Everything you MUST know before taking a pension tax-free lump sum: Our experts

Do not take tax-free cash out of your pension unless you have a clear plan for your hard-earned retirement savings.

That is the message being relentlessly hammered home by pension experts, who are worried people will harm their retirement finances if they withdraw cash based purely on speculation about a Budget raid that might never happen.

Currently, those over the age of 55 can take 25 per cent of their pension pot tax-free up to a £268,275 cap. There are concerns this sum could be slashed in the Budget and the Chancellor has refused to rule the move out.

Fears the Government will target tax-free cash on November 26 have prompted a rush of withdrawals, say pension firms.

Yet as many as one in three 60 to 78-year-olds have no idea what to do with their pension tax-free cash, according to a snap poll this month by investment platform Hargreaves Lansdown.

Around 17 per cent would put it in cash savings accounts or Isas, while 6 per cent would keep it in current accounts, where it can be eaten into by inflation or without providing any investment returns.

Former pensions minister Steve Webb has weighed in to say he doubts Chancellor Rachel Reeves will dare to wreck people’s retirement plans by lowering the current cap, let alone by abolishing tax-free cash.

‘It would create uproar among those who were close to retirement and had planned their finances around having access to a tax-free lump sum,’ he says. ‘Most people would feel that a change like this was like “moving the goalposts” and was fundamentally unfair.’

If Reeves does defy warnings to leave pensions alone, Webb believes transitional protections will be put in place. But there is no guarantee of that, so many who are eligible to take tax-free cash are wondering whether to take pre-emptive action.

We asked industry specialists AJ Bell, Aviva, Royal London, People’s Partnership and Lane Clark & Peacock to explain how the process works. 

Should you take tax-free cash?

Taking up to 25 per cent from your pension savings free of tax is a popular perk at retirement, and savers may use it to clear remaining mortgages and other debts, splash out on home renovations and new cars, or book a dream holiday.

With pensions due to be pulled into the inheritance tax net from April 2027, some are also taking out cash to give away early. If you give money away and survive seven years it typically falls outside of inheritance tax. Experts say savers must balance this carefully against damaging their own retirement through depleted funds.

For some people taking the cash could pay off, especially if they planned to do so anyway in the next year or so and want to spend the money for a specific purpose.

Getting shot of a mortgage is a common reason that makes financial sense. Fulfilling cherished goals like going on a special holiday is something you might never get another chance to do.

For others, taking out a large sum could backfire, because tax-free withdrawals are irreversible and they may miss out on future investment growth by shifting funds out of their pension.

But deciding to hold off means banking on the rules not changing, which is also a risk.

Decide how to take your cash

Those with defined benefit work pension schemes have a commitment from their former employer to pay them a retirement income. They can take a 25 per cent tax-free lump sum but it will lower their future annual income. Their pension scheme will confirm the exact figures.

As soon as you take the tax-free lump sum from this kind of pension, the payments will start too. The rules and process for taking tax-free cash in these schemes are explained separately below.

Meanwhile, turning a defined contribution work or personal pension into retirement income usually involves either buying an annuity – a financial product that provides an income for life – or remaining invested and making withdrawals to fund retirement.

You have three options open to you to get tax-free cash.

You can take the 25 per cent and use the remaining fund to buy an annuity; take 25 per cent and leave the rest of the cash invested in a process called drawdown; or leave the whole pension invested but each time you make a withdrawal 25 per cent is tax-free and the other 75 per cent is taxed.

You could also withdraw your entire pension, with the first 25 per cent tax-free and the rest taxed. But this could leave you with a large tax bill.

Clare Moffat, a tax and pensions expert at Royal London, says: ‘When you take tax-free cash, something else must happen.

‘You can’t take tax-free cash without moving the rest into drawdown, buying an annuity or taking a taxable amount alongside it. It’s…