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Taking tax-free cash from your pension

Up to 25% tax-free cash

When you can take pension tax-free cash

You can normally access your pension from age 55 (rising to 57 from 2028). If you have a defined contribution pension (like a Self-Invested Personal Pension), up to 25% can usually be paid to you completely tax free, and the rest will be taxed as income. You can see how much tax you could pay on the taxable portion with our pension income tax calculator.

But you don't have to take your tax-free cash all in one go, you can take it in stages if you prefer. It depends what retirement option you choose and how much of your pension you access at a time. For example, you might use half of your pension to buy a secure income through an annuity (getting up to 25% of that amount paid to you as a tax-free lump sum, and the rest to provide a secure taxable income for the rest of your life). The other half of your pension could stay invested until you want to access more tax-free cash or taxable income later.

Please remember, pension and tax rules can change, and benefits depend on your circumstances. If you have a defined benefit (e.g. final salary) pension, the scheme rules will normally control how much tax-free cash you'll receive and how you can take it.

Important information - What you do with your pension is an important decision that you might not be able to change. You should check you're making the right decision for your circumstances and that you understand all your options and their risks. The government's free and impartial Pension Wise service can help you and we can offer you advice if you'd like it. The information on our website isn't personal advice.

Taking tax-free cash on its own

If you want to take your tax-free cash, but you don't need to take an income from your pension just yet, you might consider drawdown. Briefly, this means you'll receive up to 25% of your pension as a tax-free cash payment and the rest will be kept invested as you choose. You can then make withdrawals (which will be taxed as income) from the remaining funds when you're ready.

With drawdown, you need to be prepared to monitor and regularly review your investment choices. There's the potential for your drawdown investments to grow, but it isn't guaranteed. The value of investments, and any income or dividends they produce, can go down as well as up, so you could get back less than you originally invest.

Taking tax-free cash with a taxable income

Buying an annuity

One option is to use your pension to buy an annuity which provides a guaranteed income. You'll normally receive up to 25% of your pension as a tax-free cash payment, and the rest will be exchanged for a regular secure income. This is taxable and can't normally be changed once set up but will be paid for the rest of your life. How much income you'll receive will depend on different factors, like your age, pension value, the rates available at the time and features you choose. It's very important to shop around for the best rate and confirm health and lifestyle details as this could mean you get more income.

Moving your pension into drawdown

Another option is to move your pension into drawdown. You'll still normally receive up to 25% as a tax-free cash payment, and the rest will be kept invested as you choose. You can then make withdrawals (which will be taxed as income) from the remaining funds, when you're ready.

Taking lump sum withdrawals

Or you could take lump sum withdrawals, where 25% of each withdrawal will usually be paid tax free and the rest will be taxed as income. You could even withdraw your whole pension as one lump sum if you want to.

With drawdown and lump sum options you need to be mindful of how long you need your pension to last, if you withdraw too much too quickly you could run out of money. Unlike an annuity, your income isn't guaranteed, and investments can fall in value as well as rise, so you may not get back what you originally invested. Taking large withdrawals could also affect your tax situation, so make sure you've planned for this before making any decisions. These risks mean that drawdown and lump sum options won’t be right for everyone. You need to be happy with the risks of investing and prepared to regularly review your investment and income withdrawal choices.

Taking tax-free cash from your pension in stages

You don't have to access your whole pension in one go if you don't want to. You can also mix and match the ways you take your pension to suit your circumstances.

For example, many people choose to "semi-retire" and want some of their tax-free cash to supplement their income as they reduce their working hours. So if you had a £100,000 pension and wanted £10,000 in tax-free cash, you could achieve this by moving £40,000 into drawdown. You can then make taxable withdrawals from the remaining £30,000 drawdown fund as and when you need to.

Then when you give up work completely, you might want a secure income to replace your salary. So you could use the remaining £60,000 in your pension to buy an annuity. You'd receive a payment of up to £15,000 tax-free with the remainder used to provide a guaranteed regular income (which is taxable), paid for life.

MORE ON PREPARING FOR RETIREMENT

Having a plan for your tax-free cash

It's usually a good plan to only take the amount of tax-free cash that you need at the time. By leaving the rest in the pension, it's got a chance to grow tax free, so you could end up with a greater tax-free sum overall. Plus, money left in your pension will usually fall outside of your estate for inheritance tax purposes.

You're free to spend or save your tax-free cash, however you want. You might decide to use some of it to pay off your mortgage, or to help your loved ones financially. But it's important to think about what you'll do with the rest. Inflation reduces the spending power of cash so just leaving it in your current account might be a mistake.

For the cash you don't need right away you might consider fixed-term savings. This is where you tie your money up for a set period in exchange for a higher rate of interest. You won't be able to withdraw the money until the term is up. But you might decide to set up a number of fixed-term savings products so they mature at different times.

Getting a decent return on your cash savings

Active Savings lets you pick and mix from a range of UK banks and building societies' savings products through one simple to use online account. You can choose from a range of easy access and fixed savings products offering competitive rates.

Discover Active Savings

The Active Savings service is provided by Hargreaves Lansdown Savings Limited (company number 8355960). Hargreaves Lansdown Savings Limited is authorised and regulated by the Financial Conduct Authority (firm reference number 915119). Hargreaves Lansdown Savings Limited is authorised by the Financial Conduct Authority under the Electronic Money Regulations 2011 with firm reference 901007 for the issuing of electronic money.

Beware of investment scams

Unfortunately, there are investment scams out there which target people who've withdrawn, or plan to withdraw money from their pension and other accounts. They can also persuade people to transfer their pension to another pension within which there is an investment scam. These scams tend to involve firms and/or investments which aren't regulated by the FCA, so if you fall victim to them there may be no compensation available.

Often fraudsters will attempt to make their 'sales pitch' as realistic and attractive as possible. They'll aim to build a rapport with you – sharing fake reviews, using convincing literature and websites or claiming to be regulated. Warning signs can include cold calling or texting, pressure to act quickly, the promise of unique or unusual opportunities, the offer of quick and easy profits or something that seems too good to be true. Scammers might also offer free pension reviews and the chance to release money from your pension early, which isn't normally allowed before age 55 under current pension legislation. You can find out more at www.fca.org.uk/scamsmart.