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The Autumn Budget is just around the corner, triggering fears once again that tax-free pension cash could be in the firing line in the Chancellor’s hunt for savings.
Given the black hole in public finances, many pension savers are worried that the Chancellor could restrict their ability to take 25% of their retirement savings tax-free. However, it’s worth noting that there were similar predictions prior to last year’s Autumn Statement, yet no changes to tax-free cash were announced.
Elsa Littlewood, private client services tax partner at BDO said: “In the lead-up to the Budget, we are likely to see continued speculation around individuals’ pension tax-free cash entitlements. However, given the uproar caused by Rachel Reeves announcing a capping of pension salary sacrifice arrangements from 2029, we believe that any major changes to pensions at Budget 2026 are an outside chance.
“In our view, a reversal of the announced changes to salary sacrifice arrangement would be very welcome as it would help restore confidence in pensions saving at a time when we know that people aren’t putting enough away for their retirement.”
You can read more about proposed changes to salary sacrifice in our guide What could changes to salary sacrifice mean for your pension?
Here, we look at some of the pros and cons of taking your tax-free cash now, and why, if you’re considering doing so, you should make sure you have a clear plan for this money.
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What are current tax-free cash rules?
Under current rules, those with defined contribution pension schemes can usually take a 25% tax-free lump sum out of their pensions once they reach the age of 55, rising to 57 by 2028. However, different pension schemes can have different rules, so you’ll need to check with your provider to see at what age you can start taking retirement benefits from your pension. Find out more in our article Should I take a tax-free lump sum from my pension?
You can currently take a maximum pension tax-free cash lump sum of £268,275 out of your pension, which is equivalent to 25% of the old Lifetime Allowance. This is known as your Lump Sum Allowance (LSA). Find out more in our article How much tax-free cash can I take from my pension?
After you’ve withdrawn any tax-free cash the remainder of your pension may, for example, be moved into a drawdown plan, used to buy an annuity or taken as cash. Any withdrawals beyond your 25% tax-free cash will be subject to income tax at your marginal rate. Read more about this in our article What are your pension options at retirement?
You don’t have to take the full 25% at once if you don’t want to. For example, you can take smaller regular amounts from your pension if you prefer, and opt for 25% of each of these payments to be tax-free. So, for example, if you had a bigger pension pot and were to take £2,000 from it each month, £500 of this would be tax-free whilst the remaining £1,500 would be taxable. Find out more in our guide How much tax will I pay on pension withdrawals?
Will Labour scrap the 25% tax-free lump sum?
No one knows for certain what will be unveiled in the Autumn Budget, or whether the 25% tax-free lump sum will be abolished, but one thing that is guaranteed is that such a move would prove extremely unpopular with pension savers.
The new Chancellor John Healey is likely to consider fully scrapping the tax-free lump sum a step too far, although some claim there could be a chance that the government might look at reducing the maximum tax-free lump sum you can take, perhaps to £200,000, £150,000 or even £100,000.
However, Rob Morgan, Chief Investment Analyst at Charles Stanley Direct, part of Raymond James, said that savers should be wary about acting on speculation. “The sensible approach is to wait for announcements, understand the details and assess how any changes affect your personal circumstances,” he said. “Tax policy is rarely as simple as the initial headlines suggest, and the finer points often determine which, if any, course of action is beneficial for you.
“So, when the Budget rumour mill starts cranking into gear, it is worth remembering that “could happen” and “will happen” are very different things. Acting too soon can create unnecessary mistakes, while taking the time to make decisions based on confirmed information usually comes with little downside.
“In the meantime, for financial planning it’s business as usual. Try to use tax-efficient allowances – notably ISAs and pensions – as far as possible to shelter more of your assets and returns from tax.”
Things to consider before taking your tax-free cash
Whenever you are planning to take a 25% tax-free lump sum from your pension, this shouldn’t be entered into lightly, and there are several things you’ll need to consider before you act.
1. What will you do with the money?
There’s little point in taking your 25% tax-free lump sum out of your pension just for it to sit in a savings account, as over long-term periods cash savings are likely to be eroded by inflation. If you invest this money outside your pension, you may have to pay Capital Gains Tax (CGT) on investment growth and tax on dividend income. It’s therefore a good idea to have a clear plan as to what you’ll do with it, whether that’s using it to pay down your mortgage or to cover everyday living expenses. Find out more about options for your tax-free cash in our article What’s the best way to use my 25% pension tax-free cash?
Bear in mind that there are rules which prevent you taking your 25% tax-free lump sum cash and paying it into another pension – if you do this there could be both tax consequences and extra charges to pay.
2. Think about inheritance tax (if it applies to you)
It’s worth remembering that, at the moment, pensions can be passed on free of Inheritance Tax (IHT), and are completely tax-free if you die before age 75. If you die after the age of 75, your pension will be taxed in the same way as income when your beneficiary (or beneficiaries) come to make a withdrawal. If you take money out of a pension, however, including your 25% tax-free lump sum, it will count towards your estate for IHT purposes.
These rules are changing in April 2027, when pensions will be brought into the scope of inheritance tax for the first time. You can find out more about these changes in our articles Inheritance tax and pensions: what’s changing in 2027 and 5 ways to beat pension Inheritance Tax Budget changes.
3. It might affect any benefits you’re claiming
Your pension income will be taken into consideration when you’re assessed for means-tested benefits such as tax credits, Universal Credit and housing benefit, so think carefully about the impact that taking a lump sum could have on these and find out whether it will reduce your entitlement. Only savings worth £6,000 (£10,000 if you are over State Pension age) or less will not affect your claim for means-tested benefits. Find out more in our article How lump sum payments and savings can affect your benefits.
4. Consider the benefits of leaving your tax-free lump sum in your pension
If you’re thinking about taking your tax-free cash, remember that there are (for now at least) several advantages of leaving it in your pension for as long as possible. Importantly, any growth your fund enjoys within a pension will be completely tax-free, and if you don’t take your tax-free entitlement straight away, this will grow too.
Of course, investment returns aren’t guaranteed, so you’ll need to be comfortable accepting that there’s a level of risk involved. The other benefit of leaving your tax-free cash for now is that your pension fund will have a greater chance of supporting you throughout retirement. Given that many of us will spend several decades in retirement, taking out 25% of your pension early on and spending it could mean you run out of money too soon in retirement.
A final thought…
If you have a specific plan in mind for your pension tax-free cash, and changes to the amount you could take could derail these plans, then you may decide that taking your 25% lump sum is worth doing ahead of the Budget, just in case any radical changes are announced.
However, if you don’t have a particular need for the money, you’ll need to weigh up carefully whether you think it’s worth taking it out now, or whether you might be better off leaving where it is so you can benefit from the tax advantages pensions provide, and hopefully end up with a higher income later in life.
This area of pension planning can be complex and will almost always depend on your own personal circumstances, so it’s worth speaking to a professional financial advisor who can help you navigate this.
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If you’re considering seeking professional financial advice on the options available to you, we’ve partnered with nationwide Chartered independent advice firm Fidelius to offer Rest Less members a free initial consultation with a qualified financial adviser. There’s no obligation, however if the adviser feels you’d benefit from paid financial advice, they’ll talk you through how that works and the charges involved.
Fidelius are rated 4.7 out of 5 from over 2,600 reviews on VouchedFor, the review site for financial advisers.
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