You can exchange part of your annual pension for a one-off tax-free cash lump sum. You can take up to 25% of the overall capital value of your pension benefits as a lump sum and you will receive £12 of lump sum for each £1 of pension you give up. The overall capital value of your pension benefits is calculated as:
Capital value of pension benefits = (Pension x 20) + lump sum + value of AVC fund (if any)
The total lump sum cannot exceed £268,275 (2022/23) less the value of any other pension rights you have in payment. Details of the maximum tax-free lump sum that you can take will be provided to you shortly before retirement and you can then choose how much lump sum you wish to take.
Mary has an annual pension of £6,706.92 and a lump sum of £7,425. If she decides to give up £1,000 annual pension for an additional cash lump sum, then the reduced annual pension is:
£6,706.92 less £1,000 = £5,706.92
And she will get an additional tax-free lump sum of:
£1,000 x 12 = £12,000
Her total tax-free lump sum will now be –
£12,000 + £7,425 = £19,425
In the current climate of long life expectancies and low interest rates, members are reminded that the cash lump sum may not be enough to replace the pension given up. If you are considering this option, you are strongly recommended to contact an Independent Financial Adviser for advice.