If you are pondering investing a pension lump sum, you’ll want to know which type of pension you should choose and how to go ahead with the investment. If so, you’ll find this Moneyfarm blog a big help. In it, we discuss the various pension options open to you and the best way of proceeding.
| Can I invest a lump sum in a pension? | Yes, you can |
| Is it wise to invest a lump sum pension? | Yes. It generates higher returns, but it’s not a good ongoing pension strategy |
| What is the best way to invest in a lump sum pension in the UK? | SIPP or private pension, an ISA, and a general investment account |
| How many tax free pension lump sums can I take? | 25% of each lump sum payment is tax free |
Why investing a pension lump sum is a good idea
Investing a pension lump sum into a personal pension or SIPP is a good idea because your state pension alone is unlikely to provide a retirement income to cover the lifestyle you would wish for yourself in your latter years. Therefore, even if you have a workplace pension, supplementing it with your state pension and a personal pension or SIPP is still a good idea.
What is the best way to invest a pension lump sum?
You can choose from two types of pension when it comes down to where to invest a pension lump sum – a personal pension or a SIPP.
A personal pension plan is a pension you set up personally via a bank, building society or an insurance or unit trust provider. Your pension savings will provide you with a regular source of income when you retire. The type of people who might set up a personal pension include:
- Self-employed people with no access to a workplace pension scheme
- Anyone who is employed but can’t afford to pay into a pension scheme
- People who want to save more for their retirement
If you will be investing a pension lump sum once only, or now and again, when your circumstances permit, a stakeholder pension is another consideration.
A further option when it comes to where to invest a retirement lump sum is a SIPP. This type of scheme also accepts a single lump sum payment, irregular smaller sums of money or regular inward payments.
Personal pensions (including stakeholder pensions) and SIPPs are excellent options for a self-employed pension.
How much do you need for your retirement?
You want to spend your retirement years without worrying about your financial situation, so you will probably ask yourself how much do I need for retirement.
According to retirementlivingstandards, depending on what sort of retirement lifestyle you would like, you will need the following:
- £10,900 per annum for a minimum standard lifestyle
- £20,800 per annum for a moderate standard lifestyle
- £30,600 per annum for a comfortable standard lifestyle
The above figures are after net, as income tax has been deducted. Please check the website mentioned earlier for a detailed breakdown of the statistics above.
Which is best – invest a lump sum or invest over time
Investing a lump sum early rather than investing smaller sums over time may be the best option. The reason is that investing your pension lump sum earlier means it sits there longer and allows compound interest to get to work.
The longer the duration, the more interest will be earned. Because the interest is compounded (earning interest on interest), it can significantly impact your pension pot.
But before you go ahead with investing a pension lump sum, it’s essential to review your financial circumstances with care. Clear as many debts as possible and establish your short-term and long-term financial needs.
If you invest a lump sum into a pension and later find yourself in a difficult financial situation, you might find yourself up the creek without a paddle. Remember, you can’t access money tucked away in a personal pension or SIPP until you’re 55.
The pension 25% tax-free withdrawal rule
Once you reach the age of 55, you can access your pension fund in its entirety or in smaller lump sums. If you want to continue working, you are entitled to do so, and it won’t impact the amount of income tax you pay as long as the money you take from your pension doesn’t exceed 25% of the pot.
The decision is up to you but taking more than 25% of your pension pot will cost you dearly in terms of income tax.
The 25% tax-free lump sum rule relates to any personal pension. It does not relate to your state pension, which is usually paid monthly and contributes towards your taxable income.
Retiring at 55
If you’re keen to know how to retire at 55, you must work out your investor profile and figure out the right investment strategy to help you reach your financial goals.
Investing a lump sum for retirement money via a pension isn’t your only option. There are other ways, such as investing in a stocks and shares ISA. However, asking yourself, ‘where should I invest my pension lump sum’ can make your choice a little more complicated.
Taking full advantage of tax relief
If you are considering how to invest £10,000, either putting it into an ISA or a pension works equally well, either way. However, if you are lucky enough to be considering how to invest £100,000, the more considerable sum makes it a little more complicated. This is because you have to choose the best investment for your large retirement lump sum if you want to optimise the tax rule allowances.
The best thing about the stocks and shares ISA vehicle is that any gains your investment makes are free from capital gains tax. Not only that, but even more importantly, all your withdrawals are free from income tax. It means your funds will stretch much further in your retirement years.
The problem, though, when talking about the best investment for a pension lump sum of £100,000, is that your ISA allowance is only £20,000 per tax year. So, perhaps the best way to invest your retirement lump sum is to diversify.
As well as your annual ISA allowance, you also have an annual pension contribution allowance whereby you can contribute up to £40,000 per annum. So, if you take advantage of both your ISA and pension allowances, you could invest up to £60,000 in contributions and get tax relief on the entire sum.
The £40,000 you would be left with from your £100,000 could then be put into a general investment account, which has no annual contributions limits.
Retirement saving in your 50s
The earlier you start saving for your preferred retirement age, the better. Nonetheless, there is nothing wrong with investing a lump sum for income at any time, even in your 50s.
When it comes to your 50s retirement savings, it is a good time to review all the pensions you have (many people may have several workplace pensions) and think about carrying out a pension transfer exercise to make things more manageable.
If you don’t want the hassle of doing it all yourself, you can get pension transfer help from a financial adviser.
Should you use your pot to buy an annuity?
If your pension investment performed well, you may decide to use all or some of the money from it to purchase an annuity. Whether or not you do so is a personal choice that people make according to their circumstances and outlook.
You might prefer to play safe, in which case an annuity could be your best choice. On the other hand, if you are sitting pretty financially, investing your 20% tax-free pension lump sum into another investment vehicle to combat inflation and make your money work hard for you might be more appealing.
Whatever you decide to do with retirement savings, we urge you to take care. Unfortunately, there are multiple pension scams around, so to make sure you stay caught up. Also, please ensure that any company you’re considering talking to is FCA approved and registered.
FAQ
Should I invest a lump sum in my pension?
Investing a lump sum into your pension will help you achieve your retirement goals faster. Also, investing in a pension lump sum early gives you more time to grow your money, which could increase the total value of your pension pot. Also, your money has the potential to generate higher returns, and compound interest is also a benefit.
Is investing in a pension lump sum the right option for me?
Ultimately, the ideal option for you depends on your financial circumstance. You should always choose whichever option works best for you financially. If you can combine investing in a pension lump sum with regular pension contributions, go ahead and do so. What matters is trying out different investment strategies and seeing which ones actually work for you. Either way, you’ll give yourself the best chance at building a bigger retirement fund.
What is the disadvantage of investing in a lump sum into a pension?
You eliminate pound cost averaging when you invest a lump sum into a pension fund. Investing a large sum exposes you to risk, which can impact your investing if there is a significant drop in the stock market.
Pound cost averaging reduces your risk and its impact on your investment. However, the returns are not as great as a lump sum pension investment.
*As with all investing, financial instruments involve inherent risks, including loss of capital, market fluctuations and liquidity risk. Past performance is no guarantee of future results. It is important to consider your risk tolerance and investment objectives before proceeding.
