A worrying number of people are withdrawing large lump sums from their pensions, potentially making a massive tax error in the process.
At the top end, 292 people fully cashed in a pension of over £250,000 after tax-free cash between October 2023 and March 2024, paying a minimum of £98,700 in tax.
Mike Ambery, retirement savings director at Standard Life, says: “It’s impossible to know whether their individual circumstances warranted them taking such a big tax hit, but for the vast majority of people it’s something they’ll want to avoid.”
“My guess is a lot of those 292 were unadvised,” says Kate Shaw, a chartered financial planner at Financial Life Planning. “Most people think you can just cash in a pension and don’t realise there will be emergency tax.”
In most cases, schemes paying out a single or ad hoc withdrawal will use an emergency tax code, referred to as a month 1 basis, meaning that when their payout is calculated, any money received and any tax deducted previously within the current financial year is not considered. For the 2025/26 tax year, this will give a tax-free amount of £1,048 and the rest of the payment will be taxable. Though you may later be able to claim a refund, it’s still likely to be a shock.
And there’s another warning: taking your full pension pot in one go will swell your estate, says Charlotte Ransom, chief executive officer of Netwealth, making it immediately liable for inheritance tax as well as tax on any investment returns and interest.
Since 2015, when the rules changed to allow people aged 55 and over to draw as much of their pension as they like, providers have reported some people feeling the need to “make a pension theirs” by drawing the money out to put it “safely” in the bank — either reflecting a lack of trust in pensions, or a desire for easier access. But the recent change in government and the pension rules has made the urge to cash in stronger, even for those who know the tax consequences.
Andrew King, retirement planning specialist at Evelyn Partners, says: “Before the election, we had a lady with £400,000 in her pension who thought Labour would ‘steal her money’ and wanted to take it all out. In the end, we had to disengage with her.”
There are more credible reasons to cash in. From April 2027, pensions will come under the scope of inheritance tax, so more people are looking to draw the money out and offer it as a gift or spend it. If you die after the rules change with a massive pension to hand down, then it could be taxed twice — at 40 per cent for inheritance, followed, if death occurs after age 75, by income tax for those receiving it. The total tax rate may be even higher than what those 292 people paid.
Therefore, you need to think about how you eke out your pension while paying the lowest amount of tax.
One tip is to look at the whole family’s tax position before carrying out an aggressive draw down. “You don’t want one person to have all the income and pay all the tax,” says Shaw.
Moving rental properties to a lower-earning spouse could be a good idea to use up tax allowances. While, if you’re married or in a civil partnership, Ransom says blending withdrawals from both pensions can help you keep more of your combined wealth, by using both personal allowances.
Spreading pension withdrawals over multiple tax years can help retirees stay within lower tax bands, which remain frozen until 2028.
James Baxter, founder of Tideway Wealth, calculates you would have to draw 12-13 per cent of your pension each year, starting at age 75 with the aim to exhaust it by 85.
He recommends people with a large pension of say £1.8mn keep withdrawals to £100,000 per year for most years and then every few years take a big withdrawal, to avoid regularly incurring the effective 60 per cent tax band. This drops the income tax paid overall compared with taking smoother withdrawals.
Nevertheless, you need to be careful about how you access your pension cash and income.
Jon Greer, head of retirement policy at Quilter, says: “Flexi-access drawdown can be a powerful tool, enabling you to withdraw funds gradually while keeping your pension invested.”
However, don’t mistake flexi-access, where non-tax-free funds remain invested, with UFPLS (which stands for uncrystallised fund pension lump sum), where the 75 per cent non-tax-free cash is released and taxable.
Also, consider using your 25 per cent tax-free cash strategically.
King gives the example of someone aged 61 — and therefore not receiving the state pension — who has a pension fund of £600,000. If they took a total one-off withdrawal of the pension, they would get £150,000 tax free and then pay £183,000 in tax on the balance, netting only £416,000.
But if they could gradually take their 25 per cent tax free cash of £150,000, by drip feeding it out at the rate of £25,000 a year, then, providing their income from other sources remained below the annual personal allowance (currently £12,570), they would have no tax to pay.
However, only some pension providers allow you to take tax free cash in tranches, so make sure your provider can facilitate this option. And don’t forget, the total amount you can normally take tax-free across all your pension pots is now £268,275, unless you have specific protections in place.
