Money Help Desk: Tough choices over pension lump sum

I AM retiring in August and I am currently considering options from my pension provider regarding the tax-free lump sum provision.

My pension payments will be index linked to RPI up to 5 per cent and I will be paying income tax at the standard rate.

The conventional wisdom is that it is normally more advantageous to take the full amount of tax-free lump sum. However, with current interest rates so low it will be hard to match the value of indexing that the pension payments will enjoy until, of course, interest rates recover to historic levels.

There is also the factor of future higher personal allowances to consider. On the other hand, the group pension fund like most others is under considerable pressure and presumably future indexing to RPI may become unaffordable. Do you think the conventional wisdom still holds?

WC, Galashiels

Tom McPhail, head of pensions research at Hargreaves Lansdown, writes:

There are several arguments in favour of taking the tax-free lump sum. The tax exemption means that a basic rate taxpayer would receive 20 per cent more from the lump sum than if they were to have the same amount paid as taxed pension income.

Having the lump sum means you have more flexibility in your finances and you might be in a position to recycle the money into ISAs – over two tax years a couple could shelter up to 40,800 in this way. You also spread risk because you are moving some of your retirement resources away from the pension scheme, thereby reducing the negative impact if something were to go wrong with the scheme. The money might also be available for bequest purposes, whereas the pension scheme income is inflexible in this regard.

It isn't simple though. The inflation proofing is attractive and is expensive to purchase elsewhere. The amount of income you have to give up to receive the lump sum is also sometimes calculated on terms which are ungenerous to the member; in other words, you can lose a lot of income for your lump sum. If you think your life expectancy is good, you are in good health and your family will live a long time, then this too could tip the argument towards the income rather than the lump sum.