Savers scramble to pull tax-free cash out of pensions

Savers have rushed to pull tax-free lump sums from pensions amid fears over a future Government clampdown. An unprecedented surge in withdrawals saw the amount pulled from pension pots soar more than 60 per cent to £18.08billion in the last financial year. The number of savers taking 25 per cent tax free cash jumped by 33 per cent to 111,869, according to figures from the Financial Conduct Authority.

And despite Rachel Reeves’ decision to leave pension tax-free lump sums untouched in the last Budget – and retirement experts’ warnings not to make rash moves – worried savers appear to be continuing to pull their cash. Withdrawals are likely to have continued at a similar or even greater rate as concerns about a cap have intensified ahead of the autumn Budget on 26 November.

Withdrawing up to 25 per cent from your pension free of tax is a popular perk at retirement, and fears the Chancellor might tighten the rules were not realised last year. The failure to rule them out seems to be weighing on savers’ minds, however. Financial planners are currently experiencing a rush of enquiries from concerned clients similar to last summer, according to Evelyn Partners which obtained the withdrawal figures under a freedom of information request. ‘The 25 per cent tax-free cash is a treasured pension benefit and hugely important to savers,’ says Emma Sterland, chief financial planning officer at the firm.

‘Many savers have a specific purpose in mind for their Pension Commencement Lump Sums – such as clearing outstanding mortgages, gifting to children, or a carefully thought-out income strategy – and while they ideally might not take it quite yet, they are also wrestling with the fear that if they don’t it could be curtailed, and they will lose out.’ Last year, many people went ahead with withdrawals as a precautionary measure, despite warnings they could miss out on investment growth under the tax protection of a pension in future.

Pension experts have issued similar alerts this summer about making hasty moves if you don’t have a plan for what you would do with the money. Savers typically use their lump sums to clear mortgages and other debts, and splash out on home renovations, new cars and holidays at retirement. A Treasury spokesperson said: ‘We do not comment on speculation around changes to future tax outside of fiscal events. We continue to incentivise pensions savings for their intended purpose – of funding retirement instead of them being openly used as a vehicle to transfer wealth.’

Many people nearing retirement age may have a mix of defined contribution and defined benefit pensions, and the rules differ for each type of scheme. Defined contribution pensions: These take sums from both employers and employees and invest them to provide a pot of money at retirement. Over-55s can take 25 per cent of their pension pot tax-free upfront, or opt to withdraw it gradually in chunks. By not withdrawing the whole lump sum out at once, if your pot grows in future you will have more tax-free cash available to take in the longer run.

Defined benefit salary-related pensions: Final salary or career average defined benefit pensions provide a guaranteed income after retirement for the rest of your life. Your options for a 25 per cent lump sum vary according to the generosity of the terms and conditions of your scheme, so you have to check the specific details. If you have a large pension pot, there was an important change following the ditching of the lifetime allowance in April 2023 – the £1,073,100 total limit people could have in their pension pot without facing tax penalties.

The 25 per cent tax free lump sum was capped at £268,275 – a quarter of the old lifetime allowance limit. However, if you have fixed protection relating to a previous, more generous lifetime allowance level your higher 25 per cent lump sum figure can apply, even if you start paying into your pension again. Fixed protection is a complicated area and it is best to seek financial advice about it.

– You do not need to take it all at once, or even at all, if you don’t have a good reason to spend it now. – Think about whether you will need the money later if you are in good health and all being well could live a long time. – If you are investing your pension and do so wisely, your pot could continue to grow and boost how much you have available to withdraw in tax-free chunks over the longer term. – When you take anything over and above your 25 per cent lump sum from a defined contribution pension, from then onwards you can only contribute £10,000 a year and still get tax relief.

– If you take the lump sum and decide to reverse your decision, you may be able to cancel the instruction to your provider but this is not guaranteed – check the rules in advance. – Be aware that if you reinvest the tax free cash back into your pension you might fall foul of recycling rules, which are aimed at preventing people trying to seek an advantage by getting extra tax relief.