Pension freedoms: what can I do with a lump sum?

A Stocks and Shares ISA could provide a flexible solution

Thanks to the UK pension changes, getting your hands on your pension fund means you now have the freedom to spend it or let it carry on earning interest. It’s a big decision that could have a lasting impact on your golden years. If you’d like the opportunity to do a bit of both, then a Stocks and Shares ISA could be what you’re looking for.

Take it or leave it?

Let’s start with what the pension options are. Essentially, as long as you have a ‘defined contribution pension’, such as an individual or group personal pension or a stakeholder pension (the rules don’t apply to state pensions), and you reach age 55, you could:

  • Leave your pension untouched
  • Take cash out when you want it, but only 25% of each withdrawal will be tax-free
  • Take up to 25% as tax-free cash then use the remaining fund to buy an annuity (a scheme that provides you with a guaranteed fixed income for the rest of your life)
  • Take out your entire pension as a lump sum. If you do this, the first 25% will be tax-free, but the remainder will be taxed as income

Decisions, decisions?

There are many things to factor in when deciding what to do, but a couple of key ones are:

  • You might outlive your pension. If you take too much money out you could find that your fund doesn’t last as long as you do. Plus, although the money may be long spent, it could still be taken into account when determining whether you’re entitled to any benefits.
  • You could pay more tax. The first 25% of your pension is tax-free cash, the rest is treated as income for tax purposes. Take out a large lump sum and it could leave you with a large tax bill you might have avoided if you’d taken the money out gradually.

What’s tax efficient and flexible?

Deciding what to do with your pension fund is a big decision. If you choose to take out some of it and aren’t sure what to do with the money one option to consider is investing it in a Stocks & Shares ISA. Here’s some things to consider:

  • You can pay in lump sums – up to the annual ISA allowance, currently £15,240 for the 2015/2016 tax year. Each April, you’ve a fresh allowance to use which means you can keep topping your ISA up
  • Once your money is in there, it stays tax-free, year after year. Someone who’d filled their ISA allowance every year since they started in 1999 could now have getting on for £100,000, including interest protected from the taxman*.
  • You can withdraw your money free of tax, although different providers have different rules and conditions about when you are able to access your money.
  • A Stocks & Shares NISA is intended to be a longer-term investment, which can potentially yield better returns than a Cash NISA

But remember…

  • Depending on how long you’ve had the ISA and when you withdraw money, as with any investment linked to the stock market, you could end up getting back less than you put in.
  • ISAs provide an opportunity for potential growth of your money but this will depend on the performance of the Stock Market and any other asset types your money may be invested in.

Please note:

Tax rules may change and depend on individual circumstances.

The content of this article is for information purposes only and does not constitute financial advice. We do not offer financial advice. If you’re unsure as to the suitability of a product you should seek advice from a Financial Adviser. You may have to pay for this advice.

*Source: Martin Lewis Six reasons why ISAs still beat other savings accounts

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