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The risks and rewards of unlocking your pension early

Your Money
Thursday 21 February 2019
From the age of 55, most pension schemes will allow you to tap into your reserve and release some of the funds.

Having a bit of extra cash is always handy, so unlocking your pension early may seem a smart way to access some. You may be eyeing some much-needed home improvements. It could be you’re looking to splash out on a well-deserved holiday. Or you might just want something to fall back on in the event of a rainy day.

But is unlocking your pension really the best way to do it?
Before taking the plunge, it’s worth considering what drawbacks there might be.

By unlocking your pension early, you should expect to have less income in retirement. That’s fine if you have ways to make up the difference later down the line. Many don’t.

You should also consider what charges you might face if you decide to go ahead. There are likely to be costs associated with taking something from your pension early. It’s worth getting in touch with your provider to see what other fees there might be.

Another thing to think about is Income Tax. If you take your pension pot as a single lump sum, you could be facing a big tax bill, especially if you’re still earning. As things stand, 25% of your pension pot can be withdrawn tax-free. Anything above that is taxable. If you have a sizeable pension pot, taking it all in one go or even withdrawing a significant chunk could push you into a higher Income Tax bracket.

Additionally, if you’re not planning on spending the money straightaway, there’s the question of where you keep it. Investment trusts and the like are not tax exempt.

If you’re in the lowest Income Tax bracket, any interest you earn each year over £1,000 will be taxed – excluding anything earned on an ISA. For higher rate tax payers, the limit is £500. And for those who pay 45% Income Tax, there’s no tax-free allowance on interest.

Inheritance Tax is also something to think about, even if you may not want to. Any money held in a pension is usually outside of a person’s estate when they die, leaving it Inheritance Tax exempt. But releasing that cash means it becomes part of your estate, potentially making it subject to Inheritance Tax.

Similarly, if you have any outstanding debt when you pass away, creditors are able to call on your released pension for payment.

All things considered, you need to judge how unlocking your pension early may affect you in the long term. It’s smart to explore your other options and seek independent financial advice. Otherwise, that extra bit of cash now could become a significant issue in the future.
Page last updated: Thursday 21 February 2019