‘I’m a retirement expert – 5 pension tax-free cash myths debunked’ | Personal Finance | Finance

A retirement expert has debunked five myths surrounding the 25% tax-free lump sum for savers considering accessing their pots for the first time. Pensions and retirement specialist, Andrew King, from wealth management firm Evelyn Partners, described the entitlement as probably the most treasured contribution of Defined Contribution (DC) pensions.

He added: “Combined with tax relief at contribution stage it can make pension saving incredibly tax efficient and powerful. Taking it is also often the first thing that savers think about doing with their pension.”

Mr King went on to suggest that while it is a well-known feature of pensions, it is also widely misunderstood.

Below, the pensions expert identifies and aims to dispel five common misunderstandings.

Mr King said while many savers think there is no going back after accessing their pension, that is totally wrong.

He explained: “You might end up with multiple pension accounts, drawdown and accumulation, but it’s far from the end of the road.

“Certain ways of accessing pensions can restrict future contributions, but even they do not prevent further pension saving or even future tax-free cash.”

The expert said you can take your tax-free cash as a lump sum at any point from the normal minimum pension age, which is currently 55 but rises to 57 in 2028.

He said: “That does not stop you building your pension savings back up. Nor does it stop you taking more tax-free cash at a later date, as long as you are within the Lump Sum Allowance, which is currently £268,275 for most people.”

The rules are different for Defined Benefit pension schemes, where options are limited.

Mr King said accessing pension tax-free cash can be done in multiple ways. He explained: “As a rule of thumb, if you take taxable amounts over and above your [tax-free cash] entitlement, this will trigger something called the ‘money purchase annual allowance’.”

This means the amount you are allowed to pay into your pension each year and still benefit from tax relief falls from the standard £60,000 for most savers, or their relevant earnings, if lower, to the MPAA of £10,000.

The Money Purchase Annual Allowance (MPAA) limits how much you can add to a DC pension per year and still get tax relief.

Mr King said: “So, if you just take your [tax-free cash, TFC], you do not trigger the MPAA – as long as you do not also access your pension flexibly and take taxable amounts at the same time.

“If you simply take the TFC and leave the rest of the pot invested or in drawdown, then you don’t need to worry about the MPAA.

“This is important to note, as many people who take their TFC want to build their pension pot back up afterwards, and the MPAA could restrict that.”

Mr King said this is probably the biggest misconception as you can choose to take your TFC in ad hoc or regular chunks.

He added: “For many savers, this strategy can make a pension pot go further in the long term because rather than taking out a large sum from the pot at an early stage, it leaves more funds in the pension to grow tax-efficiently and benefit from compounded returns over the subsequent years.

“It could also make it easier to manage future income tax liabilities.”

The expert cautioned that care should be taken over how this is done, with flexible drawdown generally the preferable option.

It means you crystallise part of your pot with each TFC withdrawal, with the other 75% going into drawdown.

The alternative, according to the expert, is uncrystallised funds pension lump sum withdrawals, where you take lump sums directly from your pension without moving anything into drawdown.

Mr King said that for each withdrawal, 75% will be immediately taxable, so this will trigger the MPAA.

Mr King said this is not necessarily a myth, but quite a rational reaction to the policy uncertainty seen in recent years. He added: “What must be remembered, however, is that it does not come without its costs.”

The expert explained it wasn’t surprising thousands of pension savers rushed to take their tax-free cash before the Budgets in 2024 and 2025, given the rife speculation that Chancellor Rachel Reeves was to restrict or remove the entitlement.

A crackdown didn’t materialise, leaving some with large lump sums taken out of a tax-free pension savings environment.

On taking tax-free cash as a lump sum, Mr King said: “Only do it if you have a well-thought-out plan for it and you are confident it will not leave you short later in retirement.

“Of course, extraneous factors might well influence the timing of TFC withdrawal, and we are seeing this at the moment due to the inclusion of unused pension assets in Inheritance Tax calculations from April next year.”

He added that the forthcoming rise of the pension access age to 57 might also encourage some savers of certain ages to bring forward a TFC withdrawal.

Mr King said: “Any speculation around TFC before the next Budget will doubtless – and understandably – further fuel such behaviour, but we would advise against acting on policy fears alone.”

The expert cautioned against paying significant amounts back into a pension straight after taking TFC, as HMRC may pick up on it.

On this myth, Mr King said: “Wrong. There are ‘small pot rules’, but they don’t really confer any tax advantage.”

He said their main benefit is that, as long as you are above pension access age, they allow you to cash in pots of less than £10,000 without triggering the MPAA – and without having to partially crystallise and have a drawdown account.

Mr King explained: “But this can usually only be done with three small pots and only a quarter of each pot will be tax-free, with the other 75% being taxable.”

The expert added that this could add quite substantially to the tax bill for someone cashing in several small pots in one tax year.

This is especially the case if they were still working or had taxable income from other sources, as it could take them into a higher tax bracket, according to the expert.