I have a question about taking a lump sum from a SIPP. Mine is fully invested, so obviously there’s no cash available immediately to pay a lump sum and the total value of the fund is changing daily, so my question is: how would you decide what the maximum lump sum is that I could take, given the continuously changing value of the fund, and how long after that assessment would I have to realise investments in order to pay that maximum lump sum?

Shaun

Rachel Vahey, AJ Bell Head of Public Policy, says:

One of the biggest tax advantages of pensions is the ability to take up to 25% of the fund as a tax-free lump sum. From the age of 55 (rising to 57 from April 2028) you can usually take up to 25% as a tax-free lump sum (as long as you haven’t gone over a total limit of £268,275 which applies across all your pension pots). You could then use the rest of the pot to buy an annuity – which pays a guaranteed income throughout your life – or keep the rest invested in drawdown and take an income from it when you need and want to. This could be a regular income or one-off withdrawals.

Any income you take from the pension pot is added to other income – for example from earnings or state pension – and will be subject to income tax.

The 25% tax-free amount is obviously a big tax perk. But if you don’t need the money then it may just sit in your bank account and could potentially be subject to inheritance tax when you die if you haven’t used it.

But if you have decided to take some or all your tax-free cash – maybe to pay some debt or an expense such as a house renovation – then you will want to think about timing.

The ‘techie’ answer to your question is that the value of the maximum lump sum is set at the RBCE (relevant benefit crystallisation event). (This is the point the lump sum is measured to compare against that £268,275 limit – the lump sum allowance or LSA for short.) At that point the valuation is locked in. You will probably need to check with your pension provider when they set the RBCE; many will use the date they receive the request to take benefits.

SELLING DOWN INVESTMENTS

You will then have to sell down investments to make sure you have enough cash to pay the lump sum, or your pension provider might automatically do that for you when they receive the request.

It’s possible the value of your pension fund will change between you making the request to take cash and the cash being paid out. What happens then depends on your pension provider. It’s likely the value of your tax-free cash won’t change, after the RBCE has been locked in. So even if the value of the pot goes up or down, it’s just the amount of money in drawdown that will change, not the tax-free cash amount.

The value of your pension fund may change between your cash request and payout. This depends on your provider. Typically, the tax-free amount remains fixed after the RBCE is locked in, so only the drawdown amount may vary with changes in the fund’s value.

One way to avoid these possible fluctuations is to sell down investments gradually to move the amount you want to take as tax-free lump sum into cash. That way you have the right amount of money in cash on the date you put in your request.

WORTH CHECKING ON THE STATUS OF WORKPLACE PENSIONS

One other thing to note. Workplace pensions may automatically shift investments to less volatile ones as you age. This is called lifestyling. Before 2015, this change often prepared members for buying an annuity by gradually moving investments in bonds and cash as their retirement age (or state pension age) drew near.

But given that now most people with a pension pot of over £30,000 move into drawdown, therefore keeping most of their pension pot invested, this automatic move may not suit your investment strategy.

For that reason, it’s worth just checking what happens to your investments in any workplace pension in the run up to your retirement or state pension age. 

DO YOU HAVE A QUESTION ON RETIREMENT ISSUES?

Send an email to askrachel@ajbell.co.uk with the words ‘Retirement question’ in the subject line. We’ll do our best to respond in a future edition of Shares.

Please note, we only provide information and we do not provide financial advice. If you’re unsure please consult a suitably qualified financial adviser. We cannot comment on individual investment portfolios.

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