People rushing to make decisions may not realise the implications it has on their financial future
There has been a rise in people taking a lump sum out of their pension ahead of the Budget, amidst fears there will be changes to the way they are taxed.
The Financial Conduct Authority (FCA) recently revealed that the overall value of money being withdrawn from pension pots increased to £70.88bn in 2024/25 from £52.15bn in 2023/24 – an increase of 35.9 per cent.
Although experts say an annual increase would be expected as more people reach retirement, the jump is more substantial than in previous years.
For some, taking out a lump sum will have been part of their long-term financial plan, but experts warn others may be accessing it out of fear their money will be taxed by Rachel Reeves come November.
Below, we take a look at how you can take a lump sum, the benefits and the risks.
How does taking a lump sum work
The pension commencement lump sum allows people to withdraw up to 25 per cent of their pension pot tax-free, currently capped at £268,275.
It is a popular option for retirees looking to pay off mortgages, support children financially or invest in inheritance tax-efficient vehicles.
With the Chancellor under pressure to boost tax revenues, speculation is mounting that changes could be on the horizon.
There are many reasons why people may choose to take money out of their pension, including to clear debt or support their family. For example, parents and grandparents often want to help with house deposits or other financial pressures.
Other people may access money to bridge the gap between receiving the state pension and their private pension.
However, there are concerns that people may be taking money now, too, as they are concerned about their pensions being taxed further in the Budget.
The inclusion of pensions in the inheritance tax (IHT) net as of April 2027 could also be encouraging more people to spend their pension or withdraw earlier than previously expected.
Andrew King, retirement specialist at wealth management firm Evelyn Partners, said: “As it seems the Treasury is unable or unwilling to put such rumours to bed, you can only assume the increase in pension withdrawals is going on as we speak, and at Evelyn we’re having conversations with clients about the wisdom or otherwise of drawing down more heavily from their pensions or taking their 25 per cent tax-free cash.”
What are the risks of taking a lump sum
People rushing to make decisions may not realise the implications it has on their financial future, experts warn.
Helen Morrissey, head of retirement analysis at Hargreaves Lansdown, said: “Taking the cash solely in response to Budget speculation may be an action you later come to regret. In the run-up to the last Budget, people rushed to take their tax-free cash and then the change did not happen.
“Many thought they could simply cancel their instruction, only for HMRC to confirm that they would not be able to do so, while reinvesting it back into their self-invested personal pension (SIPP) leaves them at risk of falling foul of pension recycling rules that could leave them with a nasty tax bill.
“Pensions are extremely tax efficient and taking the money out may also expose it to taxes that it may not otherwise be subject to – such as capital gains or dividend tax. Some will have been able to reinvest in a stocks and shares ISA but there will have been many who found themselves with money that they didn’t need to take and were now wondering what to do with it.”
Some firms allowed those who took their lump sum, 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 this week 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.
Jamie Jenkins, director of policy at Royal London, added: “While, for some people, this may be simply a function of bringing forward their plans by a few months, for others, it could have more significant implications.
“For example, some people may still be saving towards their retirement, and taking 25 per cent tax-free now could be worth less than had they left it until their overall pension pot grows further.”
He said that if the money is not needed immediately, holding it in a bank account may depreciate its value over the years that follow, instead of remaining invested in their pension and benefiting from potentially higher returns.
Should you take a lump sum ahead of the Budget?
Whether you take a lump sum or not will depend on your specific circumstances.
Experts say at the very least, people should do their research but ideally seek professional advice, especially if dealing with a large pot of savings.
Rachel Vahey, head of public policy at AJ Bell, said: “People should take care not to be pushed into a knee-jerk reaction. What’s best for them depends on their own position, needs and wants.
“People should think through what they will do with their tax-free cash. Removing it from a tax-advantageous environment to move somewhere where it’s less tax efficient will probably not make sense. So if they don’t have any immediate need to spend the cash, having a robust plan for its future investment is essential.
“Taking tax-free cash is the one part of pensions Brits both understand and value. It can often be emotive – cash lump sums can help us achieve our goals. But people need to take the emotion out of the decision and work out the best solution for them.”