In Focus: Retirement Income  

Tax-free cash: take it or leave it?

  • To understand why some people might take tax-free cash on retirement.
  • To be able to explain why it might be best to keep the funds invested.
  • To ascertain what option might be best for individual clients.
Tax-free cash: take it or leave it?
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Taking 25 per cent tax-free cash from a pension is a popular perk.

The option of taking 25 per cent of your pension fund tax-free is one of the most popular benefits of saving into a pension.

Many people like the idea of withdrawing this and spending it on the holiday of a lifetime, home improvements or helping children or grandchildren.

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However, the question should be asked: could people be better off leaving that money invested and withdrawing their tax-free cash gradually over a longer period?

It is worth thinking carefully about whether this really is the best option as this will depend much more on your personal circumstances and goals.

For example, withdrawing 25 per cent tax-free cash and putting the proceeds into a low-interest savings account could suffer a double whammy of inferior returns and, by moving the money out of a tax-efficient tax wrapper, it will be assessed for inheritance tax as part of your estate. 

There is also inheritance tax, which is an important factor to consider about when and how to access pension savings.

With the inheritance tax nil rate band (£325,000) and residence nil rate band (£175,000) now frozen until 6 April 2026, an increasing number of people are finding they have a potential IHT liability.

Unnecessarily taking money from a pension can serve to only increase this potential IHT burden, but by leaving your money in a pension, your pension can be passed onto beneficiaries tax-free.

At retirement, too often people are presented with options that suggest they must take all their tax-free cash upfront as a ‘use it or lose it’ option.

But for many people, that is not the case, and if their pension provider does not allow tax-free cash to be drawn gradually, it is worth finding one that will.

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Here is what clients should consider. 

Most retirees are able to take up to 25 per cent of their pension savings tax-free and this option is one of the most popular features of private pension saving.

As a result, few people want to miss out on taking their tax-free cash and most take their full entitlement at the point that they first access their pension.

For those taking a scheme pension or buying a lifetime annuity, they have a binary choice: either take the tax-free cash or take a higher taxable income.

However, for those looking to access their pension more flexibly, there is a third option to take the tax-free cash gradually.

For retirees who don’t need the full lump sum immediately (for example, to pay off mortgage or debts), this third option can help maximise retirement income and the inheritance available for family and friends.

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