by Michael Ormond on March 25, 2010
Possible best uses for taking pension tax free cash
In most cases, when people retire, they take the maximum tax free cash sum possible from their pensions.
The “at retirement” market is not the same as Pension Release, which applies to those individuals who are taking benefits earlier than their normal retirement age.
Usually, people taking the maximum tax free cash sum when they retire is the right thing to do, however, there are pitfalls. Here are just a few of the reasons those retiring might use tax free cash.
Create an emergency fund
Having cash savings that you can easily access is an extremely important part of financial planning, even more so when you’ve actually retired. Investing in cash may only provide modest returns but it is low risk and flexible – ideal for an emergency fund.
If you are lucky enough to have quite a lot of savings, having a significant amount of your portfolio invested in cash is not unusual. Look around to get the best rates and even consider having some cash instant access is say a building society deposit account and some tied up for longer periods in order to take advantage of higher interest rates – maybe an account where you have to give three or six months notice to withdraw your money.
Unfortunately these days more and more people are retiring with debts, which is obviously not ideal. Getting rid of these debts is quite likely to be one of the best investments you can make.
The reason for this is simple; if you could only earn say 4% interest on your savings but your debts are being charged an interest rate of 8%, it makes financial sense to clear the debts first as they are costing more than you could make from your savings. If you have several different types of debts but are unable to release enough tax free cash to clear all of them, make sure you pay off the ones charging the highest interest rate first, most likely these would be the short term ones such as credit cards.
Boost your spouse’s pension
Even if your spouse is a non-earner or doesn’t pay tax, you could pay £2,880 into a personal pension and receive tax relief, bringing the total contribution up to £3,600.
Having income paid to both spouses is tax efficient because it makes the best use of both your personal tax allowances before income tax is paid.
When taking tax free cash is not advisable
There are some instances when taking pension tax free cash is not a good idea.
1. If you have a Defined Benefit pension scheme you usually have the option to take a tax free cash sum, which in turn will reduce the amount of pension income you receive. You must check what rate is being used and see exactly how much pension is being given up. If you already have other savings and you’re in good health, it could be worth sticking with the maximum income.
2. If your pension fund has a Guaranteed Annuity Rate, it could be set much higher than you would otherwise expect in the current market. If this is the case it may be worth applying the entire pension fund in order to maximise retirement income.