7 questions before you take tax-free cash from your pension

The chunk of pension savings that individuals are able to withdraw tax-free is one of the most popular features of the pension system.

Under the current rules, 25% of pension pot money can normally be accessed without income tax to pay, up to a limit of £268,275. There can be good reasons for taking tax-free cash, of course, but there can also be dangers in doing so if you haven’t factored in all considerations.

• Read: What is tax-free cash? The basics

Below are seven questions to ask yourself before you take tax-free cash from your pension. For the full rules on taking tax-free cash, we have a  comprehensive guide on taking withdrawals from your pension here.

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1. What will you do with the money? 

Taking tax-free cash without a good use for the money is likely to be a mistake. Money inside a pension is typically invested in a way that is suitable for your needs and any gains made are free of UK tax - although investments can fall in value too.

If you withdraw tax-free cash without a good use for it you will have to find an alternative home for it. The only way to shelter gains from tax is via an ISA but annual contributions are limited to £20,000.  

2. Do you have a plan for the rest of your pot?

In order to withdraw tax-free cash, some pension schemes will require you to move the remainder of your money to a drawdown account where you will need to decide how it is invested. Do you have a plan for this money that meets your needs? If you are unsure then our Investment Pathways may be able to help.

3. Has the value of your pension pot fallen?

Taking tax-free cash from your pension may mean that investment assets have to be sold to raise the money. If you are doing it in a rush there is a risk that you make your withdrawal after your pension pot has suffered poor performance. Taking tax-free cash at that stage risks locking in those losses and denying your pot the chance to recover its value.

4. Will you need the money to provide income?

Money saved inside a pension is ultimately there to fund your retirement. Taking a quarter of it away will obviously reduce the potential for that money to generate an income in the future. It can still be put to good use, of course, depending on your wider financial circumstances, but it is important to understand the likely impact on your income in retirement, particularly if you are withdrawing tax-free cash some years before you plan to stop working.

It can pay to have a store of tax-free cash in the future that you can withdraw to reduce your reliance on taxable pension money, helping you to plan your income tax efficiently. A professional adviser can help with this.

5. If you are no longer working, is tax-free cash the most efficient way to access your money?

If you do not have much income from other sources, you may have unused Personal Allowance available. This is the amount we can all earn before any income tax is due, set at £12,570 for 2025/26.

If this allowance is not taken up by other earnings, then it may make sense to take a taxable lump-sum from your pension instead of tax-free cash. That’s because the taxable element will fall within the Personal Allowance and be tax-free anyway, leaving more of your tax-free cash for the future.

Consider, however, that this will then limit future annual pension contributions to £10,000 due to the Money Purchase Annual Allowance.

6. Will you break rules on pension ‘recycling’?

There are rules which prevent money being withdrawn from pensions and then contributed again to benefit from tax-relief - a practice known as ‘pension recycling’.

If HM Revenue & Customs (HMRC) deems you guilty of pension recycling, it can impose a charge of up to 55% of the value of your tax-free cash. 

To make that judgement, it uses five tests. 

1. You received tax-free cash 
2. You made (or someone made on your behalf) “significantly increased” pension contributions - this means your contributions increased by more than 30% compared to what might have been expected 
3. The contribution increase was linked to the tax-free lump sum and was pre-planned 
4. The recycling amount was more than £7,500 when added to any tax-free cash taken in the previous 12 months
5. The additional contributions was more than 30% of the tax-free cash sum received 

If your tax-free withdrawal and subsequent contributions satisfy all these conditions then you might fall foul of the rules and a tax charge could apply. 

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

7. Do you understand all the rules that apply?

Some occupational pension plans have rules around taking tax-free cash, including requiring you to access all of your benefits or transfer your remaining assets.

Make sure you understand all the rules governing your pension money and the ramifications of accessing your money.

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.

Our retirement specialists 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.

Got a burning question you want to ask? Why not drop us a line. Click here to ask your question.

• Read: Triple Lock: what will the State Pension be in the future?
• Read: What income might I get from a £250,000 pension?
• Read: You’ve spent a lifetime saving – now what?

Important information - investors should note that the views expressed may no longer be current and may have already been acted upon. Tax treatment depends on individual circumstances and all tax rules may change in the future. Withdrawals from a pension product will not be possible until you reach age 55 (57 from 2028). It’s important to understand that pension transfers are a complex area and may not be suitable for everyone. Before going ahead with a pension transfer, we strongly recommend that you undertake a full comparison of the benefits, charges and features offered. To find out what else you should consider before transferring, please read our transfer factsheet. If you are in any doubt whether or not a pension transfer is suitable for your circumstances we strongly recommend that you seek advice from one of Fidelity’s advisers or an authorised financial adviser of your choice. 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.