While lifestyle expenses are the most popular reason for accessing a pension, a survey suggests that a significant number of people are doing so to pay off debt. If you’re considering this, it’s important you understand how you can access your pension and what the long-term effects could be.

According to data from Royal London, more than 1 in 10 pension withdrawals were made to pay off debt. 

If you have some form of debt, whether a mortgage or credit card, and can access your pension, it may seem like a straightforward solution. However, it’s not always the best option and it could mean you can’t reach other retirement goals in future.

You can access a 25% tax-free lump sum from your pension from age 55

It can be tempting to withdraw the available tax-free cash from your pension, even if you’re not retiring or don’t need it to support your living costs.

You can usually access your pension from age 55, rising to 57 in 2028, and can typically withdraw up to 25% of your pension without paying Income Tax. You may choose to take the tax-free money as a lump sum or spread it across several withdrawals.

If you’re thinking about making a withdrawal to pay off debt, there are some key things you need to consider first.

1. If your withdrawal exceeds the 25% tax-free cash amount, you may be liable for Income Tax. It could also push you into a higher tax bracket if the withdrawal means your total income exceeds the relevant thresholds.
2. In some cases, exceeding the 25% tax-free cash means you will trigger the Money Purchase Annual Allowance (MPAA). This limits how much you can tax-efficiently add to your pension each tax year to £4,000 (2022/23 tax year). If you decide to continue to work and pay into your pension, this may affect your long-term plans.
3. If you receive means-tested benefits, taking an income from your pension may affect your entitlement.

As well as keeping these factors in mind, you also need to weigh up the long-term consequences of withdrawing money from your pension.

Could taking a lump sum out of your pension affect your retirement income?

Taking a lump sum out of your pension when you retire or before that milestone could significantly affect the income you can expect for the rest of your life. You may not be able to achieve the income you want in retirement, and you may even risk running out of money in your later years.

Keep in mind that the money in your pension is often invested. As a result, taking out a lump sum may have a much larger effect than you expect as you’d also miss out on potential returns.

In some cases, you’ll still have enough to pursue retirement goals even after taking out a lump sum, but you should fully understand the consequences before you proceed.

By making a retirement plan first and calculating your income needs, including how this will change during your retirement, you can be confident about the steps you’re taking.

If you’re thinking about accessing your pension, whether you’re ready to retire or not, we can help assess how it could affect other long-term plans that you may have. We’ll help you consider things like life expectancy, the legacy you want to leave, and how to make the most of your assets to reach your goals.

As well as weighing up the effect of taking money out of your pension to reduce debt, a retirement plan can also mean you understand what your options are when you’re ready to start taking an income from retirement savings.

Weighing up your options if you’re nearing retirement with debt

It’s natural to worry about debt as you near retirement. Depending on your assets, there may be other ways you can pay off the debt or you may be able to continue making repayments from your income in retirement. Before you access your pension, you should weigh up your options.

We can help you assess your assets, such as investments, property, or savings, if you want to understand how you could pay off debt or maintain repayments.

If you’re struggling with debt, charities, such as StepChange, can also offer support and advice.

Please note: This blog is for general information only and does not constitute advice. The information is aimed at retail clients only.

A pension is a long-term investment not normally accessible until 55 (57 from April 2028). The value of your investments (and any income from them) can go down as well as up, which would have an impact on the level of pension benefits available.

Your pension income could also be affected by the interest rates at the time you take your benefits. The tax implications of pension withdrawals will be based on your individual circumstances. Levels, bases of and reliefs from taxation may change in subsequent Finance Acts.