Answered by Michael Englefield
Can my final salary pension provide a cash lump sum?
That’s because a money purchase pension has a defined pot of money you can draw a lump sum from, whereas this isn’t the case for a defined benefit pension.
While you are technically able to take 25% of your pension as a tax-free lump sum after the age of 55, the regulations surrounding taking a final salary pension lump sum are complicated. They’re also dependent on the rules of your pension scheme.
Remember, withdrawing a lump sum from your final salary pension will reduce your final annual pension, so doing so means you’re forgoing a sum of guaranteed, index-linked income each year for the rest of your life.
Consider carefully whether you’ll be able to live on a reduced pension after taking a final salary pension lump sum. Is having ready cash today is worth having to tighten your belt in the future?
Final salary pensions and commutation factors: Calculating your final salary pension lump sum
Withdrawing a cash lump sum from your final salary pension is known as commutation. How much you can take out of your defined benefit pension and how this will affect your final pension allowance is a complex calculation, but it’s based on a commutation factor.
For a commutation factor of 16, you’d have to sacrifice £1,000 of income for every £16,000 you got as a cash lump sum.
So if you were due a defined benefit pension of £30,000 per year but wanted to take a lump sum of £16,000, your annual pension entitlement would fall by £1,000 to £29,000 in exchange for you taking the £16,000 lump sum.
Remember that you can withdraw a 25% cash lump sum from your final salary tax-free, but again even working out what constitutes 25% of your DB pension isn’t a simple calculation.
The permitted lump sum you can take out of your final salary pension is broadly calculated as 25% of the total value of your crystallised pension benefits. It’s sometimes known as a pension commencement lump sum.
You’ll need to know your commutation factor and your expected annual pension benefit to perform the calculation. However, the complexity in this area means that it’s recommended you get pensions advice and have an adviser crunch the numbers for you before you consider taking any money out of your final salary pension.
Be aware that cash lump sums withdrawn from your pension above the tax free limit are added to your other income and could push you up an income tax bracket, landing you with a larger than expected tax bill.
Get final salary pension transfer advice to access your pension with a pension transfer
Taking cash lump sums from your final salary pension using commutation rules is tricky business.
The rules for taking cash lump sums out of a defined contribution pension are much simpler and you have a far greater level of flexibility with a money purchase scheme today than you do with a defined benefit plan.
If you’re still keen to take a lump sum out of your defined benefit pension, you might want to consider a final salary pension transfer instead. This would turn your defined benefit pension into a defined contribution pension and give you greater freedom with regards to how you take your pension benefits.
You might have received a cash equivalent transfer value or CETV from your pension provider, which is the first step. However, if you haven’t had one, why not use the Drewberry Final Salary Pension Transfer Value Calculator to see how much you could get?
Alternatively, if you want to discuss transferring your defined benefit pension, our pensions advisers are available. They can request a pension transfer value for you, so why not pop us a call on 02084327333 for further advice?
We’re able to advise on all final salary pension transfers, and can also help you plan for retirement with your new pot of cash.
Before considering a final salary pension transfer, you should get pensions advice to make sure it’s suited for you. If your scheme is worth more than £30,000, it’s a mandatory requirement.
Frequently Asked Pensions Advice Questions
Very helpful and professional advice. Would recommend using Drewberry if you are looking for help with Relevant Life Insurance.
I cannot commend highly enough the quality of advice and service I have received from Drewberry. Jake kept me fully informed throughout the process until the insurance was finalised.
Great job on Life insurance. Phoned back quickly. And quickly found me good alternative when issue with first provider. All super easy to set up and do.