Conventional wisdom suggests that when we get to retirement, we consolidate our small pots into one big pot and then spend the money with the help of an adviser of an investment pathway.

Along the way , we take all the tax free cash we can, as pensions are taxable.

All “nice thinking” for the dashboardistas who envisage a single sight of our multi-pot retirement finances will enable us to combine and spend at the swipe of a screen.

Life and Pensions are of course not like that. Most people know by now that they can take a quarter of their pot as tax-free cash provided they are over 55; – a decision which they can take without regret. Many rich people will be doing this prior to the October budget because they fear a further cap on tax-free cash from the Chancellor’s budget. We get tax-free cash. But we don’t get much more than that.

A very respected pension actuary came into my office last week   to ask me the question again “will the Chancellor restrict my tax-free cash?” There’s a lot of paranoia about.

People with small pots do not fear a reduction in the £268k cap on their tax-free cash.  They  know that each of their pots guarantees them a quarter of their money back and many will be panicked between now and October to forestall the Chancellor’s  axe by taking money they don’t need into their bank account- before its time.

Such is the allure of the certainty of that money , such the signals of distress coming out of the Treasury, that a raid on pensions seems only too likely.

Image courtesy of Pete Matthews

Of course, people like me are supposed to be advising the people who read the Sun and Mirror and Money Mail pages to stay calm and only take cash as and when you need it. But my voice isn’t going to be listened to and anyway I’m not sure that this time the scaremongers may not be right.

If you are in a DC pension, taking the tax-free cash is not hard (provided you know who has your money). Get your policy or membership number to hand and get yourself a valuation of your pot. Most of us can get this online but you may need to phone up or in very old schemes, send an email or even request in writing.

You should get 25% of the valuation as tax free cash but be prepared to get more or less than that amount because the encashment of a quarter of your pot will probably on a future day of the week and the valuation may have changed between now and then. You can choose to stabilise your fund into cash but the same risk applies, the switch our of “units” or into cash is not under your control.

Nor is the price you get for your units , the price quoted on the day. That’s because units in DC funds are subject to a single swinging price. If more people are selling than buying, then that price may be set against you – to protect existing unit-holders (though there are those cynical enough to believe some pension companies are making money out of the single swinging price).

In any event, you are not in a position to moan about the price you get for 25% of your fund as you are subject to terms and conditions governing your money that somewhere in the dim and distant , you assented to.d

Of course the amount you get in your bank account could be more than quoted if the single swinging price worked in your favor. I’ve been trying to get to the bottom of how single swinging prices work and whether we collectively get fair value, it’s the kind of thing that trustees and IGCs should be monitoring (and the kind of thing that often gets overlooked).

But putting aside the fairness of the price you achieve, you should be able to get your tax free cash within a week of asking for it – provided that is that you are in a modern contract that does not need complex calculations on your valuation.

If however you are in an older contract – especially if it has with-profit guarantees or early exit penalties, then it may take longer to get your money. And if you are in one of the few remaining policies with guaranteed annuity rates or a guaranteed minimum pension or a protected tax free cash sum then you really need to be careful and speak with your provider of your adviser before taking your cash. It may come to you tax-free but it isn’t necessarily penalty free – you could be giving up more in pension than you can buy with cash.

Which brings me on to Defined Benefit pensions and their treatment of tax-free cash. Here the formular for calculating tax free cash is rarely 25% of the pot as there is no pot. What you get is usually based on a complicated formula involving your pension and the value of taking the cash depends on the amount of pension you give up in exchange for your cash.

It amazes me that more is not made about the trade-off between cash and pension as you are basically entering into exactly the same decision as those taking cash equivalent transfer values (other than the CETV is taxed and your cash isn’t). Unscrupulous schemes have been known to set the exchange rate (known as commutation factors) against savers so that the scheme (and ultimately the sponsoring employer) get more value from the transaction than is “fair value”.

I turned down my tax-free cash on that basis and I advise anyone who is taking their defined benefit scheme to speak to someone who knows about commutation factors which are fiendishly complicated. I have a cupboard full of retired actuaries who are always ready to help on this. In my experience financial advisers aren’t very clued up on fair value commutation factors and will do what I suggest and give you the names of a couple of actuaries who know their way around. You may have to pay for the opinion, but it is usually a price worth paying.

And  some lucky people, especially those in LGPS but also many in other DB schemes, are allowed to use certain kinds of AVCs to fund their tax-free cash which is almost always the right thing to do, as this takes out all the guess work on commutation factors and allows you to take your DC AVC pot as your tax-free cash,

In summary, most people can take tax-free cash quickly and simply and many will be checking procedures with their providers to make sure they can do so if they lose their nerve and choose to cash-out prior to the budget.

But if you have complicated old fashioned DC pensions or DB pensions, I advise you get in touch with your providers now, to make sure you have time to take your tax-free cash in good time.

What should I do?

Rachel Reeves already has form on taking impetuous and un-costed pension decisions, though the OBR will need to be involved in budget decisions

Okay – remember this – Liz Truss didn’t get the OBR to score her mini-Budget.

Fast forward.

“Rachel Reeves carried out “no impact assessment” before withdrawing winter fuel payments for 10 million pensioners”

“Department for Work and Pensions (DWP) said that: “A full impact…

— sandieshoes 🇬🇧🇺🇸 (@sandieshoes) August 23, 2024

So in this consider the old tag

‘Si vis pacem, para bellum’

“You want peace, prepare for war.

If you have your tax-free cash lined up for spending (for me it’s lined up to pay off my interest only mortgage) then you may feel pretty war-like if you have to pay tax on money you had considered out of the tax-man’s reach.

If you have no need for the cash and you are over 55, then my advice is to think long and hard about taking cash you don’t need and losing the amazing tax exemptions that allow you to buy a better pension later in life. Tax-free isn’t always worry free. If you are under 55 – there isn’t much you can do – so don’t worry!