Once you reach the age of 55 (rising to 57 from 2028) you can withdraw some or all of your pension in cash, and the first 25% is tax-free. 

Some people choose to take their tax-free allowance as soon as they are able – and this can indeed seem a tempting option. But is this a wise thing to do?

According to Standard Life, 43% of people over the age of 55, and 52% of people between the ages of 50-54 are not aware they can even take 25% of their pension tax-free. Of those who are aware, 21% over the age of 55 have already taken it, and 9% say they plan to. 

So, should you take your pension tax-free allowance as a lump sum? Let’s look at the advantages and disadvantages of taking your pension as a tax-free lump sum when you are entitled to. 

The advantages of taking your lump sum up front

Here are some benefits you might look forward to when taking your tax-free pension lump sum up front.

You can pay off debts

If you have debts with high interest, you might choose to use your lump sum to clear them. However, there are several issues to consider when using your pension to pay off debt, such as the potential impact on any benefits you receive. It can also impact a debt repayment plan, if you have one. So make sure you speak to a free debt advisor first. 

You have access to money for a big purchase

You might have a large purchase you wish to make. Perhaps your home needs a new kitchen, you might want to move home, or maybe you need a new car, and your tax-free lump sum can enable you to buy. 

You can retire earlier

In some cases, people use their tax-free allowance as an opportunity to retire early. So rather than waiting for the state pension to kick in, they either stop work on reduce their hours and plug the gap in their income with their tax-free private pension money. 

You can pay off your mortgage

If you have a mortgage, you may choose to use your tax-free allowance to pay off some or all of it. However, it’s important to think this through carefully first. For example, if you have a very low mortgage interest rate, you might be better off leaving your money in your pension, especially if your pension fund growth is higher than your mortgage rate. 

You could save money on tax

Reducing the size of your pension pot could potentially keep future withdrawals within a lower tax bracket. 

You can take advantage of investment opportunities 

It might be that you want to invest in an opportunity, and your tax-free allowance can enable that to happen. Those please note, any investment opportunity comes with risk. 

The drawbacks of taking your lump sum up front

Here are some of the potential downsides to taking your tax-free pension lump sum up front.

You’ll shrink your pension

Taking money out of your pension obviously reduces the size of your pot. It also impacts your chances of benefiting from compound interest, as you have less money to compound. This could mean you will have less money to live on later. 

You could have less money to live on in retirement

A knock-on effect of down-sizing your pension pot is that you could have less money to live on later. You might find yourself making harder financial choices, or your money may not last as long as you need. 

You could be hit by poor market timing 

The markets are always fluctuating, and your pension will rise and fall accordingly. But all the time your money remains invested, any gains or losses are all just on paper. If you decide to take any money out in a market downturn, you ‘crystallise’ that loss, and potentially reduce your future income. 

You could be targeted by a scam

If you are targeted by a scammer, the more money you have available to you, the more you can potentially lose. So you’ll need to be extra vigilant if you draw your tax-free allowance out as a lump sum. 

You could affect your eligibility for benefits

If you are entitled to means‑tested benefits, such as Universal Credit, any withdrawals from your pension could impact this. 

Think carefully before you take your tax-free allowance as a lump sum

It can be tempting to withdraw money from your pension once you are able – after all who wouldn’t like a tax-free lump sum of money to play with?! But as you can see, there are important issues to consider first, not least reducing your future potential income. So make sure you think carefully and get good, independent financial advice before doing so.