How does Rest Less make money
We make money through advertising and commission from affiliate links, which enable us to offer Rest Less as a free service to our users. The content on this page may use affiliate links, which track traffic from our website to a third party provider and enable us to receive a commission or payment from any traffic we refer.
* Affiliate links on this page have an * next to them. We place enormous importance on our editorial independence and the integrity of our content which means that we will never change how we write about something as a result of an affiliate link.
With less than a month to go before the Budget on October 28, there is speculation as to whether there might be changes to the 25% tax-free lump sum available to most savers when accessing their pension.
Last year saw a surge in people wanting to withdraw tax-free cash ahead of the budget, despite the fact that doing so has significant long-term financial consequences.
According to analysis by wealth management company Evelyn Partners, between April 2024 and March 2026, around £40.38 billion was withdrawn in tax-free cash lump sums, a 109% increase compared to the £19.30 billion withdrawn from April 2022 to March 2024. The number of pots where only tax-free cash was taken increased 60.8% over the same period, compared to a 23.8% increase in the overall number of pots accessed for the first time.
Here, we look at some of the issues that could arise from taking a big chunk out of your pension now, as well as why the Chancellor might well decide that changing tax-free cash rules will cause more problems than it is likely to solve.
Advertisement
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.
How much tax-free cash can you take from your pension?
Under current rules, you can usually take up to 25% of your defined contribution pension as a tax-free lump sum once you reach the age of 55 (rising to 57 in 2028). The maximum tax-free lump sum you can take is £268,275. This cap is based on the old Lifetime Allowance of £1,073,100 — so only those with pots this size or larger can currently take the full £268,275.
If your pension is smaller than that, you can still take 25% of it tax-free, and this wouldn’t change unless the government reduced the maximum tax-free amount.
Once you’ve taken your 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 in our article Your pension options at retirement.
You can spend your tax-free pension cash on whatever you want, with some people choosing to use the money to pay off a mortgage or clear other debts, or to give some of their savings to loved ones.
However, if you don’t have a good reason to withdraw your pension tax-free cash, think carefully about whether you may be better off leaving your retirement savings to grow tax-free for longer. Find out more in our article Should I take a tax-free lump sum from my pension?
Downsides of acting on speculation
If you take money out of your pension without any clear plan for it, there’s a real risk it comes out of a tax-efficient environment, misses out on investment growth, and is eroded by tax and inflation. There’s also the possibility that you could end up running out of money in retirement if you spend too much of your savings too soon.
Andrew King, retirement specialist at wealth management firm Evelyn Partners, said: “Unplanned or ill-conceived pension withdrawals can be subject to big tax charges, can remove funds from an advantageous tax and investment environment, and could reduce your future standard of living in retirement, especially if they involve selling investments amid a market downturn.
“However, with the possible double-taxation of a pension pot inherited from someone aged 75 or older from April 2027 – as the beneficiary could also pay income tax at their marginal rate as they withdraw cash – it must be recognised that a major incentive will exist among some savers to spend down or to gift their pension pots. And it can certainly make sense for many of this age to take their tax-free cash, as this benefit would disappear at death and would not be available to the beneficiary.
“So at the very least do a lot of research but ideally seek professional advice, especially if you are dealing with a large pot of savings or a variety of different schemes.”
Beware pension recycling rules
If you are considering taking your tax-free cash due to Budget speculation, don’t assume you’ll then be able to pay it back into your pension if no changes to pensions are announced.
HMRC has tightened up its guidance in recent years, so if you do decide to take your tax-free cash lump sum, you won’t be able to reverse that decision if no changes are announced.
There are specific pension recycling rules in place which aim to prevent savers from doing this, so that they don’t receive tax relief twice. Rachel Vahey from AJ Bell said: “In broad terms, this means that where someone has taken their tax-free cash, their contributions cannot increase significantly above what they would normally have been, either before they take the lump sum or after. On top of this, the person must not have intentionally withdrawn the money with the aim of recycling their tax-free lump sum.”
If you fall foul of these rules, you risk being hit with a hefty tax bill which could wipe out a large chunk of your retirement savings.
Can I still pay into my pension if I take my tax-free lump sum?
If you’ve sought advice and are still convinced that taking your tax-free lump sum now is right for you, then it’s worth noting you’ll still be able to continue to contribute to your pension in future.
Philip Lewis of Evelyn Partners explained: “Just taking the tax-free lump sum does not reduce the amount a saver can pay into their pension each year with tax relief, as the ‘money purchase annual allowance’ (MPAA) is not triggered. So most people who are not very high earners and subject to the tapered annual allowance can continue to pay in up to the annual allowance of £60,000 (depending on their earnings) even after they have taken their tax-free lump sum.
“This can be very useful to those who want to take their tax-free cash soon after they turn 55 but also remain in work and build their pension back up. The bad news is that HMRC will be watching out for large or increased pension contributions by those who have just taken their tax-free cash. If making pension contributions shortly after taking tax-free cash, it is important for savers to speak to an adviser about what is and isn’t considered “recycling” under the pension rules.”
However, if you take out more than your tax-free lump sum, this will trigger the MPAA, which means your annual allowance will reduce from £60,000 to £10,000. You can find out more about how the MPAA works in our guide What is the Money Purchase Annual Allowance?
A final thought…
Removing your whole tax-free cash from an environment where it can grow tax-free without having any clear plan of what you are going to do with this money could prove highly risky, so make sure you seek professional advice before taking action.
Helena Morrissey of Hargreaves Lansdown said: “Rumours can be worrying but it’s important not to react in haste to something that may not even happen. This is money for your long-term future that needs to be planned for carefully, otherwise you could be left counting the cost. This could be due to missing out on investment growth, poor interest rates and tax charges that come out of nowhere.”
Bear in mind too that this time you won’t be able to reverse your decision if no changes are announced. Ms Vahey said: “Leaving money in your pension until you need it is normally the best course of action. It can continue to grow tax-free, meaning you should be able to take a bigger tax-free cash lump sum. If your pension is worth £400,000 today, your maximum tax-free cash will be £100,000. Waiting until it hits half a million – which may only take a few years with a decent rate of contribution and strong market growth – would give you an extra £25,000 tax-free.”
Advertisement
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.
Rest Less Money is on Instagram. Check out our account and give us a follow @rest_less_uk_money for all the latest Money News, updated daily.
Join the discussion
Read our full commenting terms and guidelines