Cashing in your entire pension pot

Without very careful planning, you could run out of money and have nothing to live on

You could close your pension pot and take the entire amount as cash in one go if you wish. Normally, the first 25% (quarter) will be tax-free, and the rest will be taxed at your highest tax rate by adding it to the rest of your income. Once you’ve taken all the money, your pension will close and you won’t be able to make any further payments into it.

However, there are many risks associated with cashing in your entire pension pot. For example, it’s highly likely that you may be subjected to a significant Income Tax bill. Opting for this approach also means that it won’t pay you or any dependent a regular income – and without very careful planning, you could run out of money and have nothing to live on in retirement.

If you’re planning to put the money you take into savings or other investments, you should compare and think about how it will get treated for Inheritance Tax purposes. If you are considering taking your entire pension pot, you should first obtain professional financial advice to fully understand the impact on you and your financial situation.

Three quarters (75%) of the amount you withdraw is taxable income, so there’s a strong chance your tax rate would go up when the money is added to your other income. If you exercise this option, you can’t change your mind. Also remember, this option will not provide a regular income for you, your spouse or any other dependent after you die.

For many or most people, it will be more tax-efficient to consider one or more of the other options for taking your pension. Taking a large cash sum could reduce any entitlement you have to benefits now or as you grow older (for example, to help with long-term care needs).

Cashing in your pension to clear debts, buy a holiday or indulge in a big-ticket item will reduce the money you will have to live on in retirement. Another consideration is that you might not be able to use this option if you have received a share of an ex-spouse’s or ex-civil registered partner’s pension as a result of a divorce, or if you have certain protected rights with your pension.

Your pension scheme or provider will pay the cash through a payslip and take off tax in advance (PAYE). This means you might pay too much Income Tax and have to claim the money back – or you might owe more tax if you have other sources of income.

Extra tax charges or restrictions might apply if your pension savings exceed the lifetime allowance (currently £1,073,100), or if you have reached age 75 and have less lifetime allowance available than the value of the pension pot you want to cash in.

If the value of your pension pot is £10,000 or more, once you start to take income, the amount of defined contribution pension savings on which you can get tax relief each year is reduced from £40,000 (the annual allowance) to a lower amount (called the ‘Money Purchase Annual Allowance,’ or ‘MPAA’). The MPAA for 2020/21 is £4,000. If you want to carry on building up your pension pot, this option might not be suitable.