Research published recently by the Prudential shows that the majority of people, nearly eight out of 10 in fact, take a tax free lump sum from their personal pension plan or company scheme, when they retire.

Pension savers have historically used the lump sum for a variety of different things, perhaps a once in a lifetime holiday, a final new car, repaying some lingering debt or simply as a nest egg for future use.

The research done by the Prudential shows that around 30% of retirees spent their lump sum on home improvements with the same number of people using it to pay for a holiday. One in five people used the money to buy a new car.

Annuity Rates

Most people are aware that over the past few years Annuity rates have fallen significantly, the two major contributing factors to this reduction have been increased longevity and a reduction in gilt rates.

It is possible that lower Annuity rates will force pension savers to change their buying habits when they reach retirement. The tax free lump sum may no longer been seen as a bonus but in fact vital to producing sufficient income to meet living costs.

So, with falling Annuity rates, rising inflation, and historically low interest rates what are the main things you should think about when you are deciding whether or not to take a tax free lump sum from your pension:

Income or capital, which is more important? This is probably the most fundamental question you need to answer when deciding whether or not to take your take free lump sum.

If capital is required, are there other options? We have already seen how capital could be needed for all sorts of things. It can be extremely tempting to see the tax free lump sum as an easy way of meeting your need for capital, but take a second look.

Make sure you consider all the possible options, could your savings be used to meet your capital requirements and allow your pension to provider a greater income?

In the current climate of relatively high inflation and historically low interest rates it is unlikely that your savings will be attracting an interest rate above inflation. Consider whether these should be used to meet your requirement for capital instead of the tax free lump sum.

Your savings may of course be insufficient to meet your capital needs, you may therefore have no alternative but to use some or all of your tax free lump sum.

If you need income consider all the options If income is a greater priority for you think about how best you can use your pension to maximise the income you will enjoy for the rest of your life.

Many people simply use 100% of their pension fund to buy an Annuity. If you are thinking of doing this then consider whether you would benefit from combining a traditional Lifetime Annuity with a Purchase Life Annuity.

A Purchase Life Annuity benefits from preferential tax treatment. HMRC deem part of the income to be a return of capital, it therefore does not attract tax. This can often mean that the net income of a Lifetime Annuity and Purchase Life Annuity combination is better than using your entire pension fund to buy a Lifetime Annuity.

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