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After years of saving, being able to take 25% of your retirement savings as tax-free cash often feels like one of the biggest pension perks, especially as you’re usually able to access this money from the age of 55 (rising to 57 in 2028).
But before rushing in to take out your tax-free cash, make sure you’re aware of the consequences and potential downsides of doing so. These include lost investment growth and a smaller retirement income.
Here, we explain how much you’re allowed to take, and why you need to think very carefully if you’re planning to take your 25% tax-free cash all at once.
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If you’re considering seeking professional financial advice on the options available to you, nationwide advice firm HUB Financial Solutions is offering you a free initial consultation with an expert retirement specialist. There’s no obligation; it’s to help you understand your options and how our services work. If you choose to receive paid-for regulated advice, we’ll explain how that works and the fees involved.
HUB Financial Solutions is rated ‘Excellent’ on Trustpilot (Mar 2026). With investing, your capital is at risk.
How much tax-free cash can I take from my pension?
Under current pension rules, you can usually take up to 25% of your pension tax-free from age 55 (rising to 57 from 2028).
For example, if your pension is worth £150,000, you could take £37,500 as tax-free cash. The remaining 75% stays in your pension, and any withdrawals from that portion are usually subject to income tax.
However, things become more complex if you have a larger pension. There’s a cap on how much tax-free cash you can take overall, known as the Lump Sum Allowance (LSA). For the 2026/27 tax year, this is £268,275.
This figure is based on 25% of the old Lifetime Allowance (which was £1,073,100 before it was abolished), and it effectively limits how much tax-free cash you can take across all your pensions combined. Find out more in our article How much tax-free cash can I take from my pension?
Imagine you have three pensions worth £250,000, £550,000, and £400,000, for a total of £1,200,000. Normally, 25% of this total (£300,000) could be taken tax-free.
However, the Lump Sum Allowance caps the total tax-free cash you can take at £268,275.
If you take 25% (£62,500) from the first pension at age 55, this reduces the remaining allowance. You would then have £205,775 (£268,275 minus £62,500) left to use across your other two pensions.
Without the Lump Sum Allowance, you could have taken £300,000 tax-free, but because of the cap, you’re limited to £268,275, a difference of £31,725.
Not all lump sums count towards your Lump Sum Allowance. Some smaller withdrawals are excluded. For example, taking a small pension pot of £10,000 or less as a lump sum, cashing in very small total pension savings (typically under £30,000), or certain payments when a pension scheme is winding up, may not use up your allowance. Learn more in our article Cashing in small pensions: what you need to know.
Philip Lewis, Head of Financial Planning Advice at Evelyn Partners, said: “Taking tax-free cash too early or without careful consideration might end up coming back to bite you tax-wise and could also undermine retirement plans.
“Simply taking a large amount of money out of a tax-protected environment and moving it into a taxable one can backfire even if the pension withdrawal itself is tax-free. Any interest, income or capital gains that the sum earns from then on could be subject to tax unless it falls within allowances or is placed in another tax-protected wrapper like an ISA.”
What are the pension cash tax-free traps I need to watch out for?
Before you take tax-free cash out of your pension, it’s important to understand the potential financial impact doing so can have, especially if you’re planning to take out a significant sum.
Here are five of the most common traps that could catch you out if you’re not careful.
Trap 1: Lost investment growth from withdrawing too early
Many people access their tax-free cash as soon as they can, which is currently usually the age of 55 (rising to 57 in 2028). This may be because they’ve got plans for this money, whether it’s to use it to pay off a mortgage, help their children onto the property ladder, or to allow them to start winding down by moving from full to part-time work.
However, one of the biggest drawbacks of taking your tax-free cash as soon as you’re able to is the loss of long-term investment growth. Money left in your pension remains invested in a tax-efficient environment, with the potential to grow over time. Once withdrawn, it no longer benefits from that compounding growth, which can have a significant impact over the long term.
According to Standard Life, someone who starts working at age 22 on a salary of £25,000 and pays minimum auto-enrolment contributions (5% employee, 3% employer) could build a pot of around £210,000 by age 68 if they leave their pension untouched, adjusted for inflation. However, if they took their 25% tax-free cash at 57 and spent it, their pot could fall to £168,000, a loss of around £42,000 due to missed investment growth.
This example assumes 3.5% salary growth per year and 5% annual investment growth, with figures adjusted for 2% inflation. An annual management charge of 0.75% is also factored in.
Mike Ambery, Retirement Savings Director at Standard Life, part of Phoenix Group, said:“Taking money out of your pension early can mean missing out on years of potential growth, and that can have a surprisingly large effect on your eventual retirement income. The power of compounding is often underestimated – even small decisions made years ahead of retirement could add up to tens of thousands of pounds over time.”
Trap 2: You’ll be hit by tax on the remaining 75%
Only 25% of your pension withdrawals are tax-free, with the remaining 75% being taxed as income. That means if you take large withdrawals from the taxable portion of your pension, you could end up pushing yourself into a higher income tax band and paying more tax than necessary.
Example: Taking £40,000 out of your pension
Imagine you want to take £40,000 out of your pension in one go and have no other income.
- The first 25% (£10,000) is tax-free
- The remaining £30,000 is taxable as income
You’ll also have your personal allowance (currently £12,570), which is tax-free. This means the remaining £17,430 is taxed at 20%
Total tax bill: £3,486
If you were to take the £40,000 more gradually say £20,000 over two tax years.
Each year:
- £5,000 is tax-free (25%)
- £15,000 is taxable
Of this £15,000, £12,570 is covered by your personal allowance, which means only £2,430 is taxed at 20%, leaving you with a tax bill of £486 each year.
Total tax bill over two years: £972
This example shows that spreading your total £40,000 withdrawal over two tax years rather than taking it all at once would save you £2,514 in tax. It therefore makes sense to consider phasing your withdrawals over multiple tax years to reduce your overall tax bill. Find out more in our article How much tax will I pay on pension withdrawals?
Trap 3: Triggering the Money Purchase Annual Allowance (MPAA)
There is a limit on the amount you can pay into a pension each year once you’ve started taking taxable income from it, known as the Money Purchase Annual Allowance (MPAA). Once triggered, your annual pension contribution limit drops significantly (from £60,000 to £10,000), which could affect your ability to keep building your pension.
You don’t trigger the MPAA by taking your 25% tax-free cash alone. However, it is triggered if you start taking taxable income through flexible drawdown. This is particularly important if you’re still working in your 50s or 60s and plan to continue contributing to your pension. You can learn more about the MPAA in our guide What is the Money Purchase Annual Allowance?
Trap 4: It might affect your benefits and allowances
Taking a tax-free lump sum from your pension can affect your entitlement to certain forms of financial support, such as means-tested benefits, council tax support, or help with care costs later in life.
This is because money held inside a pension is usually ignored for means-testing, but once you withdraw it, it becomes part of your savings, and therefore could reduce your entitlement to support.
For example, if you take a large lump sum and leave it sitting in a bank account, you could find that your savings exceed the thresholds at which you’re no longer eligible for support. This could reduce the amount you receive, or mean you no longer qualify at all.
The same principle can apply when local authorities assess your ability to contribute towards social care costs, where higher levels of savings may result in you having to fund more – or all – of your care yourself. Learn more in our article How lump sum payments and savings can affect your benefits?
Trap 5: Running out of money too soon
Taking a tax-free lump sum will reduce the size of your pension pot, which can leave less available to support you in later retirement years.
While this is straightforward mathematically, the bigger risk is often behavioural, and how people use the money once it has been withdrawn.
Without a clear plan, it’s easy to underestimate just how long retirement might last, particularly now that many people are spending 20 to 30 years or more out of the workforce. What might feel like a comfortable lump sum initially can shrink much faster than expected once you start tapping into it.
Inflation also needs to be considered. Rising living costs can steadily erode the value of savings over time, meaning your money may not stretch as far in later life. Taken together, these factors increase the risk of running short of money when you may have fewer options to rebuild income.
Maike Currie, Personal Finance spokesman at PensionBee, said: “With pensions set to become liable for inheritance tax from April 2027, more people may consider accessing larger sums earlier. This makes it even more important to think strategically about timing – remember that your pension needs to last for the duration of your life in retirement and unnecessary withdrawals will reduce the money available later.”
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If you’re considering seeking professional financial advice on the options available to you, nationwide advice firm HUB Financial Solutions is offering you a free initial consultation with an expert retirement specialist. There’s no obligation; it’s to help you understand your options and how our services work. If you choose to receive paid-for regulated advice, we’ll explain how that works and the fees involved.
HUB Financial Solutions is rated ‘Excellent’ on Trustpilot (Mar 2026). With investing, your capital is at risk.
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