Your options when you want to cash in your pension

At age 55, you can start to access the hard-earned savings in your pension pot. There are a few ways to use your pension to generate retirement income, each with its own advantages and disadvantages.

Ruth Jackson-Kirby Published on 24 March 2021. Last updated on 25 March 2021.
Your options when you want to cash in your pension

As you approach retirement, you will need to think about how you are going to turn your pension into an income. Once you turn 55 you can access the money you’ve worked so hard to save but how should you go about doing it?

New rules introduced in 2015 give you a lot more freedom over how to access your pension. They apply to any defined contribution personal pension you may have had through work or that you set up yourself but don’t cover defined benefit pensions like final salary schemes which pay you an income automatically when you retire.

Your key options for generating an income from a defined contribution pension are:

Take your pension as cash

Once you turn 55 (rising to 57 in 2028) you can cash in your whole pension if you want to. But you may end up with a huge tax bill – up to 25% of your pot can be withdrawn tax-free, but anything above that will be added to your income for the year and taxed at 20%, 40% or 45% depending on your total annual income.

This option could also leave you dangerously short of cash in later life if you aren’t careful with your savings. You can find out more about taking cash from your pension with our guide to pension lump sums.

Go into income drawdown

Alternatively, you can leave your pension invested and take a regular income from it, often switching into investments that focus on paying dividends.

Known as going into drawdown, this option means you can choose how much income you need and when you need it and leave the rest of your pot to carry on growing. Although this option offers maximum flexibility there is once again a risk that your money could run out if you take too much out or fail to manage your investments well.

» MORE: Everything you need to know about pension drawdowns

Buy an annuity

The final option is to use some or all of your pension to buy an annuity. This is an insurance policy that guarantees you an income for the rest of your life – no matter how long you live. Prior to the pension freedoms introduced in 2015 this was the mainstream option for people with private pensions. Find out more with our guide to annuities.

Pick and mix

You do not have to pick one option – you may decide to take some cash to pay for home improvements, for example, take out an annuity to ensure your regular bills are paid and leave some money invested for further growth.

» MORE: How to make the most of your pension

Can I sell my pension?

No. You cannot sell your pension, but you can use it to purchase an annuity or you can sell the investments held in your pension and withdraw the cash.

If you have a defined benefit pension, such as a final salary scheme, you cannot sell your pension either. However, you may be able to transfer out of it. This isn’t an option to be taken lightly though as it means giving up guaranteed income – for this reason if your scheme is worth more than £30,000 you will be required to get financial advice first.

A common pension scam involves you being contacted by phone or email by a conman who tells you they know a way you can sell your pension.

How are pensions taxed?

When you start accessing your pension you can take the first 25% tax-free. This is straightforward if you take the whole lot as cash in one go, buy an annuity or move it all into a drawdown.

Once you’ve accessed all of your tax-free cash the rest of your pension will be taxed as income when you take it from your pension. The amount you take from your pension will be added to any other income you receive, and the total will decide how much income tax you pay.

If, however, you make partial withdrawals and leave the rest of your pot where it is without going into drawdown – under so-called ‘uncrystallised funds pension lump sum’ rules – you will only receive the first 25% of each payment tax free with the remaining 75% subject to tax.

Total annual income Tax band Income tax rate
  • Under £12,500
  • £12,501 to £50,000
  • £50,001 to £150,000
  • Over £150,000
  • Personal Allowance
  • Basic Rate
  • Higher Rate
  • Additional Rate
  • 0%
  • 20%
  • 40%
  • 45%

Can I cash in my pension early?

In general, you cannot access your pension before you turn 55. However, there are a few exceptions.

You may be able to access your pension early if:

  • You can’t work because you’re too ill.
  • You’re expected to live for less than a year AND your total pension is worth less than the lifetime allowance (currently £1,073,100).
  • You work in a profession with a lower than normal retirement age, such as an athlete.

If you access your pension without meeting the above criteria you could face a tax charge of up to 55% of the amount you withdraw. On top of that you may face fees from your pension provider.

If someone contacts you out of the blue saying they can help you access your pension early it is likely to be a pension scam.

Other sources of pension income

When you start thinking about accessing your pension don’t forget it isn’t necessarily your only source of retirement income. You can of course, use any other saving or investment plans you might have to supplement your income in retirement. You may also be entitled to a state pension and, if you are on a low income, pension credit.

Pension credit is made up of two elements – Guarantee Credit and Savings Credit. Guarantee Credit boosts your weekly income if it is below £173.75 (for single people) or £265.20 (for couples). Savings Credit is an extra payment that you may be eligible for if you reached state pension age before 6 April 2016 and you have some pension savings but insufficient to provide a suitable income.

» MORE: How to plan for retirement

Where can I go for financial advice?

Choosing what to do with your pension is one of the most important financial decisions you will make. It is also complicated so it is a good idea to get some professional advice or guidance to help you make the best decision for your circumstances.

Everyone aged over 50 with a pension is entitled to a free pension consultation with the government’s Pension Wise service – however, this just provides guidance rather than advice tailored to your individual circumstances. An independent financial adviser can provide bespoke advice but you will have to pay for the service. You can find an IFA at Unbiased or via the Personal Finance Society.

» MORE: How to get pension advice

Image source: Getty Images

About the author:

Ruth is a freelance journalist with 15 years of experience writing for national newspapers, magazines and websites. Specialising in savings, investments, pensions and property. Read more

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