Investing your pension lump sum

Chancellor George Osbourne’s pension reforms in 2014 opened-up the pensions market and enabled people to take much more control of their future income than before. Since 2015, retirees have had the freedom to invest their pension pots in assets that suit their requirements. 

Before 2015, withdrawals were largely nominal and only available to people with small pension pots. Now the value of the entire pension can be withdrawn, although 75% of it will be taxable. The first 25% withdrawal is tax free though, and some people may choose to take a lump sum and make their own investments to select the best assets for their circumstances.

Obviously, the risk profile of a retiree will be vastly different to someone younger who is just starting on their investment journey. Diversifying any investments to spread the risk is key to protecting decades of hard-earned pension value. This is especially true today, when the outlook for the global and local economy remains very uncertain. A balanced basket could include assets like equities, property, bonds, cash and alternative assets like gold, which hedge against the inherent risk of the other assets in a pension investment portfolio.

Investing in Equities

The COVID-19 pandemic has been devastating for some pension investments, especially ones with substantial share exposure. The average pension plan fund value fell by 15% in the first quarter of 2020 according to the Moneyfacts UK Personal Pension Trends Treasury Report. While there has been a slight recovery in the stock market, those who plan to retire soon will still be feeling the effects of the slump.

Conversely, the decline in stock values has also created opportunities for people looking to invest their pension lump sum today. Money invested in equities now are starting in a lower market. While it’s still a volatile and uncertain time for companies, prudent investments can be had for less than they could six months ago. Selecting stocks individually or entrusting them to an index or investment fund would be a good start in building a diversified portfolio.

Pension Property Investments

The residential property market was in limbo for several months during the UK’s national lockdown when almost all transactions were paused and many were abandoned altogether. Since the easing of restrictions, the market has seen a healthy bounce back when forced sellers and buyers rushed ahead to complete their sales.

The economy is still depressed, and as more and more jobs are cut, the long-term outlook for property is not clear, however, property has been a largely stable growth asset for many years. Retirees investing in property and looking to generate an income from buy-to-let, or solidify their own housing situation, should consider investing if it suits their requirements. It’s worth remembering that retirees who don’t have the wherewithal to manage a buy-to-let property will need to factor a management company into their costs and rental income.

Investing in Premium Bonds.

Premium bonds are a government savings tool that work on an ‘interest lottery’ basis, which means each bond is entered into a monthly lottery draw. If you don’t ‘win a prize,’ your investment is safe but it doesn’t grow, however, the more you invest in buying premium bonds, the more  you increase your chances of winning and earning a return. In addition, the winnings are tax free which can be a significant boon for people who have already used their tax-free personal savings allowance. You can invest up to £50,000 in premium bonds and the prizes range from £25 to £1 million monthly.

Investing in ISA’s

Interest earned in an individual savings account (ISA) is tax free. Adults can invest up to £20,000 per year in either a cash or stocks and shares ISA, or a combination of both. You can choose to manage your investments within the ISA or select one that is managed based on your risk profile and preferences (these will incur management fees).

ISAs have become one of the most popular savings vehicles since their introduction two decades ago. ISAs are essentially taxed on the way in (because tax has already been paid on income), whereas pensions for the most part are taxed on the way out (because pension savings are not taxed until they are drawn as income), however, putting the 25% tax-free pension lump sum into an ISA is tax-free at both ends. 

Investing in Physical Gold

Gold is classed as an alternative investment, alongside items that appreciate over time like antiques, art, collectibles and fine wines. The benefit of gold is that it has thousands of years of historical value preservation behind it. Even as the price has fluctuated, gold has retained its value through many crises.

As a safe-haven asset, it usually increases as other asset classes fall. While it may not pay out a dividend or interest, its inverse relationship to other assets means it is used as a hedge against uncertainty and risk. This makes it particularly useful for retirees who are looking to remove as much risk as possible from the investments they make with their pension lump sum. Since the start of the COVID-19 crisis, the value of gold has increased by almost 27% as uncertainty has fuelled demand for the precious metal.

Certain types of gold have the added benefit of being tax free. The VAT was removed from investment grade gold in 2000, and gold coins like gold Britannia’s and gold Sovereigns are capital gains tax free because they are legal tender; this means a tax-free pension lump sum can remain out of reach of HMRC when invested in gold.

Like all other investments, gold should form only part of a portfolio, with the balance of risk tailored to suit each circumstance and person.

When can I invest my pension lump sum?

You can take up to 25% tax-free from a defined contribution pension from the age of 55. You can also get a lump sum from a defined benefit pension scheme, although it is more complex and dependent on various factors. There is a huge (55%) tax penalty for taking the money out of your pension before you turn 55.

If you choose to take the tax free lump sum, the remainder can stay in the pension pot, accruing interest or dividends and growing while retirees draw down on it over time.

Annuities are also still a viable option for people who want a guaranteed income for their lifetime, but there is now a much wider range of options that cater for different requirements. If a lump sum is not required, retirees can take a series of withdrawals over time, a quarter of each will be tax-free. However you choose to manage your pension pot, risks need to be balanced and all your golden eggs shouldn’t go in one basket.