Taking a tax-free lump sum from your pension could be a fantastic way to kickstart your retirement plans. If it’s something you’re thinking about, it’s important to consider the long-term implications and understand how much you could withdraw from your pension before facing a tax bill, as the rules have changed in 2024/25.
Previously, you could take up to 25% of your pension as a tax-free lump sum (or 25% of your unused Lifetime Allowance if less). This could be through a single withdrawal or spread across several. However, following the removal of the pension Lifetime Allowance, there are now two new allowances and the tax-free lump sum is the lower of 25% of your pension, the amount of Lump Sum Allowance you have left and the amount of Lump Sum and Death Benefit Allowance you have left. For many people, the end result for tax-free cash will be the same.
If you have drawn any pension benefits before 6 April 2024, before taking any tax-free cash after that date, you should take guidance on whether you might benefit from applying for a Transitional tax-free amount certificate to potentially achieve a higher limit for future tax free lump sums.
The “lump sum allowance” is £268,275 in 2024/25
In 2023, Chancellor Jeremy Hunt announced the pension Lifetime Allowance (LTA) would be scrapped in the 2024/25 tax year. The LTA limited the amount of pension benefits you could build up during your lifetime without incurring a tax charge.
With workers now able to save more into their pension tax-efficiently during their careers, the government has frozen the limit on tax-free withdrawals from your pension.
In 2024/25, you can usually take up to 25% of your pension tax-free up to a maximum of ÂŁ268,275.
Your lump sum allowance may be higher if you have a protected tax-free cash amount due to your accrued rights before 5 April 2006, when the LTA was first introduced, or if you have lifetime allowance protection such as fixed, individual, enhanced or primary protection.
Withdrawing a tax-free lump sum could harm your long-term finances
If you want to take a lump sum from your pension, the new rules aren’t the only area you might want to consider. You may also want to weigh up the effect it could have on your long-term finances.
There are plenty of reasons why you may want to take a lump sum from your pension, and some could improve your retirement finances. For example, you could use the lump sum to clear your mortgage or other debt, which may significantly reduce your outgoings in retirement and lead to a more comfortable and secure lifestyle.
Alternatively, you might plan to use the money to reach aspirations, like travelling the world once you stop working.
It could be a great way to fund your early retirement plans. However, taking a lump sum from your pension could have a significant effect on your long-term financial security and income. Not only will you be reducing the size of your pension but, as your pension is usually invested, you could experience lower returns than expected too.
Understanding the potential implications of taking a lump sum at the start or during your retirement could help you make a decision that’s right for you.
You may find that after taking a lump sum from your pension you’ll still be financially secure and able to reach long-term goals. If this is the result, you might feel more confident taking a lump sum and more able to enjoy your retirement.
On the other hand, if you find taking a lump sum could harm your long-term finances, you may decide to halt your plans or make adjustments to improve your financial security throughout retirement.
As a financial planner, we can help you understand what the consequences of taking a lump sum could mean for you.
On average, over-55s spend a third of their tax-free lump sum within 6 months
A 2023 survey from Standard Life found that over-55s who have taken a tax-free lump sum, on average, spend or expect to spend a third of their withdrawal within six months.
While having some cash to fall back on in retirement could be useful, withdrawing a lump sum to hold the money outside of your pension might not be financially savvy.
The money held in your pension is usually invested, so it has the potential to deliver returns during your retirement. In addition, investments held in your pension are not liable for Capital Gains Tax, so it provides a tax-efficient way to invest. If you withdraw money from your pension to hold in cash, its value could fall in real terms and you might miss out on potential long-term growth.
Of course, investment returns cannot be guaranteed and they could experience volatility. As a result, it’s important to consider your risk profile and circumstances when deciding how to manage your pension.
Setting out how you plan to use your tax-free lump sum and making it part of your wider financial plan could help you assess if withdrawing it now or in the future is right for you.
Contact us to talk about your pension withdrawals
When you’re accessing your pension, whether to take a lump sum or a regular income, you might worry about what’s right for you. Working with a financial planner could give you confidence in retirement. Please contact us to talk to one of our team about how to access your pension in a way that’s tax-efficient and aligns with your goals.
Please note:
This blog is for general information only and does not constitute advice. The information is aimed at retail clients only.
A pension is a long-term investment not normally accessible until 55 (57 from April 2028). The fund value may fluctuate and can go down, which would have an impact on the level of pension benefits available. Past performance is not a reliable indicator of future performance.
The tax implications of pension withdrawals will be based on your individual circumstances. Thresholds, percentage rates, and tax legislation may change in subsequent Finance Acts.
Please do not act based on anything you might read in this article. All contents are based on our understanding of HMRC legislation, which is subject to change.
This blog is based on legislation as of April 2024. While we strive to provide accurate information, legislation can always change and, as a result, the following details may no longer be accurate.
