Helen Nugent

Spend your pension pot wisely

Spend your pension pot wisely
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There was an almighty hoo-ha when George Osborne introduced pension freedoms. In the biggest change to pensions in a generation, anyone aged 55 and over is now allowed to take their entire pension pot as a lump sum, paying no tax on the first 25 per cent and the rest taxed as if it were a salary at their income tax rate.

I was among the naysayers and one of those who thought the then Chancellor was absolutely bananas for implementing the new rules. The temptation to blow the lot on a round-the-world cruise or a fancy car must be overwhelming, and falling back on the State in later years will be no picnic.

But among all the fanfare surrounding pension freedoms, the long-held ability to take a quarter of your pension as a tax-free lump sum - and what to do with it once you've got it - has been largely overlooked. New research from Aegon reveals that more than half of working age people plan to take advantage of this, freeing up around £26,000, nearly the equivalent of the average UK salary.

In its UK Readiness Report, Aegon calculates that, on average, those aged 55 to 65 have £105,496 saved in pensions (hence the £26,000 payment). Steven Cameron, pensions director at Aegon, said: 'The ability to take up to 25 per cent of your pension tax-free has always been a popular option with retirees. The option is intended as an incentive to save through a pension and often allows people to fund the early part of their retirement and to make the most of their new found freedoms. It’s particularly beneficial to those whose retirement incomes are likely to be above the tax-free annual allowance of £11,500.

'Arguably the decision to take cash this way at retirement has become more complicated since the introduction of the pension freedoms. Previously the majority of people took their cash and then bought an annuity with the remainder. Now people can access their savings in a variety of ways, including by keeping them invested and drawing an income, or by accessing it all as cash either in one or multiple go’s.'

According to Aegon, one in six people accessing tax free cash from their pension will put their savings into a cash ISA and 15 per cent plan to put the money into a bank account. A further 14 per cent plan to use the money to take a holiday, 12 per cent are thinking about purchasing a property and one in 10 will use the savings to clear debts.

Cameron said: 'Retirees need to think carefully when deciding whether to take their maximum tax-free cash lump sum immediately or leave more of their money invested. For some people the cash received is vital to clear debts, perhaps pay off a mortgage or clear a credit card. However, not everyone needs it as soon as they retire and money left invested in the pension will continue to grow tax-free while also offering beneficial inheritance tax aspects.

'Cash ISA rates and returns on savings accounts are at all-time lows, with the combination of inflation and low interest rates effectively eating away at spending power from these accounts. Yet, nearly a third of people plan to put the money in a cash ISA or a bank account and this raises a red flag. Savers have worked their whole life to put money away so should be wary of leaving it languishing in bank accounts which aren’t returning the favour. Delaying taking it until they really need it might be a more sensible option.'

Helen Nugent is Online Money Editor of The Spectator