Taking small cash sums from your pension pot

Taking money from your pension as and when you need it

You can use your existing pension pot to take cash as and when you need it and leave the rest untouched where it can continue to grow tax-free. For each cash withdrawal, normally the first 25% (quarter) is tax-free, and the rest counts as taxable income. There might be charges each time you make a cash withdrawal and/or limits on how many withdrawals you can make each year.

With this option, your pension pot isn’t re-invested into new funds specifically chosen to pay you a regular income, and it won’t provide for a dependent after you die. There are also more tax implications to consider with this option.

Your pension pot reduces with each cash withdrawal. The earlier you start taking money out of your pot, the greater the risk your money could run out. What’s left in your pension pot might not grow enough to give you the income you need to last you into old age – most people underestimate how long their retirement will be.

The administration charges for each withdrawal could eat into your remaining pot. Because your pot hasn’t been reinvested to produce an income, its investments could fall in value – so you’ll need to have it reviewed regularly. Charges will apply, and you might need to move or reinvest your pot at a later date.

Once you take money out of your pension pot, any growth in its value is taxable, whereas it will grow tax-free inside the pot – once you take it out, you can’t put it back. Taking cash lump sums could reduce your entitlement to benefits now or as you grow older.

Three quarters of each cash withdrawal counts as taxable income. This is added to the rest of your income – and depending on how much your total income for the tax year is, you could find yourself pushed into a higher tax band.

So if you take lots of large cash sums, or even a single cash sum, you could end up paying a higher rate of tax than you normally do. Your pension scheme or provider will pay the cash through a payslip and take off tax in advance – called ‘PAYE’ (Pay As You Earn). This means you might pay too much 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 (2020/21 tax year) – or if you have less lifetime allowance available than the amount you want to withdraw.

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 (the ‘Money Purchase Annual Allowance’, or ‘MPAA’). In 2020/21, the MPAA is £4,000. If you want to carry on building up your pension pot, this option might not be suitable.

If you die before the age of 75, any untouched part of your pension pot will pass tax-free to your nominated beneficiary or estate, provided the money is paid within two years of the provider becoming aware of your death. If the two-year limit is missed, it will be added to your beneficiary’s other income and taxed in the normal way.

If you die after the age of 75, any untouched part of your pension pot that you pass on – either as a lump sum or income – will be added to your beneficiary’s other income and taxed in the normal way.