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Retirees buy holidays with tax-free pension cash

One in three spends tax-free lump sum on a holiday

Eight out of 10 retirees with company and private pension funds are taking a lump-sum averaging £21,500 from their pension fund, according to new research from Prudential. However, up to a third are spending the cash on a holiday, putting their future pension income at risk.

The average tax-free lump-sum has fallen by 11% since 2008 when pensioners were taking £24,154, suggesting that the effects of the recession have hit pension funds and pay-outs.

However, the Prudential study shows that an increasing number are spending the money on luxuries and DIY – or even giving it away – potentially dramatically reducing the monthly income they get from their pension fund as a result.

More positively, many are using the tax-free cash to clear debts – 19% used part of the windfall to pay off some or all of their mortgage, while 17% used the money to clear credit cards or loans.

Most popular ways of spending pension tax-free cash lump sum
  2011 2008
Put it in savings for the future 52% 52%
Used it for home improvements 33% 31%
Went on holiday 31% 18%
Invested in stocks, shares or investment trusts 26% 24%
Bought a new car 19% 17%
Paid off all or some of the mortgage 19% 22%
Paid off credit card/unsecured loans 17% 17%
Gave some money to my children 15% 13%
Treated myself to things I’d always wanted 13% 14%
Gave some money to other relatives/dependents 4% 4%
Bought a second home/holiday home 3% 2%
Paid school fees for children/grandchildren 1% 1%

Prudential urges consumers to take financial advice

Vince Smith-Hughes of Prudential said: ‘The effects of the recession have made the majority of people in Britain more financially aware and cautious with their money. It’s understandable that people are keen to enjoy the money they’ve worked so hard to earn when they retire, but it is important to assess how this will impact on their long-term financial health before committing a significant part of their lump-sum.

‘A high proportion of pensioners are choosing to spend their lump-sum on luxuries, despite the fact that the cost of living is rapidly increasing, so we’re urging people to think carefully about how they are going to use this money and avoid making impulse purchases that may ultimately put them under financial strain. Consulting a financial adviser will help to determine the different options available.’

Consider paying off debt or buying a purchased life annuity

Which? principal researcher Martyn Saville commented: ‘It can be hugely tempting when you get your tax-free cash to blow it on the trip of a lifetime or some other big purchase. However, taking 25% out of your pension fund can make a real dent in your retirement income if it’s spent on non-essentials. Tax-free cash of 25% can be taken from the age of 55, potentially years before you retire. That’s 25% of your fund that won’t be attracting investment growth in those key years leading up to retirement.

‘That said, if you’re in a money-purchase pension scheme, it can often make sense to take the tax-free lump sum at retirement, even if you don’t need it immediately. If you use the cash to buy a standard annuity, chances are you’ll pay more tax on the income than you need to. Using your tax-free lump sum to buy a purchased life annuity, for example, can be more tax-efficient, or it may be wise to pay off existing debt such as a mortgage or credit card. Always take independent financial advice before making any decision.’

For more information about your pension options, read the Which? guide Planning your retirement.

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