This is a very in-depth look at the ways that you might be able to cash in some or all of your pension, but it is quite a technical subject which is why we always recommend that you seek independent, expert advice before doing anything. There are lots of companies that might offer help, but, if you are at least 55 years of age, we recommend that you click here to contact Age Partnership (link opens in a new window) as they are one of the leading firms who can walk you through everything and answer any questions you might have after reading this article.
As we all know, the purpose of a pension is to provide for us in later life once we’ve retired. In order to entice people to put money aside for their future, pension schemes come with many benefits. The downside of this is that they’re also highly restrictive in terms of when and how they’ll allow you to access the money you’ve paid in.
The tax relief that comes with paying into a pension (20% if you pay the basic rate, 30% in you pay higher rate and 50% if you’re in the highest band) makes it a very efficient way of saving. In fact, by the time you come to draw on it, as much as half your pension could be made of tax relief. In return for this help, part of the deal in taking a pension is that this money has to be used to support you in later life rather than for any other purpose.
You might be asking yourself “can I cash in my pension?” but, aside from in a few special circumstances, you will not be able to receive any of your savings until you hit at least 55 (though normally the terms of your plan will specify a higher age, such as 60 or 65) at which point you’ll be able to take as much as 25% of the funds as a tax free lump sum payment. The rest you’ll use to provide yourself with a regular income for the rest of your life, usually by buying an annuity.
Though by far the most common route, this is not the only way of taking your pension. Depending on your circumstances there may be other options available to you. In this guide we’ll look at;
- Ill Health
- Protected Pension Age
- Pension Liberation Fraud
- Pension Unlocking
- Income Drawdown
- Trivial Commutation
Taking Your Pension Before 55
Whilst the vast majority of people need to wait until 55 to access their pension funds, there are a limited number of exceptional circumstances where you may be able to start taking payment from your pension plan early;
If you are incapacitated due to ill health you may be able to draw your pension early, but only in certain cases.
Qualifying for Early Payment
As far as HMRC are concerned, to qualify for early payment you must;
However, as well as fulfilling these criteria, you will also have to satisfy whatever extra terms your pension plan provider might have. There is a good chance these will be more detailed and stringent, so you should contact your administrator if you believe you may be entitled to withdraw money on grounds of ill health.
If you do qualify to take your pension early you will normally have the same options as to how you can take payment as you would if were simply retiring, with as much as 25% available as a tax free lump sum. Again, this will depend on your pension provider’s particular policies. Tax will be paid on the money you receive as income in the same manner as if you’d retired.
Should you recover from your condition and find you’re able to work again before your retirement age, your pension provider may reduce the level of your payments or stop them altogether. This is at their discretion, so contact them for details.
Serious Ill Health Lump Sums
In extreme cases you may be able to receive your entire pension as a single lump sum, depending on the rules of your scheme. Such payments are known as a ‘serious ill health lump sum’, and can only be paid in cases where;
- A doctor has confirmed that you’re expected to live no longer than a year.
- You’ve not started receiving your pension.
- You’ve not used up your ‘life time allowance’. (This is the amount you can pay into pensions before you stop benefitting from tax relief and, currently stands at £1.25 million.)
Lump sums received under these rules are completely tax free as long as you’re under 75. If you’re over 75 you’ll be taxed 55% on the entire amount.
You may still be able to receive a serious ill health lump sum if you’ve used up your lifetime allowance, however, everything in excess of the limit will be taxed at 55%. (As stated above, if you’re older than 75 this rate will be applied to the whole amount, regardless of whether you’re under or over the lifetime amount.)
Protected Pension Age
Though you now need to be 55 to be able to draw your pension, this wasn’t always the case. If you had a pension before the 6th of April 2006, and if on the 5th April your pension allowed you to take your payments before 55 without having to gain the consent of an employer or trustees, you may still be able to receive payments before 55 now.
In such cases you may qualify for what’s known as a ‘protected pension age’. This will ensure you can withdraw your pension at the same age you would’ve been able to as per your pension arrangements on the 5th of April 2006, even though the rules have since changed.
Protected Pension Age Criteria
There are extra criteria that will determine whether this is the case depending on the type of scheme you were on at the time:
Personal Pension or Retirement Annuity Contract (RAC): The job you were employed in must be one recognised by HMRC as needing to pay a pension before 50 and you must have had the right to withdraw your pension before age 50 (as opposed to 55) on 5th April 2006. You should ask your scheme administrator if this is the case.
Company or Public Sector Schemes: You must have had the right to withdraw before 55 on the 5th of April 2006 and, in addition, this must have been set out in the rules of scheme on or before the 10th of December 2003.
If you do have a protected pension age, moving your pension will mean you lose the right to withdraw before 55. The only way you can transfer your pension and maintain your protected pension age is by transferring all the funds in the scheme in question to the new scheme at the same that another member of the old scheme also transfers their rights to the new scheme. Even then, you can only do this as long as you haven’t been a member of the new scheme for more than a year.
If you want to use protected pension age rules to take your pension before the age of 55 you must start to take payment from all pots under the protected scheme. You cannot leave part of the funds to be paid later.
If you start taking your pension before 55, unless you’re on a personal pension or RAC, it can potentially have an affect on your employability.
If your protected pension age is under 50 there are usually no restrictions. You can normally take your pension and stay working with the same employer if you so wish. However, if you own or control the company who sponsor your pension, you need to leave before you can take it.
If your protected pension age is between 50 and 54, you have to leave your employer in order to take the pension. You can then immediately start working for another company as long as they are not linked to your old employer or your pension scheme. If you want to rejoin your old employer you must wait at least six months. This rule doesn’t apply if you are coming back into a completely different job. In such cases you only need to wait one month before you can return.
Pension Liberation Fraud
Aside from the examples given above, once you’ve invested in a pension, though you can move it into a different pot, you cannot get the money out again until you reach the commencement age. Whilst this helps to ensure that you don’t chip away at the fund, it can also mean that, frustratingly, if you fall on hard times, you’ll be unable to use make use of the money.
Unfortunately, there are some dubious schemes out there that will look to capitalise on this frustration. Various firms will claim to be able to help you get your hands on your pension pot before time by finding ways around the rules. Normally, they will revolve around having you transfer the pension to them, then allowing you to ‘borrow’ from them as they loan a portion of the money back to you. The rest will usually be put into hard to track overseas investments over which you’ll have little or no control.
The combination of administration fees and lack of tax rationale inherent in such schemes mean the pension holder is left much worse off, often to the tune of hundreds of thousands of pounds. The The Pensions Regulator and HMRC both warn under no uncertain terms that such schemes should be avoided.
Methods of taking money from a pension early are usually dubbed as ‘Pension Liberation Operations’ and are essentially illegal as, in contrivance with pension regulations they (claim) to allow access to any percentage of a pension fund as a lump sum at any age. (As stated above the most you can receive as a lump sum is 25% – with the exception of trivial commutations which we’ll look at down the article – and, by law, 55 is the earliest you can receive any money.)
By stepping outside of the law you’ll be putting yourself at risk, not just from the illegitimate company you may be dealing with, but also from the authorities. If caught, you could be hit by unauthorised payment charges from HMRC which could equate to as much of 70% of the monies you’ve received.
Even if you managed to evade such penalties, those running the scheme will charge you an extortionately high commission, typically 20% of the amount transferred. Between these fees and the potential penalty charges, by attempting to liberate your pension as cash, you could lose the majority of your savings straight away. Needless to say, even if you do end up with some cash, you’ll having nothing left in the pot for later life.
On top of this, lump sums are often paid out as loans, the terms of which are extremely punitive. There will generally be a high rate of interest which will further erode your savings. The rest of the funds will be left in the hands of the company and they will usually invest them at their own discretion, leaving you with no control of your money and placing your savings at further risk.
Normally, those running such schemes attract customers by cold calling, mass texts, spam mail or via a website. If you are approached by anyone offering to give you early access to your pension, look out for the following danger signs.
- Contact encouraging you to use such a scheme coming out of the blue.
- This should be even more of a warning sign if you’ve had credit problems in the past as schemes often target those facing bankruptcy or other credit problems. This is a hallmark of schemes that ‘’liberate’ the pension as a loan.
- The use of overseas investments. These are used to make payments harder to trace if the organisation is shut down.
- The offer of a cash bonus for immediate transfer. This is generally not an incentive offered by aboveboard pension schemes.
- Promising to use ‘legal loopholes’. Whatever ‘loophole’ they believe they may have found to transfer you the money, if it is clear to HMRC that you’re liberating your pension, you will be hit with heavy penalty taxes.
- Requesting detailed personal information.
- Using a courier to send documents for you to sign. This tactic can increase pressure on you to rush into an agreement.
- No mention of the tax implications of such payments.
- Lack of proper documentation to accompany the transfer. Unfortunately, those running the scheme will look to leave you in the dark as much as possible.
- Insistence that the pension be transferred quickly and frequent pressure to rush decisions. The scheme could be shut down at any moment and they will want to get hold of your pension pot before they are caught.
- As a general rule you must remember that only in a very limited set of circumstances can you legitimately access pension funds before you’re 55. Any scheme which offers to give you access to the money before this time will pose a substantial threat to your savings.
To avoid becoming a victim of such schemes, look out for the above signs and;
- Refuse to give personal/financial information to cold callers.
- Conduct thorough research into the background of any company trying to persuade you to transfer your pension.
- Demand a statement showing how your pension will be paid after retirement and information on who will be managing your money until that time.
- Seek independent advice before making a pension transfer.
- Never rush into any decision regarding your pension.
If you think that you may have been the targeted by the administrator of a pension liberation fraud operation, you should contact Action Fraud either through their website or by calling 0300 123 2040.
Alternative Ways of Taking Your Pension After 55
Once you’ve reached 55, depending on the terms of your scheme, you may be able to start taking money from the fund. As discussed before, once it’s available most people take a portion of their savings as a tax free lump sum and then sell the remaining pension pot to an insurance company in return for a lifelong income in the form of an annuity. Whilst this is the most common course of action, there are other ways of receiving the money…
Taking a Pension Early Using Pension Unlocking
Not to be confused with the shady world of pension liberation, pension unlocking only applies to those over the age of 55 and is a legitimate way to make use of your pension before you’ve retired.
Whatever the commencement age of your current pension plan, as long as you’re over 55, you can unlock the funds earlier by moving them into a personal plan and then, with help of an unlocking specialist, cashing in your tax free lump sum, leaving the rest to either buy an annuity immediately or at a deferred date in the future.
Whilst this may sound like an attractive prospect, just as with pension liberation, taking your money early by unlocking it can leave you much worse off in the long run and is only suitable for a limited number of people.
If you are unsure what the best choice is when it comes to getting the most from your pension, we highly recommend that you contact Age Partnership (you must be at least 55 years of age) who can talk you through the options available to you.
The Downsides of Unlocking
For one thing, taking the lump sum will leave you with a reduced fund from which to draw from once you do actually retire. This could seriously affect your quality of life in the years to come. If you start taking income as well as the lump sum (assuming you don’t use income drawdown – more on which later) the impact will be double as not only will the funds available have to be spread over a greater amount of time, by taking early payment, you also miss out on the opportunity to keep your pension growing.
Secondly, even though the lump sum is tax free, taking your pension early is actually very inefficient in tax terms. This is because the regular payments you receive are counted as income on top of your wages and taxed accordingly. If you waited until you retired to receive them you would probably be in a lower tax category than you were as a worker. Conversely, if you take them early you could even be pushed into a higher tax bracket, further diminishing the return you’ll get out of your savings. By the same token, this increased income could also eliminate your ability to claim certain state benefits to which you might otherwise be entitled. On top of all this you will usually have to pay an advisor a fee for unlocking your pension.
Aside from eroding your savings, depending on your particular pension type and the arrangement you have in place with your plan provider, their maybe other consequences on unlocking your pension;
Penalties for Unlocking
There are a number of benefits that might be included as part of your pension package. By transferring your fund away to have it unlocked, you may also be giving up some of the following;
- Your Terminal Bonus: In the case of pension funds that are linked to investments, the profits earned are usually added in a series of bonuses. The terminal, or final, bonus ensures who have received all of you share of the profits your money has earned before you leave the plan. If you transfer out so as to unlock your pension, you may sacrifice your final bonus.
- Your Guaranteed Benefits: Many occupational schemes, especially ‘final salary’ pensions, come with a number of very attractive guarantees to assure your financial well being. The level of pay you’ll receive may be assured by your employer, and they may also take care of inflation proofing the fund for you. They will also usually be backed by the Pension Protection Fund and could also offer your dependents benefits too. You may surrender some or all of these privileges by unlocking.
- Your Annuity Rates: Some personal pensions give access to guaranteed annuity rates once the plan has matured. These are often well in excess of the market level. Unlocking may mean you have to settle for a less attractive rate, and therefore live off a lower income.
- Your Protection from Creditors: Though an obvious asset, pensions are often protected from your creditors should you fall into debt or become bankrupt. However, if you unlock your pension and realise its value as cash, you’ll lose this protection.
Often used as an alternative to buying an annuity, with income drawdown you start taking a regular income from your pot whilst the bulk of the funds are invested and (assuming they perform well) continue to grow. Once you’re over 55 you’re able to move some or all of your pension into an income drawdown plan, regardless of the commencement age of your current plan. In this sense, like unlocking, income drawdown can allow you to get hold of your pension money earlier.
Income Drawdown Rules
Whether or not you’ll be able to use income drawdown to take money from your pension will depend on the policies of your provider, but normally you’ll have to have a minimum amount saved, generally in the region of £100,000.
There is a maximum amount that can be withdrawn using income drawdown. This is equivalent to the amount that could be acquired by the same person through a single life annuity based on Government Actuary Department rates. There is no minimum amount you have to take. Indeed, you don’t need to take anything.
The exception to this rule is if you use what is known as ‘flexible drawdown’. In this case there is no limit on how much you can withdraw, however, you must be able to show that you’re receiving pension income of at least £12,000 a year from other sources (previously £20,000 before March 27th 2014). These can include annuities, other pension schemes and state pension benefits.
Whether or not taking income this way will eat into your pension depends on how your investments perform and whether you adjust your income accordingly. Ideally, you should only withdraw from the returns your money yields. Normally, such plans are flexible enough for you to ensure that this is the case.
For example, you can designate from which of the investment vehicles you’re using that your income should actually be taken from. By only taking money from safe options, such as cash or government gilts, you can ensure any losses made in riskier areas, such as the stock market, aren’t crystallised as a payment, but are left in the fund and given a chance to recover.
So, whereas income drawdown lacks the guarantees of an annuity, it does allow for a larger degree of control and offers the potential to keep your savings growing. If you find poor returns are forcing you to eat into your capital, should you wish, you can always take your money out of the plan and simply buy an annuity.
Once again, the best way to be sure you are utilising your pension in the most effective manner is to seek independent advice. We suggest Age Partnership as our pension experts of choice (you must be 55 or over for them to be able to help).
As previously stated, once you’re able to access your cash, you can usually only take 25% of your savings as a tax free lump sum. However, if your pension is relatively small, thanks to what is known as ‘trivial commutation’, once you’ve reached 60 you can take your whole pension in one payment.
There are a number of factors which will determine if this option is available to you…
The Size of Your Pension
Whether or not you can obtain a cash lump sum will depend on the value of your pension. If it’s worth more than a set limit, you won’t be able to cash in the whole pot at once.
The rules governing how this limit is set have recently changed. Before April 2012 it was calculated by working out your pension rights as a percentage of the lifetime allowance (the amount of pension savings you can make before exceeding the threshold for tax relief). If your pension rights amounted to more than 1% of the lifetime allowance, you could not cash in.
However, these rules have now been changed and the limit is set at a fixed level each tax year (currently £30,000 for commutation periods beginning on or after 27th March 2014). Whilst this simplifies things slightly, working out whether you’re below the limit is still fairly complex, depending on the type of pension in question.
If you have more than one pension plan then their combined value must be below £30,000. Otherwise, the most you can take as a cash payout is 25% of their total value. This applies even if one, or indeed all, your pension plans are worth less than £30,000 individually.
Working Out the Value of Your Pension
Defined Benefit Pensions
- If you are on a defined benefit scheme (often referred to as a final salary pension) which has yet to be paid, how much it is worth will depend on how long you worked for the firm in question and what fraction of your final salary you accrued each year. The employer or the scheme provider should be able to tell you exactly how much your pension would be worth in cash terms.
- If you’ve already started to receive such a pension, whether or not it exceeds the limit will be calculated by taking the amount you receive year on year and multiplying it by twenty. If you already took a lump sum, this will also be added on to the total.
Defined Contribution Pensions
- If you have a private pension consisting of your own contributions then the provider will be able to tell you its current market value and whether or not this exceeds the limit. (Your statements will also tell you its current market value, but its best to get a specific commutation figure from the provider.)
- Again, if you’ve already started to receive payments, the value of your pension (for purposes of testing against the limit) will be calculated by multiplying your yearly income by twenty.
Pensions in Payment Before 2006
If you started receiving your pension prior to April 2006 calculating its value is a little more complicated. You may need to seek advice to get an accurate idea of whether you’re under the limit.
Under new rules you can receive a cash payout even if you do not meet the criteria outlined above. As long as you’re over 60, you can receive as much as £10,000 in a lump sum from an occupational pension. However, taking such a payment will cancel your right to benefits from the scheme. Furthermore, you can not have transferred out of the scheme for at least three years previous. If you are a controlling director of the company that sponsors the pension, you cannot take such a payment.
Again, with a non-occupational pension (such as a SIPP, for instance) you can take a payment of up to £10,000 even if you do not meet all the triviality criteria. You still need to be over 60 and it will mean surrendering your rights to further benefits. You can take up to 3 of these smaller pensions out as cash regardless of whether they are occupational or non-occupational.
Tax Issues with Trivial Commutation
Unfortunately, it is very common for lump sums paid out under the triviality rules to be taxed incorrectly. This is because, if paid by an ex-employer, they will apply your old PAYE tax code to the payment, whereas if it’s paid by a pension provider they will have to use an emergency code.
In both cases there’s a strong chance you will be overcharged as neither of these codes will take account of unused tax allowances you may have built up or the tax you’ve already paid. Unfortunately, if you are overcharged reclaiming the money is no easy task.
Getting a refund will require a P45 form from the pension payer showing the amount you’ve been paid and the tax that’s been taken. In practice the payer may well be unaware that they have to do this, so you will need to insist that they fulfil this obligation.
Furthermore, as they are fairly unusual, many HMRC staff are not very well versed in dealing with in-year tax refunds, which can slow things down. To claim a refund during the tax year you need to get in touch with your tax office and request a P53 form on which you will have to give full details for your income for the year. You can then return this along with the P45 mentioned before.
If you are not sure that you’ve been overcharged and are not in urgent need of the money, or the tax year is near its close, you can wait to receive a tax refund from HMRC, who will review your tax situation and (hopefully) pay you the funds you’re due automatically.
All or Nothing: If you opt to receive a trivial commutation from a pension plan, you have to take 100% of its value at once.
Benefits: If you receive state benefits which are means tested, receiving a lump sum could mean you are no longer able to claim. Your entitlement to pension credit may also be affected. If this would be an issue for you, it could be prudent to seek advice before taking a payout.
Time Limits for Multiple Payouts: If you have more than one pension that you’d like to receive in full as a trivial commutation, you need to take all the lump sum payments within 12 months of taking your first. Bear this in mind if multiple payouts are part of your retirement plans. Even though you have to take all payouts within 12 months of each other, it’s possible to spread them over separate tax years to avoid excessive charges. Remember that you can only cash in if the combined total you receive is below £30,000. If you exceed this amount you will be taxed on the whole amount at a penalty rate of 40%.
Tax Efficiency: If you take payment in the same tax year that you retire your total earnings will, in all likelihood, be higher than in later years, so you might find you’re better waiting before receiving the money as you’ll be in a lower tax band. By the same token, your personal allowance for tax goes up at 65 and again at 75, so if you are approaching either of these birthdays it could be worth waiting until the tax year in which you’ll become entitled to the higher allowance.
Other Types of Triviality Payment
Under triviality rules you can also take a payment of up to £18,000 when a pension scheme winds up. In the case of scheme winding up your age is no restriction to being able to take the payment.
If you take a payment from a scheme that has wound up on a non-voluntary basis it will not count towards your threshold when calculating whether or not you’re able to take triviality payments from any other schemes you might have.
If you are the beneficiary of the pension of someone who dies you can also receive up to £18,000 as a lump sum regardless of how old you are.