Under flexible rules introduced in April 2015 you can now use your pension pot to take out cash as and when you need it. However, there are tax implications and a risk that your money could run out.
How it works
You take cash from your pension pot whenever you need it.
For each cash withdrawal normally the first 25% (quarter) will be tax-free, but the rest will be added to your other income and is taxable.
There might be charges each time you make a cash withdrawal and/or limits on how many withdrawals you can make each year.
Things to think about
This option won’t provide a regular retirement income for you or for any dependant after you die.
Your pension pot reduces with each cash withdrawal. The earlier you start taking money out of your pot, the greater the risk your money could run out.
What’s left in your pension pot might not grow enough to give you the income you need to last you into old age – most people underestimate how long their retirement will be.
The administration charges for each withdrawal could eat into your remaining pot.
Because your pot hasn’t been reinvested to produce an income, its investments could fall in value – so you’ll need to have it reviewed regularly.
Charges will apply and you might need to move or reinvest your pot at a later date.
Once you take money out of your pension pot any growth in its value is taxable, whereas it will grow tax-free inside the pot – once you take it out you can’t put it back.
Taking cash lump sums could reduce your entitlement to benefits now or as you grow older.
Tax you will pay
Three quarters of each cash withdrawal counts as taxable income.
This is added to the rest of your income and depending on how much your total income for the tax year is, you could find yourself pushed into a higher tax band.
So if you take lots of large cash sums, or even a single cash sum, you could end up paying a higher rate of tax than you normally do.
Your pension scheme or provider will pay the cash through a payslip and take off tax in advance – called PAYE (Pay As You Earn).
This means you might pay too much tax and have to claim the money back – or you might owe more tax if you have other sources of income.
Extra tax charges or restrictions might apply if your pension savings exceed the lifetime allowance (currently £1,073,100), or if you have less lifetime allowance available than the amount you want to withdraw.
Tax relief on future pension savings
If the value of your pension pot is £10,000 or more, once you start to take income, the amount of defined contribution pension savings on which you can get tax relief each year is reduced from £40,000 (the ‘annual allowance’) to a lower amount (called the ‘Money Purchase Annual Allowance’ or ‘MPAA’).
In 2021/22 the MPAA is £4,000.
If you want to carry on building up your pension pot this option might not be suitable.
What happens when you die?
- If you die before the age of 75, any untouched part of your pension pot will pass tax-free to your nominated beneficiary or estate provided the money is paid within two years of the provider becoming aware of your death. If the two year limit is missed, it will be added to your beneficiary’s other income and taxed in the normal way.
- If you die after the age of 75 any untouched part of your pension pot that you pass on – either as a lump sum or income – will be added to your beneficiary’s other income and taxed in the normal way.
The Lifetime allowance charge
If the value of all of your pension savings is above £1,073,100 (tax year 2021/22) when you die, further tax charges might apply.
Your other retirement income options
Taking cash sums is just one of several options you have for using your pension pot to provide a retirement income.
Because of the risk of running out of money, we recommend you think very carefully before using this method to fund your retirement income.
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