Should you access your pension tax free cash?

Today’s question is ‘should you access the tax free part of your pension fund?’

A few caveats to begin with.

Firstly, tax free cash (TFC) can also be known as a pension commencement lump sum (PCLS). I generally prefer the second term as the payment may not actually be tax free.

Tax free cash is not necessarily tax free

If you live outside the UK, the the tax treatment will depend on the double taxation treaty between your country of residence and the country that your pension is located in, i.e. UK (or elsewhere if it is a QROPS).

You should always consult a tax adviser in your country of residence before accessing your pension.

Secondly, the standard TFC/PCLS amount is 25% of your pension fund. However this can be up to 30% with a QROPS.

Finally,  I am assuming that the pension is a money purchase arrangement (e.g. personal pension, Self Invested Personal Pension (SIPP), Qualifying Recognised Overseas Pension Scheme (QROPS) and not a defined benefit/final salary scheme.

Now, onto the question. If you actually really need the money (e.g. to fund children’s further education in the absence of other savings), then you might as well ignore the rest of this post and just access the money (although, as mentioned above, do remember to consult a local tax adviser first).

However, if you don’t really need the money and are simply looking to draw the money down to invest elsewhere, then here are 3 reasons why you might want to think twice about doing so.

1. The money within your pension grows free of income tax and capital gains tax.

2. The TFC/PCLS is expressed as a percentage. Therefore, if your overall pension grows then the TFC/PCLS portion grows too.

E.g. you have a pension fund worth GBP500,000 and you are age 55 or over. You could access 25% of that as TFC/PCLS today (i.e. GBP125,000). Alternatively, if you leave the fund where it is, and it grows by 6% pa net for the next ten years, you then have a pension fund worth GBP895,424. The TFC/PCLS part is then GBP223,856.

No inheritance tax

3. Money in your pension is outside of your estate for UK inheritance tax (IHT) purposes. This is obviously important if IHT is likely to be an issue for you.

In addition, death benefit rules have changed in the past few years meaning that you can now leave your pension to whoever you want, with no tax on the transfer.

The receiver may have tax to pay from their side, depending on whether age on death is below or over 75. However, if it were a QROPS, the receiver would have no UK tax to pay.

So there you have it, three good reasons to avoid accessing your tax free cash unless you really need to.

As always, pension and tax rules are regularly subject to review so do seek professional advice.