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Pensions: should you take tax-free cash when you retire?

One of the big benefits of pensions is the 25% tax-free cash lump sum you can take from your pot when you retire. But is this the right thing to do?


by Michelle McGagh on Dec 14, 2012 at 15:03

Pensions: should you take tax-free cash when you retire?

One of the big benefits of pensions is the 25% tax-free cash lump sum that you are allowed to take from your pot when you retire.

This lump sum is truly tax free as you will have paid no tax on the money that went into your pension and you will pay no tax when you take out up to a quarter of the money that has grown inside the plan. 

Of course, the remainder of your pension savings is subject to income tax.

But although it feels good to get your hands on your tax-free cash from the pension, is it the best thing to do?

Yes and no: the impact of low annuity rates

Traditionally, most people would use their pension savings to buy an annuity when they retire. The annuity would pay an annual income - your pension - until death. However, annuity rates have plunged as people have lived longer and interest rates have fallen. This means anyone retiring today needs a much bigger pension pot to provide a decent pension than if they had retired 10 years ago.

Given this fact, you can make a case for taking the tax-free cash from your pension and for leaving it in your pension pot.

Arthur Child, managing director of Arch Financial Planning in Guildford, says one way to boost your income is not to take your tax-free cash as the more money you have in your pension pot then the bigger the annuity you can buy.

On the other hand, he says you could invest your tax-free cash and generate a better return than you would get from an annuity.

For people saving into a personal pension, Child says taking the tax-free cash may prove the better option.

‘Annuity rates are so low for personal pensions that taking the tax-free cash is probably the right answer,’ he said.

‘A 65-year-old man who wants an inflation-linked annuity will probably get an annuity rate of 4%. If you take out the tax-free cash and invest it you could easily get 4%.’

When not to take the cash

However, there are circumstances where tax-free cash should not be taken, says Child. If you are part of a generous defined benefit, or final salary, pension scheme from your employer then the value of keeping the cash in your pension pot and taking it as income is much higher than taking the cash.

‘You do not want to take your tax-free cash if you are in a final salary pension scheme. What you lose in pension income and what you gain in cash is not worth it,’ said Child.

Also if you have a guaranteed annuity rate written into your pension policy then you should not take the tax-free cash either as you lose out on a significant amount of income.

‘If you have a guaranteed annuity rate, say for example of 8%, then you would be crazy to take the tax-free cash and give up the income because there is no way we could generate an 8% return by investing the cash.’

What do you need the money for?

Child said most retirees automatically take the 25% cash without asking themselves whether they need it.

In his experience, Child says people typically fall into two categories.

‘Some people find the cash burning a hole in their pocket and they spend it on cruises and cars but once that money is gone, it’s gone, whereas pension income from an annuity keeps coming,’ he says.

But he adds: ‘On the other hand there are those who take the tax-free cash and have a small pension but £100,000 sitting in deposit in the bank and they are too scared to spend it although they are living hand to mouth. Most people are better off having a higher income and for them income is more valuable.’

Don’t take it all

When it comes to taking tax-free cash, it’s not an all-or-nothing situation, you can choose to take less than 25%.

‘If you have £25,000 still left on the mortgage then pay that off [with the tax-free cash], but do you need anymore than that?’ asked Child.

It is easy to change the amount of tax-free cash you take, he added.

‘If you are not using an IFA [independent financial adviser] who will do it for you, phone your life company and they will send you a new annuity quote. They typically send a default quote with the income you would receive if no tax-free cash is taken and a quote with 25% tax-free cash taken and people think they are the only options they have,’ he said.

And what about the tax conundrum; surely leaving money to be taxed when you can take it tax-free is a bad idea?

Child answers: ‘Pension income is taxed but most people in retirement haven’t got enough income to pay a lot of tax – as a couple you have to earn £20,000 a year before you are taxed.’

He added that an IFA will help you to decide whether you need to take your tax-free cash, get the best annuity deal and ensure you aren’t paying too much tax.

‘To sort out an annuity an IFA will charge you between £500 and £750 but you could be a lot better off after.’

Further Reading

The Lolly guide to pension schemes.
The Lolly guide to annuities and retirement.

44 comments so far. Why not have your say?


Dec 14, 2012 at 15:31

Or you need the money to pay off a mortgage having taken out a pension linked mortgage.

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Dec 14, 2012 at 15:31

Utter rubbish! Your pension pot is your money and it is locked up until you die - and then you lose whatever is left. And remember not many of us survive to be a 100 or even 90 and good percentage don't even make 70. Take the 25% and invest and even draw down some of the capital but if there is any left when you pop your clogs at least it will go to whoever you want - not the annuity company.

And if you have the option of a flexible draw down type pension then take it and take the maximum benefit each year, as long as you don't spend it. Set your budget, invest the rest and again it is your choice where it goes to when you die.

Yes, you do have to be disciplined and sensible - but if you weren't you probably wouldn't have a pension pot to start with.

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Stevie Boy via mobile

Dec 14, 2012 at 15:37

A good reason to speak to a fee- charging IFA is the removal of conflict of interest. If an adviser is remunerated through 'adviser charging' then they may be swayed into advising you to take maximum PCLS just so that they can get their hands on it and invest it. Otherwise, if you take no tax free cash they won't get paid as there may be little or nothing to invest.

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Dec 14, 2012 at 15:51

I suggest that except for final salary DB schemes almost everyone would be better of taking the 25%. Or if a couple and you don't think you need the tax free lump sum then perhaps take the lump summ and put it in your partners SIPP and get tax relief on your tax free lump once again.

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Brian Pearson

Dec 14, 2012 at 15:55

Again! another article talking about annuities and NOT income drawdown. You can still take your 25% if you have converted to a SIPP and will be taking income drawdown and with recent changes whereby, using this method of pension, you can get 120% of any GAD figure, you can take your tax free allowance and still potentially have a reasonable pension income. Let me give you an example. If I took 100k from my pension pot, then took 5K from it as part of my yearly income, the remaining 95K was invested earning me 4% interest, then my 95K would increase by £3,800, so after taking my 5K out, my investment would still be 98,800 at the end of the year (100K - 5K = 95K @ 4% = £3,800. so 95K plus 3,800 = £98.800 left in my pot or to put it another way, I can take 5K out and it will only reduce my pot by £1,200. If I was lucky enough to get 5% return on my investment, then my pot would only go down £250 and I would still have taken £5K in that year as living expenses. Of course this is a rough calculation, but it shows that you can manage your money and remain pretty fluid. Oh on top of that, the money is yours to use/take if and when you need it..

I also totally agree with Barry1936 comments.

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Dec 14, 2012 at 15:58

What isn't mentioned is the effect of taking teh tax-free allowance if you opt for drawdown rather than an annuity.

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Dec 14, 2012 at 16:04

Who does this Child character think he is? God??

For most people living outside the 'cosy' souf east of england, taking the tax free cash may be a necessity - it's their money to spend and if they need it to pay off debts, or provide one good holiday (or whatever) before they die, then let them.

Also, in most instances, £25K is worth more to an individual (or family) than say £800 a year annuity (after tax), so that means a mere 20+ years to live for 'equalisation', or perhaps 15+ years if no tax is paid (assuming some inflationary increase and that tax free cash is just held on deposit with little or no interest)

And I say 'have the money now, when it's worthwhile, not have it strung out over 20 years or so, when you can't do anything much with it'.

Also, Child's example of £25K cash to pay off mortgage is spectacularly higher than the oft quoted average pot, of perhaps £30K (meaning only £7.5K cash).

Basically, whole financial situation needs to be looked at and everyone is different is what I say.

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J Thomas

Dec 14, 2012 at 17:16

For goodness sake take the tax free 25% while you still can.

Will it still be on offer in five years time......who knows?

will it still be on offer in ten years time.......I dont think so.

Will it still be on offer in fifteen years time......almost certainly not.

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Dec 14, 2012 at 17:27

J Thomas - and not being there in 15 years time will be a terrible blow to many, that is how I intend to bridge the gap between retiring and my deferred DB pensions coming on stream.

But you can bet your life successive governments will be eyeing it up for another round of theft. They will start some propaganda about how unfair it is for the wealthy to get a 25% lump sum - they already started vilifying higher rate tax payers so that they can remove the higher rate tax relief, which will no doubt appear at some time in the future

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P Williams

Dec 14, 2012 at 17:31

Take the money ASAP the Goverment looked at reducing the percent last month but decided against - if you trust them fine but if not take the cash otherwise it will ALL be taxed.

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Dec 14, 2012 at 17:36

I took 25% of my total pension fund. I had invested in AVCs, so I took the 25% from the AVCs and NOT the final salary pension. In 2006, I got 6% in a savings account, the same rate as the annuity. Now the interest is less, but I can change the investment to equity ISA. Also some is in ZOPA, getting 5%+. If you manage your own affairs, you can have an income and have something for the Grandchildren.

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Dec 14, 2012 at 17:37

I agree with the final salary plans not taking the cash lump sum if one's economic situation permits. Generally, one would generally have to earn between 8% and 11% on the lump sum to break even on the shortfall in monthly payments.

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Dec 14, 2012 at 17:39

Taking the lump sum from the AVC and executive AVC is a very good idea, if the administrator will move them to the main plan.

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Dec 14, 2012 at 17:40

I have taken 25% from every one of the small pension pots I have built up over the years. Each lump has been used to buy mainly quality stocks & shares + a few gambles when the going was good. There have been up and downs, but I have done much much better than leaving the cash in a 'play it safe' kitties controlled by others; two of which went nearly belly up.

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Bob saxton

Dec 14, 2012 at 18:37

Everyone seems to only be thinking of the money. What about the quality of life issues? Sitting in a damp nappy being abused and neglected in one of Gods commercial waiting rooms until I am a hundred does not appeal to me.

By retirement time we are definitely on the downward slope of the parobola of life. That is the y = -x squared parabola.

Take as much as you can now and enjoy it as well as you are able to. If you can still enjoy walking go to where you have always wanted to. If not take a cruise.

I am talking from experience. I could afford any cruise or to go to any hotel in the Bavarian Alps or Italian Dolomites but I am too nackered to want to do either of them anymore. If I had done either of these things ten years ago I would have perhaps £20,000 less in the bank but now I am exhausted after walking half a mile and cannot face a whole pub lunch. I have to put half in a doggy bag and reheat it for supper.

I would gladly exchange the £20,000 for some good memories instead of

unfulfilled dreams.

Bob the electrician

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Bob saxton

Dec 14, 2012 at 18:43

p.s. I am thinking about spending the £20,000 on a great big motorbike and seeing how fast it will go over the Snake pass. It sound better that the Liverpool Pathway.

Only joking

Bob the electrician

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Dec 15, 2012 at 00:20

With savings rates falling so low, and the potential return on equities likewise. Maybe we've gone full circle back to annuities (for the majority). Where a guaranteed regular income for life seems the best option.

Seen many friends who work in the NHS leave at 55. Used lump sum to pay off mortgage. Bought expensive cars. 3 holidays a year. I do wonder if this is sustainable...........

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Dennis .

Dec 15, 2012 at 09:39

Generally speaking and if you are healthy, the earlier you retire the less benefit in taking the lump sum, in my wife's local government scheme she only had to live for 12 years to be better off by not taking it.

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Dec 15, 2012 at 09:43

Some retirees aren't aware that they can take between 0% & 25% as a lump sum, & so they automtically go for the maximum. The way that annuity providers set out their quotes doesn't help to make it crystal clear.

A word of caution; a number of retirees from defined benefit schemes now regret taking as much cash when they retired, & they are now feeling the pinch despite receiving annual pension increases

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Pensionable age

Dec 15, 2012 at 12:14

I'm with Bob Saxton on this one, My dad is using his pot to pay for his care home fees at £545 a week! It won't take long to erode the pot at £25K/annum.

Is that what you want to spend your money on?

No cruises, no fast cars, and certainly no loose women where he is.

If you are lucky enough to have a £100K pension pot at 66, based on current rates you would need to make it to 86 years of age just to break even. How many of us will be able to guarantee that?

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Dec 15, 2012 at 15:08

My querry is the same as Cardeulis'.

If you take an annual sum from a SIPP ie Capped Drawdown or Flexible Drawdown, of say £2,000, is 25% of this (or other factor) tax free?

After all if you used a slice of the pension fund of say £50,000 to produce the same £2k pa as an annuity you would be able to take up to £12,500 as a tax free lump sum

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Dec 15, 2012 at 15:30

"If you are lucky enough to have a £100K pension pot at 66, based on current rates you would need to make it to 86 years of age just to break even. How many of us will be able to guarantee that?"

The whole basis of "insurance" is to pool risk. When "we're gone" does it matter what we leave behind.? Or is it preferable to know that you've a guaranteed income for as we are alive.

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Dec 15, 2012 at 16:27

I'm surprised there is anybody even considering not taking their tax-free cash. At age 60 I got a quote from my (private-sector) employer on the dfifferent retirement benefits from a DB pensionthat I would receive if I did or did not take the 25% out. A calculation based on realistic inflation rates and investment returns indicated I would have to live past 79 to stand a chance of getting a higher aggregate total, and on most scenarios it was even later. Aside from the fact that I might not be lucky enough to live that long, when would I rather have the extra cash? In my 60s and 70s or in my 80s? This seems to be one of life's easier decisions..

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Dec 15, 2012 at 16:48

By 2030. The forecast average life expectancy is forecast to be 87 for both sexes.

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Dennis .

Dec 15, 2012 at 17:30

peterj I am surprised that you came to that conclusion. I was in a private sector DB scheme and came to a very different answer for two reasons when I retired at 55. My decision not to take the money was based on two facts.

1. The pension scheme wants you to take the cash because it's in their interest as on average, they pay out less this way.

2. In my case the break even point was only 12 years.

This illustrates he importance of doing your own calculations.

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Dennis .

Dec 15, 2012 at 17:35

It ultimately depends on whether you need the cash now.

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Dec 16, 2012 at 11:59

Dennis, I don't think it does depend on whether you need the cash now. I didn't and I still took the money. The fallacy in many people's calculations is that they work out how long it will take their increased pension payments to catch up with the absolute amount of money withdrawn. I wouldn't be surprised if that produced a result of only12 years to "break even", which explains why pension funds like you to take the money. However, this disregards the fact that you can invest the withdrawn money. Even assuming only average returns this pushes the break even date out much further, in my case to 19 years, which makes the case for increased flexibility. And if you spend some of that money in the meantime it only proves the flexibility was justified!

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Dec 16, 2012 at 14:02

WOW!!! It looks like the IFA business is a bit like the legal profession when two opposing lawyers go to court. Both think they know the answer, but actually only one wins and one loses. I guess clients must beware of the advice of their chosen IFA because even though he may have the same license as others, his understanding and advice may be completely different with some right and others wrong to the detriment of the client.

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smoking gun

Dec 16, 2012 at 16:20

The wise owls of this article are those who advise taking the lump sum. After all a bird in the hand is always worth two in the bush. Barry 1936 is absolutely right - many do not last long after retirement and never get the benefit of their pensions. And MJS1234 also points out that lump sum can be very useful when there is a need to pay off mortgage. As far as pension lump sum is are concerned, take what's yours and run, and take the maximum while your at it. Re-invest it, pay off mortgage, buy a car, go on a world cruise or even just blow it. It's your cash to do with as you please and the choice is yours but you may have to cut your aspirations later.

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Anonymous 1 needed this 'off the record'

Dec 16, 2012 at 16:29

Peterj ultimately I think it does come down to your age and how much you need the cash. I started drawing my pension at 55 so there is a better chance that I will pass the break even point however you calculate it. Also the first 5 year of my pension is guaranteed so that if I die in the first 5 years the balance will be paid to my family.

My house is paid off and I don't have any debts. I have around £300K non pension investments and don't need any more. My wifes plus my own pensions incomes are about £1K a month more than we need so they are just going into more investments and I haven't factored in my state pension yet. Would you still take the money?

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Dec 16, 2012 at 17:15

Anonymous 1, yes I would. My situation is almost identical to yours other than I retired at 60 rather than 55. I still would have taken it even if I had been 55; smoking gun has hit the nail on the head most succinctly.

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smoking gun

Dec 16, 2012 at 17:19

Anon: Lucky you. But remember there are hundreds, nay thousands in fact millions of workers asnd unhappy non- workers out there who don't have the luxury of retiring well off, debt free and a guaranteed pension - and most mav have to to work till they are 65 (60) and older in future years. I think that is the trouble with many comments on pages like this is that people can only see their own (hopefully) happy situations. Please remember the rest. I agree there are many who take no action for their later years and rely on the state but equally there are many who just haven't the means or perhaps even the knowledge or education to realise that they should make some provisions.

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Rose G

Dec 18, 2012 at 10:00

Regarding tax free lump sum, I had someone call me on my mobile phone asking me if I was in a position to get a tax free lump sum etc. I politely asked them to get off the phone & not bother to call again - how are people getting this information? It begs the question of whether my pension company have already sold this information to the financial services.

I think it is pernicious that government, government & other agencies are able to make money from my data, and when we complain we are asked to tick the box on the electoral voting registration from (which I was not aware off) to indicate that I am not happy with having my data shared with all & sundry!

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Anonymous 1 needed this 'off the record'

Dec 18, 2012 at 10:17

Had the same thing with one of my wife's pensions when about £20K lump sum hit our current account. The bank rang up offering financial advice, I just said "what's the big deal it's only £20K?" . This however was the wrong thing to say, they took it that I was worth more than they thought and I got even more calls offering reviews etc.

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Dennis .

Dec 18, 2012 at 10:25

smoking gun, would you really want to go on a cruise? Catch Norovirus, holed up on a floating overcrowded hotel with people whose ambition in life is to dress up for dinner with the crew (captain's table) etc. I thought hell was somewhere you went after you died.

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smoking gun

Dec 18, 2012 at 16:41

Dennis: You are absolutely right. Been on cruises, caught a bug (thankfully not norovirus), but the main point is that what are called cruise ships nowadays are in fact holiday hotels complete with climbing walls, golf ranges, keep fit salons etc. More like Holiday camps. We Golden Oldies prefer something a bit more sedate so no more cruises for me (unless its a day trip on The Waverly but definitely not on the Good Ship "Butlins".) But if that's how someone wants to blow their lump sum, as I said above, that's their choice although I used the bulk of mine to pay off mortgage, remainder still invested in shares with reasonable returns.

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Arthur Childs

Jan 04, 2013 at 13:46

Thank you for your comments. Yes it is me - there should have been an 's' on my surname. The task of an IFA is to get clients to think about the options that are available to them otherwise they just choose the options presented by the product provider.

I agree that in many cases taking the maximum cash is the right thing to do but certainly those with final salary pension benefits could be paying dearly for doing so.

It is a sad fact that even in Surrey the majority of people end up with a pension pot well under £75,000 and so taking the maximum cash is perhaps the only option.

For the lucky ones who have pension pots in excess of around £300,000 then some form of pension drawdown may be appropriate and flexible drawdown is especially attractive once you have £20,000 of guaranteed income benefits from elsewhere but we are still talking about relatively few people in that situation.

My advice, as always, is to avoid the basing your decision on what worked for someone else as we are all different and to try and research all the options even if the decision seems to be blindingly obvious.

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Brian Pearson

Jan 04, 2013 at 15:07

I totally agree Arthur. Everyone is different, that is why it is so important for people to seek out their options and not just take the first thing put in front of them. I hope people always remember that what works for one may not work for others, even though the pension providers, will try and make it seem so. I am not in a final salary scheme and have a large pot, so will definately be taking the 25% cash option when I retire, assuming its still available. :)

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Arthur Childs

Jan 04, 2013 at 15:30

Thanks Brian. Don't forget that pension funds can be passed free of inheritance tax (IHT) before age 75 provided nothing has been withdrawn. So with a large pension pot (especially prior to retirement) you might want to consider nominating children to receive it in the event of your death always supposing that your spouse would not be left short by doing so.

One advantage of staggering taking your tax free cash over a few years is that part of the fund would still be untouched and could still be passed free of IHT. Say you had a fund of £500,000. If you take £125,000 tax free cash that is part of your estate until it is spent. Also the remaining £375,000 fund would be subject to 55% tax if left in the form of a lump sum. However, you could take, say, £25,000 tax free cash each year for five years. The remaining pot of £475,000 is free of IHT and there is no 55% charge before age 75 and so can be passed as a lump sum to your spouse or children. The next year you take another £25,000 and there is still £450,000 to leave as a lump sum and so one.

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Arthur Childs

Jan 04, 2013 at 15:37

Ooops. My maths went a bit astray there. In the example, if you take £25,000 tax free cash then your fund is split into £75,000 (the remaining 75% after tax free cash is taken) and a fund of £400,000 which is free of IHT. If you take a further £25,000 the next year then you have £150,000 in total which is taxable at 55% id left to someone on your death as a lump sum and £300,000 which is free of the 55% or of IHT. Apologies for that - doing too many things at once.

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Brian Pearson

Jan 04, 2013 at 15:56

Lol Arthur. My colleague and I was going to ask you where you could get a fund which returns enough to leave you with $475K after taking £25K per year for 5 years. Thats some return on investement. Thanks for coming back and correcting anyway.


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Dave T

Feb 06, 2013 at 17:46

I've followed this thread with interest as I'm due to get my final salary pension in a few months time. Almost all advice I've seen seems to suggest not taking the 25% cash free sum from a DB scheme if the money isn't needed. My DB scheme is slightly unusual in that around 40% of the annual pension is level, with the remaining 60% indexed at a max of 5%. I'm told by the scheme administrators that taking the max 25% cash will only affect the level part of the pension, with the indexed part left untouched. Example: No cash, £15k per annum of which £8.9k is indexed. Max cash of £64k reduces pension to £9.6k per annum of which £8.9k is indexed.

Does this fact mean the argument for taking the cash is stronger even though I can't invest the £64k and make up the annual loss? Thanks.

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May 28, 2013 at 21:05

Always looking for advice

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May 28, 2013 at 21:12

I will be 57 this September, I have nearly 36 years in our company,s final salary scheme so will have my 40 years service in the scheme when I'm 61 yrs and 5 months. My salary at 61 yrs should be around £44k. My question is how do I calculate my expected lump sum and pension thereafter? Based on me being 61 years old. The scheme is 40/60

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