If you’ve recently been tempted to draw your tax-free lump sum from your pension, you’re certainly not alone.
A report in SAGA found that the total value of tax-free lump sums taken in 2024/25 increased by over 60% compared to the previous tax year.
The tax-free lump sum is the amount you can take from your pension without paying any tax. It is typically available for 25% of your pension, up to a maximum total amount of £268,275 (2025/26), which is known as the “lump sum allowance” (LSA).
Withdrawing your lump sum early or all at once comes with several implications, and it may not be the best way to ensure you get the most from your retirement savings.
Read on to find out why tax-free withdrawals have been rising and why you should be careful before accessing yours.
Tax-free lump sum withdrawals have risen sharply in the last year because of 2 key factors
The report in SAGA highlights the significant rise in lump sum withdrawals.
Data from the 2024/25 tax year reveals that a total of £18.08 billion was withdrawn, up by 61% from £11.25 billion in 2023/24. Moreover, the number of people accessing their tax-free cash went up by 29.1% over the same period.
There are two key factors behind this rise.
The first was the fear that the government would reduce the LSA from £268,275. This would have meant that people with large pensions may have had to pay tax on a bigger portion of their retirement income than they initially planned.
However, this fear didn’t come to fruition in the recent Budget, and many people who had drawn from their pensions were left with significant amounts of cash and unable to put it back.
The second factor behind the rise in lump sum withdrawals is that people are looking for ways to ensure their pension remains efficient in light of the reforms to Inheritance Tax (IHT) announced in the 2024 Budget.
Under the new rules, pensions will be liable for IHT from 2027. So, while they have typically been a highly efficient way of passing on wealth, pensions will now be subject to IHT as well as possible Income Tax.
This change has prompted an increasing number of people to draw more from their pensions to pass to their loved ones early, to help ensure the money remains efficient.
Although this could be an effective strategy, it’s also very risky, and there are other methods (we’ll explore below) that could be more appropriate.
Whatever you choose to do with your pension wealth to maximise its efficiency, it’s important to consult a financial planner before doing so.
You can read more about the upcoming changes to pensions and IHT in our previous article on the topic.
Withdrawing your tax-free lump sum without careful planning comes with several risks
Most people with a pension will one day withdraw their tax-free portion, whether in a lump sum or through drawdown. But the key is to do so carefully.
There are several risks it’s important to be aware of before withdrawing your lump sum, including:
- Losing investment growth – Once you remove cash from your pension, it no longer benefits from tax-efficient growth. Even if you reinvest the money in the market, you’ll likely have to pay tax on the returns.
- Reducing your retirement income – A further key risk of losing growth is that you’ll have less invested for later life. This increases the risk that you’ll run out of savings during retirement or that the real value of the cash you withdraw will be eroded by inflation.
- Triggering the Money Purchase Annual Allowance (MPAA) – Once you draw from your pension, you trigger the MPAA. This limits the amount you can contribute tax-efficiently to your pension from £60,000 a year to £10,000. So, if you withdraw money while still working, in preparation for legislative change, you will be limited by the contributions you can make in the future.
- Potential tax penalties – If HMRC believes you have attempted to put withdrawn cash back into your pension, you could face a penalty charge of up to 70%.
The primary risk of withdrawing your lump sum is that your retirement savings won’t grow tax-efficiently and may lose their real value to inflation, meaning you have less money in retirement. But as you can see, several risks and considerations could also affect you.
As such, it’s important to work with a financial planner to plan your retirement income and lump sum withdrawal or drawdown. They can help ensure your savings remain efficient, open to growth, and aligned with your long-term goals.
Other strategies can help keep your pension efficient in light of the upcoming changes
If you’re concerned about your beneficiaries having to pay IHT on your pension, rather than withdrawing your lump sum, you may want to explore alternative strategies that could be more secure.
These include:
- Making full use of your nil-rate bands – With careful planning, you and your partner could pass on up to £1 million IHT-free, so it’s important to maximise these allowances.
- Taking out life insurance and putting it in trust – Using your pension fund to pay for a life insurance policy held in trust can be an efficient way of transferring it from your savings to your future beneficiaries.
- Creating a drawdown plan that incorporates gifting – You can create a plan to draw from your pension that ensures you still have enough invested while also gifting portions to your beneficiaries. As long as you stay alive within seven years of the gifts, the money will remain efficient.
A financial planner can help you create a plan that ensures your retirement income is sufficient for your needs, continues to grow, and remains efficient when passed on to your beneficiaries.
To speak to a financial planner, get in touch.
Email admin@stonegatewealth.co.uk or call us on 01785 876222.
Please note
This article is for general information only and does not constitute advice. The information is aimed at retail clients only.
All information is correct at the time of writing and is subject to change in the future.
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.
The Financial Conduct Authority does not regulate estate planning or trusts.
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 value of your investments (and any income from them) can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance.
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