8 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.

Which is why talk that it could be made less generous in the Budget on 26 November is a particular worry for those planning on taking theirs. Of course, talk can be just that - rumours of tax rises and painful rule changes are regular features in the run-up to every Budget and most never come true. 

It is the case, however, that the government has warned it will need to raise money. The fact that it has ruled out rises for the major revenue-raising taxes like Income Tax and National Insurance means other personal taxes and features of the savings regime could be targets.

• Read more on how the government might change pensions

Under the current rules 25% of pension pot money can be accessed without tax to pay, up to a limit of £268,275. There have been various reforms suggested over the years, including from the influential Institute for Fiscal Studies which has mooted reducing this ‘tax-free cash’ - or Pension Commencement Lump Sum in the official jargon - to just £100,000.

Such speculation could lead some people to consider withdrawing theirs on the back of that assumption. 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.

Below are eight 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 tax-free - 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. Do you plan to pass money on after you die?

Money inside pensions currently enjoys some protection against Inheritance Tax (IHT), but this is due to change.

At the moment, pension pots fall outside of your estate for IHT purposes. If you were to die before age 75 your pension can be passed to beneficiaries completely free of tax. If death happens after age 75 then the money is taxed at the recipient’s marginal income tax rate.

This has meant that pensions have been useful for those expecting to pass on money that would otherwise be subjected to IHT. In those cases - under the rules as they stand - taking tax-free cash from a pension risks exposing this money to IHT.

However, changes announced in last year’s Budget, and due to begin in April 2027, will mean pensions will be included in estates for IHT purposes.

The shifting position on pensions and IHT makes it extra important that you understand the implications of any withdrawals you make. A professional adviser can help if you are worried that you will be affected. 

• Read: How could the inheritance tax seven-year rule change?

5. 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.

6. 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.

7. 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’.

The rules can apply if: If you take more than £7,500 from your pension as tax-free cash; and contributions to your pension then increase by 30% or more; and the additional contributions are more than 30% of the tax-free lump sum taken.

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 taxman will want to know that contributions were not pre-planned, but rather part of your “normal retirement planning”.

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

8. 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.

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.

See our current offers to help make your money go further

• Read: Why are retirees rushing back to this income option?
• Read: Autumn Budget 2025: how might the government change pensions?
• Read: Inheritance tax changes - what we know so far

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.