Can I reinvest pension tax-free cash and claim more later?

Q: If I were to withdraw 25% of my tax-free lump sum, then re-invest it back into the pension fund over a period of years, this should boost the overall value of my pension due to tax relief. Would I be able to take 25% of this bigger pot as a one-off tax-free lump sum?

A: In theory, yes — but there are several important caveats to bear in mind.

First, you only receive tax relief on pension contributions if you’re under the age of 75 and have relevant UK earnings (typically from employment or self-employment). Taking any cash, including tax-free cash, from your pension does not count as “earnings” for this purpose.

• Get expert insights straight to your inbox with our free investor emails
• See our current offers to help make your money go further

Generally, the maximum that individuals can contribute to pensions each tax year is the lower of their annual earnings or £60,000 - a figure known as the annual allowance.

Beyond that, there are also specific rules on withdrawing a tax-free lump sum (officially known as the Pension Commencement Lump Sum or PCLS) and then reinvesting it inside a pension - a process known as ‘pension recycling’. If you make contributions after you’ve taken tax-free cash of at least £7,500, and those contributions represent 30% or more of your tax-free cash, then you might fall foul of the rules and a tax charge could apply.

On the basis of this, you would be able to take 25% of your tax-free cash and reinvest it, as it falls below the 30% limit. The taxman will, however, want to know that contributions were part of your “normal retirement planning”.

The rules surrounding this can be complicated so seek professional help if you believe you may be affected.

You should be aware that there are also rules that limit pension contributions if taxed income is taken from your pension. This triggers the Money Purchase Annual Allowance (MPAA), which restricts your future annual contributions to just £10,000. If the MPAA is triggered it also means you cannot carry forward unused allowances from previous tax years — another significant restriction.

However, the MPAA is not triggered if you take only the tax-free lump sum and do not take any taxable income.

• More on pension drawdown and how it works

Essentially, there are two main ways of taking cash out of a pension pot: via an Uncrystallised Funds Pension Lump Sum (UFPLS) or through Flexi-Access Drawdown.

With UFPLS, you take money directly from the uncrystallised pension pot as a one-off lump sum (or a series of them). Each withdrawal is automatically split: 25% is paid tax-free, while the remaining 75% is taxed as income.

The advantage of UFPLS is its simplicity — there’s no need to set up a separate drawdown arrangement. It can work well for those taking small, occasional withdrawals.

However, the major drawback is that using UFPLS will automatically trigger the MPAA, limiting future pension contributions to £10,000 a year.

With Flexi-Access Drawdown, you crystallise part of your pension and take 25% of that portion as a tax-free lump sum. The remaining 75% is moved into a drawdown account, which stays invested and can be accessed for income at any time.

While this structure may sound similar to UFPLS, the key point is that if you only take the tax-free lump sum and leave the rest invested, you do not trigger the MPAA.

This allows your drawdown pot to continue growing, and you can keep contributing to your pension — up to the full £60,000 allowance, provided you have sufficient earnings.

The Government’s Pension Wise service offers free, impartial guidance to help you understand your options at retirement. You can access the guidance online at www.moneyhelper.org.uk or over the telephone on 0800 138 3944.

Fidelity’s Retirement Service also has a team of specialists who can provide you with free guidance to help you with your decisions. They can also provide advice and help you select products though this will have a charge.

If you’ve got a burning question you want to ask, why not drop us a line. Ask us your question.

• More on taking tax-free cash from your pension
• More on Taking money from your pension savings
• More on Pension Drawdown

Important information - investors should note that the views expressed may no longer be current and may have already been acted upon. Withdrawals from a pension product will not be possible until you reach age 55 (57 from 2028). This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to one of Fidelity’s advisers or an authorised financial adviser of your choice.