Lump-Sum Pension Payment: All You Should Know

Sponsored content

You are finally approaching your retirement age? Well, your hoard work will be factored in your pension. At last, you will have something to get home with. The pension scheme is designed to help you lead a good life after retirement. This guide is going to take you through all things pension, focusing on lumpsum payment from your pension and taxable pension lump sum.

Tax And Pension Lump Sum

Taxable pension withdrawals are often considered income. They’ll therefore be directly added to your annual income. Depending on the amount of money you withdraw, your income tax margin might vary significantly. Taking out a higher amount from the taxable portion of your pension will mean a higher rate tax band.

Tax Efficiency

Depending on how much you withdraw each year, pension lumps can either be taxable or not. What’s the impact of the pension lump sum on your annual income tax? Well, if the impact is substantial, then you might be charged more tax. But if it’s minimal, you might be exempted from paying annual tax. Taking out so much money from your pension could cost you a lot in tax. So, it’s always better to withdraw smaller amounts for several years.

Tax-Free Pension

If you choose to withdraw 25% of your pension in one go, then you won’t need to pay tax. Anything less than twenty-five percent is usually tax-free. But if you wish to take any amount above the 25% threshold, you’d have to pay tax on the additional amount. Differences between defined contribution and benefit pension schemes

Just like in a benefit pension, a defined contribution also allows you to withdraw a lump sum amount. However, the amount you can withdraw without paying tax might vary depending on your specific type of pension.

Defined Contribution

Most people prefer this type of pension. And this is mainly because its retirement value depends on how much you paid into it through your employer, as well as, how it performs over a given period of time.

If you choose to withdraw twenty percent of your pension, then you won’t be charged any tax. But as soon as your withdrawals go beyond 25 percent, you’ll have to pay tax on the extra amount.

Defined Benefit

This is a less popular type of workplace pension. Here, the retirement value is dependent on your salary, as well as, the number of years you’ve worked with your employer. They also have a tax-free portion set at 25 percent of the total pension value.

It’s also important to note that there’s a calculation referred to as the ‘commutation factor” that must be taken into consideration.

When you withdraw tax-free cash from your pension, this will be deducted from the annual income that you’ll receive from your pension scheme. Your income will then be reduced by a fraction of the tax-free lamp some that you withdrew. This factor is typically known as the commutation factor. In most cases, the commutation factor is about 15. The lower the commutation factor, the higher the amount of annual pension you’ll need to give up so as to receive the tax-free cash.

Lump-sum Pension: The Pros Versus Cons

There are many benefits you’ll enjoy by taking out a pension lump sum. You can withdraw regular chunks of money as you wish. You can withdraw 25% of your pension without paying tax. Leaving a portion of your pension invested will also help it grow. However, it’s important to note that this strategy also has its downsides. For instance, you might end up paying more depending on the amount you withdraw.  

State Pension

State pension typically refers to a regular benefit payment that’s commonly made by the government. It often begins when you attain the retirement age (66years). When it comes to this type of pension, you won’t be able to take out a lump sum, unless you choose to delay receiving regular payments.

If you decide to delay receiving your regular payments, you’ll enjoy the following benefits when the time comes to receive the payment: regular payments for a higher amount; withdraw the total value of your delayed payments. Remember, you’ll also receive an additional six percent more per year delayed.

Can You Combine Your Pensions?

Do you have more than one pension? Well, figuring out how much money you should take out without paying tax can be quite tricky. That’s why it’s always important to consider combining your pensions into a single fund. This makes it easier to manage withdrawals.

Your Options

When it comes to accessing funds in your pension, there are many options to choose from. And these include: buying an annuity; taking a cash lump sum; withdrawing money directly from your pension scheme, and leaving a portion of it invested. Here are the tax rules for each option.

Cash Lump Sums 

If you wish, you can take the whole portion of your pension pot at once. Alternatively, you can choose to withdraw smaller amounts whenever there’s a need. Twenty-five percent of your pension pot will always be tax-free. But you’ll have to pay tax for the rest of your pension as if it were income.

Purchasing An Annuity

Another option is to purchase an annuity from a reputable insurance provider. An annuity typically refers to an annual income that you’ll receive for the rest of your life. There are numerous types of annuities available for purchase. So, be sure to shop around before settling for a specific type of annuity.

You can simply withdraw a portion of your pension as a tax-free cash sum and then use the rest to purchase an annuity.

Income Drawdown

This allows you to make some income from your pension scheme, while the rest remains invested. Ask your pension provider if they offer this option. Not all providers include this option in their pension schemes.

The good news is that there aren’t any restrictions on the amount you can withdraw using income drawdown. However, it’s important to note that withdrawing money from your pension fund can affect your benefits.

Certain benefits are calculated based on the amount of income or capital you have. And these benefits are commonly referred to as “means-tested benefits”.  Common examples include housing benefits, pension credit, income support, support allowance, as well as, income-related employment allowance. Taking out some cash from your pension pot could impact your eligibility for these benefits.

Over Pension Based Credit Age

When a person applies for means-tested benefits, a portion of the money will be taken out from their pension fund. This amount will then be taken into consideration when determining their capital income.

Once you get the tested benefits, you should then make a point to take out the money from your pension. Otherwise, the benefits could be reduced or even stopped altogether. If you don’t make any withdrawals, you’ll be considered to be having what’s called “notional income”. And this typically means that the money will significantly impact your entitlement benefits.

If you take a lump sum from your pension and then apply for benefits immediately, you might not get approved because the cash you took out from your pension could be categorized as “notional capital”. Thus, when deciding whether or not you should withdraw money from your pension, be sure to take the following aspects into consideration:

• If you withdraw some money from your pension, the amount will be taken into account when determining if you qualify for means-tested benefits. As a result, your entitlement will decrease oy you could even lose your eligibility.
• If you qualify to take income from your pension pot and you fail to do so, then it’ll be considered that you’re having “notional income”. The higher the amount of capital or income you withdraw at once, the greater the impact it’ll have on your income.
• In the event that you spend your lump sum quickly then apply for means-tested benefits, your benefit decision-maker could be forced to reduce your benefits. They’ll think that you spent the money quickly so that it couldn’t affect your means-tested benefits. So, be wise when deciding how to spend your lump sum.

Under Pension Based Credit Age

Remember, only the money you withdraw from your pension pot is what’s considered income or capital. It isn’t the entire amount. In this case, the money you withdraw from your pension fund is classified as income or capital when determining your eligibility for benefits. Similarly, the more you withdraw, the more your entitlement will be affected.

If you withdraw a lump sum amount after receiving your means-tested benefits, then your benefits could be reduced or stopped. Again, if you spend your money quickly then your entitlement might get reassessed.

If the decision-maker realizes that your intention for spending the money swiftly was to ensure that it didn’t impact your tested benefits, then your benefits could be reduced or even canceled. So, if you want to make sure that you’re on the safe side, consider utilizing a benefits calculator to determine your benefit eligibility.

Lump-Sum Versus Regular Pension Payments

So, you’re approaching your retirement age, and you’re wondering which pension plan you should choose. Should you opt for a lump-sum distribution or lifetime monthly payments?

Understandably, you may be tempted to take out a lump sum. This might be the largest amount of cash you’ll ever receive but before making that decision, be sure to give it a serious thought. Take your time to explore different options before making your final choice.

Special Considerations

Employers usually have various reasons for cashing out beneficiaries from their pension plans. For instance, they might utilize it as an incentive for the old or higher-cost employees to retire early.  It’s also important to note that they can make the offer in order to eliminate pension payments as this generates accounting gains. 

Therefore, before choosing a payment option, it’s always imperative to conduct your own research regarding how companies calculate the value of lump-sum payouts. But generally speaking, you’ll receive the same amount of cash when you either choose the lump sum or pension payment. What the pension administrator does is that they often calculate their employees’ lifespans and then adjust the payment plans accordingly.

If you enjoy a longer lifespan, then you’ll benefit more from the lifetime payments. However, if that isn’t the case, then the opposite is better. The best approach is to have it in both ways: Use part of the lump sum to purchase an annuity and then invest the rest. This will ensure that you have a lifetime stream of income and at the same time reliable investments. The good news is that there are many pension schemes out there. So, you can always find an excellent choice for your needs.

Key Takeaway

Pension payments typically last forever. In fact, they can even continue after death. Lump-sum payments offer you better control over your finances. Thus, it provides you with increased flexibility for spending or investing it the way you desire.

As compared to lump-sum payments, pension payments often continue until death. With a lump-sum payment, you’re more likely to run short of money quickly. However, it’s also important that when you go bankrupt, your pension payments could be stopped. Thus, before deciding whether to opt for a lump sum or pension payments, be sure to seek professional guidance. This will help you choose the best plan for your needs.

The Bottom-Line

The above guide is all you should know as far as your pension is concerned. This guide will particularly delve into taking a lump sum from your pension. Understanding these basics will help you get the most out of your pension.  The above guide will help you get it right as far as lump sum pension payment is concerned. From tax issues on your pension to your options, this is the guide that will make the process smooth.