allowance (if you have any left), then you know what you need to take and can work out if you need the full 25% to top up to your spending level, or just some of it.

For those who have taken their full lump sum, have you also drawn down the tax free allowance ie £12,750? Just feels like in doing this you're in danger of depleting the fund too quickly.

The reason for taking the 12k personal allowance is that then you get that out tax free. If you don't, you pay (at least) 20% tax on it so effectively you lose 2400 every year you don't take it, you could instead drip that into a stocks and shares isa while you are uk resident, so that it continues to grow tax outside your pension.

Yeah...I guess it's all about where you put it once it's out of the pension wrapper.

I’ve asked AI about this today (with much smaller sums than you and different circumstances). While obviously I’m not going to rely on it, it did explain some stuff and got me closer to understanding where the “sweet spot” might be.