5 pension tax-free cash misconceptions | Personal Finance | Finance
The freedom to take 25% of your pension savings as tax-free cash is hugely popular, but also widely misunderstood. Andrew King, pensions specialist at wealth management firm Evelyn Partners, warned that confusion around the rules could cost you dear. “‘The 25% tax-free entitlement is probably the most treasured feature of defined contribution pensions. Combined with tax relief on contributions, it can make pension saving incredibly tax efficient and powerful.”
King is keen to dispel five common misunderstandings about tax-free cash, officially called the Pensions Commencement Lump Sum.
1. You only have one shot at taking it.
You can take tax-free cash from age 55, rising to 57 in 2028, and still rebuild pension savings afterwards.
King said you may also be able to make further withdrawals, provided you do not exceed 25% of your total pot or the maximum Lump Sum Allowance, currently £268,275. “For example, a £600,000 pot allows £150,000 to be taken tax-free, with scope to rebuild and take further cash later, subject to rules.”
2. Taking tax-free cash limits future contributions.
Accessing pension benefits in full can trigger the Money Purchase Annual Allowance (MPAA), which cuts the maximum you can invest in a pension each year while claiming tax relief from £60,000 to £10,000.
Taking only tax-free cash does not trigger this limit, provided no taxable income is drawn at the same time.
3. You must take it all in one go.
This is probably the biggest misconception, King said, fuelled by the benefit often being called the “tax-free lump sum”. “This disguises the fact that you can choose to take the cash in stages, either regular or ad hoc.”
Phased withdrawals can leave more money invested for longer, benefiting from compounding. Spreading withdrawals can also reduce income tax liabilities.
4. Tax-free cash will come under attack.
Before the last two Budgets, there was speculation that chancellor Rachel Reeves would limit tax-free cash, and the Treasury did nothing to quash this.
Many understandably rushed to withdraw the full amount, only to regret it, King said. “No crackdown emerged and they were left wondering what to do with a big lump sum taken out of a tax-free environment.”
He advised against rushed decisions based on speculation: “Only take the cash if there is a well-thought-out plan for it, and it will not leave you short later in retirement.”
5. Small pots can be taken tax-free.
Small pots don’t have any extra tax advantages, King said. “Up to three pots under £10,000 can be cashed in without triggering the MPAA, but as with any other pension, only 25% is tax-free and further withdrawals are taxed as income.”
