The chancellor’s refusal to rule out the policy ahead of the Budget last year fuelled a surge in pension withdrawals

Taking the 25 per cent tax-free lump sum from your pension early can cost you thousands of pounds across your retirement as a result of lost investment growth, analysis shows.

In the lead-up to the last Budget, and to this one, some pensioners have acted on rumours that Chancellor Rachel Reeves will cut the amount of cash that can be taken from pension pots without cash being owed.

But research from pension firm Standard Life shows how taking the cash early can damage pensioners financially, because the longer they leave their pension invested, the bigger it becomes and the more they can take tax-free.

Those aged 55 and above can normally take up to 25 per cent of the value of their pension tax-free, up to a maximum of £268,275. This is set to rise to 57 in 2028.

Reeves has been urged, by think tank The Fabian Society and others, to cut the lump sum to £100,000 – a move she also considered ahead of last year’s Budget.

Savers withdrew over £70bn from their retirement pots in 2024/25, figures from the Financial Conduct Authority (FCA) show, up 36 per cent from the previous year.

Recent reports suggest this change could now be off the table.

How much you lose out on by taking your pension early

Standard Life’s figures show that someone who starts working at age 22 on a salary of £25,000 and pays the minimum auto-enrolment contributions could see their pension grow to £128,800 by 57, once salary growth of 3.5 per cent a year and investment growth of 5 per cent a year are factored in.

If they took their 25 per cent tax-free lump sum at 57, they could get around £32,000.

If they waited until they were 62, their pension could grow to £161,400 and they could be able to withdraw £40,350 tax-free.

But if they waited until they were 68, they could amass a pension worth £210,000, and be able to withdraw £52,500 tax-free.

Mike Ambery, retirement savings director at Standard Life, said: “Taking money out of your pension early can mean missing out on years of potential growth, and that can have a surprisingly large effect on your eventual retirement income.

“The power of compounding is often underestimated – even small decisions made years ahead of retirement could add up to tens of thousands of pounds over time.”

Once removed, the money cannot go back in

After last year’s Budget, some firms allowed those who took their cash and regretted it in the light of the lack of policy change to put their money back into their pension and undo their decision. They were able to do this under rules that allow cancellation of certain actions within 30 days of it being taken.

But new guidance from HMRC has cast doubt on whether this will be allowed in future.

Statements from the taxman and the FCA in September suggest many decisions to take out a pension will not be covered by the 30-day rules, and that some individuals could be treated as having used up some of their lifetime lump sum limit of £268,275, even if the money has gone back into their pension.

In a newsletter at the time, HMRC said: “If an action has resulted in a tax consequence, and an attempt is made to reverse the action, normally the resulting tax consequences cannot be reversed. The tax consequences will normally stand.”