Do not take tax-free cash out of your pension unless you have a clear plan for your hard-earned retirement savings.
That is the message being relentlessly hammered home by pension experts, who are worried people will harm their retirement finances if they withdraw cash based purely on speculation about a Budget raid that might never happen.
Currently, those over the age of 55 can take 25 per cent of their pension pot tax-free up to a £268,275 cap. There are concerns this could be slashed in the Budget and the Chancellor has refused to rule a move out.
Fears the Government will target tax-free cash on 26 November have prompted a rush of withdrawals, say pension firms.
Yet as many as one in three 60 to 78-year-olds have no idea what to do with their pension tax-free cash, according to a snap poll this month by investment platform Hargreaves Lansdown.
Around 17 per cent would put it in cash savings accounts or Isas, while 6 per cent would keep it in current accounts, where it can be eaten into by inflation or without providing any investment returns.
Current rules: Those over the age of 55 can take 25% of their pension pot tax-free up to a £268,275 cap. There are concerns this could be slashed in the Budget
Former Pensions Minister Steve Webb has weighed in to say he doubts Chancellor Rachel Reeves will dare to wreck people’s retirement plans by lowering the current cap, let alone abolish tax-free cash.
‘It would create uproar amongst those who were close to retirement and had planned their finances around having access to a tax-free lump sum,’ he says. ‘Most people would feel that a change like this was like ‘moving the goalposts’ and was fundamentally unfair.’
If Reeves does defy warnings to leave pensions alone, Webb believes transitional protections will be put in place. But there is no guarantee of that, so many who are eligible to take tax-free cash are wondering whether to take pre-emptive action.
We asked industry specialists to explain what they need to think about and how the process works.
Should you take tax-free cash?
Taking up to 25 per cent from your pension savings free of tax is a popular perk at retirement, and savers may use it to clear remaining mortgages and other debts, splash out on home renovations and new cars, or book a dream holiday.
With pensions due to be pulled into the inheritance tax net from April 2027, some are also pulling cash to give away early. If you give money away and survive seven years it typically falls outside of inheritance tax. Experts say savers must balance this carefully against damaging their own retirement through depleted funds.
For some people taking the cash could pay off, especially if they planned to do so anyway in the next year or so and want to spend the money for a specific purpose.
Getting shot of a mortgage is a common reason that makes financial sense. Fulfilling cherished goals like a special holiday is something you might never get another chance to do.
For others taking out a large sum could backfire, because tax-free withdrawals are irreversible and they may miss out on future investment growth by shifting funds out of their pension.
But deciding to hold off means banking on the rules not changing, which is also a risk.
Decide how to take your cash
Those with defined benefit work pension schemes have a commitment from their former employer to pay them a retirement income. They can take a 25 per cent tax-free lump sum but it will lower their future annual income. Their pension scheme will confirm the exact figures.
Turning a defined contribution work or personal pension into retirement income usually involves either buying an annuity, a financial product that provides an income for life, or remaining invested and making withdrawals to fund retirement.
You have three options open to you to get tax-free cash.
You can take the 25 per cent and use the remaining fund to buy an annuity; take 25 per cent tax-free cash and leave the rest invested in a process called drawdown; or leave the whole pension invested but each time you make a withdrawal 25 per cent is tax-free and the other 75 per cent is taxed.
You could also withdraw your entire pension, with the first 25 per cent tax-free and the rest taxed. But this could leave you with a large tax bill.
Clare Moffat, a tax and pensions expert at Royal London, says: ‘When you take tax free cash, something else must happen.
‘You can’t take tax free cash without moving the rest into drawdown, buying an annuity or taking a taxable amount alongside it. It’s important to plan what happens to the rest of the money as that could be the foundation of your retirement.’
You should also be aware that if you want to take multiple chunks that are 25 per cent tax-free and 75 per cent taxed, you lose this option if you tie up your entire pot in an annuity or income drawdown scheme.
These flexible pension withdrawals, known as uncrystallised funds pension lump sums, can ultimately boost the total amount of tax-free cash tyou receive. As it remains invested, your pension can continue to grow and so you are taking 25 per cent of a larger amount overall tax-free.
Angela Staral, chief operating officer at People’s Partnership, advises checking whether your pension has any valuable benefits before you cash in – for example, guaranteed annuity rates better than open market ones now.
‘Some older defined contribution schemes have valuable additional product features, which may be lost or limited by early withdrawals or transfers,’ she says.
If you have a final salary or career average defined benefit pension, which provides a guaranteed income after retirement for the rest of your life, then as soon as you take the tax-free lump sum your payments will start too.
The rules and process for taking tax-free cash are different in these schemes and are explained separately below.
How to take the cash
You can start the process by going online or phoning up your defined contribution work pension administrator, or your private self-invested personal pension (Sipp) provider.
Whether you do this over the phone, or via an online or paper form, you will have to provide a fair amount of information and go through various verification checks, including on your age. You need to be 55 to access your tax-free cash (this will go up to 57 from April 2028).
Ms Moffat at Royal London says: ‘Make sure you have any paperwork or your pensions app close by, as it will help if you have the pension policy number to hand. If you don’t understand a phrase or terminology, ask for an explanation. Pensions are complicated and most people need to ask for help.’
Some providers will make the process smoother than others.
Ms Staral, of People’s Partnership, says: ‘You will need your personal details, your pension account number, and your bank details. Be prepared to verify your identity – you may be asked for additional documents.’
Aviva told us that it will ask people about their reasons for making a tax-free cash withdrawal, to check they aren’t being scammed and that they are making an informed choice.
Before you finalise your decision, you should be informed about the free independent help available from the government-backed Pension Wise at moneyhelper.org.uk, where you can book a phone or in person appointment.
Even if you are sure of your intentions, it is a good idea to use this service. It will give you impartial guidance on your plans and can fill in gaps in your knowledge.
Your pension scheme will also probably flag up the benefits of paying for financial advice. This is worth considering because there are many important decisions to make when you start accessing pensions, a significant financial asset probably second in value only to your home. An adviser can help you avoid tax traps and other costly errors, and plan for inheritance.
Caution: Experts are worried people will harm their retirement finances if they withdraw cash based purely on speculation about a Rachel Reeves Budget raid that might never happen
Make sure you understand tax implications
If you have multiple pots, you do not have to take 25 per cent from all your pensions at once. You can separate out your withdrawals, in terms of timing and the approach you take.
Therefore, your scheme will ask questions about what tax-free cash you have already taken to ensure you won’t go over the lifetime lump sum allowance of £268,275.
If you have a large pension you might have ‘fixed protection’ enabling you to take more than this, which you will have to declare. This is a complicated area, so it is best to get financial advice.
Make sure you understand any tax questions you are asked and answer them precisely. HMRC could impose a tax charge if you give incorrect information. If you can’t afford financial advice, ask Pension Wise.
When you tap a defined contribution pension for any amount over and above your 25 per cent tax-free lump sum, that money becomes liable for income tax.
Also, taking taxable cash limits future pension contributions. You are then only able to put away £10,000 a year and qualify for valuable tax relief.
This new and permanent limit is known in industry jargon as the ‘money purchase annual allowance’ (MPAA).
It is intended to put people off recycling pension withdrawals back into their pots to benefit from tax relief twice.
Taking the final steps
If you don’t have cash available in your pension pot, taking a tax-free lump sum involves selling some pension investments.
You can let your scheme sell them in equal proportions from any funds you hold, or make an active decision about investments to cash in.
If you have a Sipp you should sell assets yourself to ensure you have enough cash available in your account.
When it comes to where your money is sent, your scheme may already have your bank details but check these sooner rather than later and leave time for verification.
When everything else is done, you will reach the settlement stage, which is when your scheme processes and releases your cash to you.
Ms Staral, of People’s Partnership, says: ‘If all required information is provided upfront, claims are typically completed within a couple of weeks. These times can vary, depending on the provider, and may be longer if further details are needed.
‘Delays often come from incorrect or outdated personal data – for example, if your name changed and you didn’t update your records.’
What about final salary pensions
If you have a defined contribution pension, usually known as a final salary or career average scheme, the tax-free lump sum is taken at the same time it starts to pay out. It is not available later on.
However, your options for a 25 per cent lump sum vary according to the generosity of the terms and conditions of your scheme, so you must check the details, including the minimum pension age.
You are allowed to take anything up to 25 per cent tax-free. But the bigger the lump sum you withdraw, the more future pension you sacrifice – and some schemes force you to forfeit more than others.
What you give up is down to the so-called ‘commutation factor’. For example, you might be offered £12 in the form of a lump sum for every one pound of future pension you give up. This is a commutation factor of 12:1. But some schemes will offer you £20 of lump sum for every pound of pension income you sacrifice. That would be a far better commutation factor of 20:1.
In some cases, there is only one offer, but in others you can choose different combinations of tax-free lump sum and pension income.
Steve Webb, a partner at Lane Clark & Peacock which runs such schemes, says: ‘When people get in touch with the administrators to say that they want to access their lump sum and pension they would typically be sent an ‘options’ pack.
‘We also give information about the right to transfer out the entire value of the defined benefit pension. If the scheme has paid for it, we would flag access to free or subsidised financial advice.’
