In the lead up to the government’s Autumn Budget, many are anticipating what changes will be introduced to pensions. As speculation mounts, some providers have reported an increase in the number of over 55s taking the tax-free cash from their pension pots. This highlights a concern that consumers won’t be given enough time to respond to any changes made.
But dipping into your pension shouldn’t be a knee-jerk reaction made in response to political rumours. Many experts have cautioned against panic - particularly because taking your tax-free cash isn’t reversible. Once you choose to withdraw the tax-free cash from your pension, the tax consequences are triggered and you can’t cancel and return the money.
Taking your tax-free lump sum is a big decision, which needs to be balanced against keeping savings invested for as long as possible to provide an income that stretches across the whole of retirement. So it’s worth planning carefully when and how you plan to take your tax-free cash. Used wisely, it can strengthen your retirement finances in the longer-run.
Chief Business Officer UK at PensionBee, Lisa Picardo says: “When savers are left unsure about future rules - they may be tempted to make hasty decisions that can undermine their longer-term retirement security. Pensions are designed to provide a sufficient retirement income throughout later life. Withdrawing money early based on speculation removes that chance to stay invested, ultimately leaving people with less money in their pension later down the track.”
What’s the tax-free lump sum?
Once you turn 55 (rising to 57 from 2028) you can usually take up to 25% from your pension tax-free, up to a maximum of £268,275. This known as the lump sum allowance (*LSA) and applies to all your pensions. The rest of your pension will be subject to Income Tax when you access it.
For example, if you have a pension pot worth £400,000 you could access £100,000 tax-free. But you don’t need to take it all at once - you can withdraw it gradually.
Before making any withdrawals from your pension, it’s worth checking the impact it will have on your long-term retirement plan. PensionBee’s Pension Calculator can show you how taking your tax-free cash now could affect your future income.
Being able to take your tax-free lump sum from your late-50s onwards can provide an opportunity to use that money sensibly to prepare finances for life in retirement.
*You could have a higher LSA if you applied for protection. You can check at GOV.UK.
Here are three ways you could use your tax-free lump sum.
1. Use your lump sum to cut your debt
As you approach retirement, your monthly outgoings matter more than ever. The more you can reduce those expenses, the further your pension will stretch. Using your tax-free lump sum to clear expensive debts will free up more of your pension to cover living expenses once you retire.
This could mean making a final push to pay off your mortgage with overpayments, or clearing credit cards, car financing, overdrafts or personal loans. If your repayments would otherwise stretch into retirement, becoming debt-free could give you both peace of mind and extra flexibility.
2. Top up your income with your lump sum
Another use for your pension tax-free lump sum could be to supplement your income. You don’t have to take your full tax-free amount at once, you can take chunks of it regularly.
This can help bridge the gap if you want to stop working before you reach State Pension age, or ease the transition into part-time work or a phased retirement.
It can also help with tax planning. You could choose to take your tax-free money as an income until your earnings drop into the basic rate band and then access the taxable part of your pension.
Keeping more of your tax-free allowance invested gives it time to grow, boosting your future retirement income.
3. Leave your lump sum in your pension
Just because you can access your pension’s tax-free lump sum from 55 (rising to 57 from 2028) doesn’t mean you have to. By delaying taking it, it remains invested and has the potential to benefit from investment growth. That means you’ll have a larger pot to draw on in retirement, giving you a more comfortable income.
For example, imagine you’re 55 with a £200,000 pension pot. If you took your £50,000 tax-free lump sum and retired at 67 you could have a *£16,700 annual pension income that would last until you were 87.
But if you left your £50,000 invested at 67, you’d be able to take *£20,500 a year as retirement income and your pot would still last until you were 87.
Leaving your tax-free lump sum invested also means you won’t be tempted to spend the cash once it is in your bank account. Unless you have a clear use for it - such as clearing debts or to supplement your income - keeping your pension invested could be the most rewarding decision.
You can use PensionBee’s Pension Calculator to see how leaving your own lump sum invested could change your future income.
*Calculations are from PensionBee’s Pension Calculator and assume:
contributions of £600 per month from 55 until 67 years of age;
5% investment growth per year;
2.5% inflation per year; and
one annual management fee of 0.70%.*
The bottom line
It can be tempting to get your hands on your hard-earned, long-saved money. But used with care, your tax-free lump sum can make a significant difference to your lifestyle in retirement.
Try to avoid making pension choices based on rumours and fear. Plan carefully, using tools and calculators to help you see how different decisions could impact your retirement income.
There’s no one size fits all when it comes to taking your pension. The most important thing is that you make a considered decision based on your age, stage and circumstances and that you consider both the near-term and the longer-term picture. If you aren’t sure, consider seeking guidance or professional advice from a qualified Independent Financial Adviser (IFA).You can find one using the Financial Conduct Authority’s (FCA) register, Unbiased or MoneyHelper.
Ruth Jackson-Kirby is a Financial Journalist passionate about making money matters clear and accessible. She’s written for The Mail on Sunday, MoneyWeek, The Sun, and Good Housekeeping, helping readers navigate pensions and personal finance with confidence. She believes everyone deserves financial security and is on a mission to cut through jargon and make finance relatable.
Risk warning
As always with investments, your capital is at risk. The value of your investment can go down as well as up, and you may get back less than you invest. This information should not be regarded as financial advice.
