From the age of 55 you can start to access your private and most workplace pension schemes1. And I’m sure you’re aware that the first 25% of your pension can be taken tax-free. This has become a very popular option for many to help with things like paying off a mortgage or funding essential home improvements.
So, what happens with the rest of your savings once you have taken your tax-free cash? Well, this all depends on the type of scheme you have.
What if I have a defined contribution scheme?
If you have a defined contribution scheme, any money placed into your pension over the years would have been invested in the stock market. This is how your pension pot grows for retirement. When you withdraw money from this type of pension, the rest of your funds remain invested. So, your pot has the potential to continue to grow until you start taking a regular income.
What if I have a defined benefit scheme?
Defined benefit schemes work a little different. While your money is still invested, the return of the investments will not impact your retirement income as this type of scheme guarantees you a set income for life from your retirement age. When you take your tax-free cash, this guarantee remains in place. However, in some cases, withdrawing your tax-free cash can reduce the income you will receive at retirement.
Do I have any other options?
Absolutely. If you have a defined contribution scheme you might decide that you want a more secure retirement income. In which case, you can use all or some of the money left in your pension to buy an annuity. This is when you sell your pension fund to an insurance company and in return, they promise to pay you a guaranteed income throughout your retirement.
How will the rest of my pension be taxed?
All the while your savings are in your pension, you are not paying any tax on them. It’s only when you withdraw the money that tax comes into play. And only the first 25% is tax-free. So, when you start to make further withdrawals after taking your tax-free cash, the money will be subject to income tax at your marginal rate. It’s a good idea to keep an eye on how much you are withdrawing from your pension as taking too much in one go could push you into a higher tax bracket and you could be lumped with a large tax bill.
1Taking money from your pension early isn’t right for everyone as it can leave you with less to live on later in life.