Taking cash from your pension pot
Last updated 6 April 2016
You can often draw out some or all of your pension savings as cash lump sums even if you are not ready to retire.
If you have the type of pension scheme where you build up your own pot of savings (defined contribution scheme), once you reach age 55, you can draw out some or all of your savings as cash either at retirement or before then.
In addition, if you have small amounts of pension savings in any type of pension scheme, you can take the whole lot as cash.
Cash before retirement
If you have a defined contribution scheme and don’t want to start a pension yet, you might still find it handy to draw out one or more cash lump sums. You could even cash in your whole pension pot. Withdrawals like these are called ‘uncrystallised funds pension lump sums’ (UFPLS).
A quarter of each lump sum is tax-free, but the rest is taxed as income. For example, suppose your salary is £30,000 a year and you decide to draw £50,000 out of your pension pot. In 2016-17, you would pay tax of £3,880 on your salary (the first £11,000 is covered by your tax-free allowance and you pay 20% tax on the rest). Tax on the £50,000 lump sum is £12,400 because, although a quarter is tax-free and part of the rest is taxed at 20%, some of it falls into the next tax band and is taxed at 40%. This means that, after-tax, your lump sum is only £37,600.
The pension provider will deduct tax from the lump sum before paying it to you and may have to use what is called an ‘emergency tax code’. This can result in too much tax being deducted in which case you will need to claim a refund from HM Revenue & Customs.
Cash at retirement
When you are ready to start an income, you might use your pension pot to buy an annuity (a secure income for life) or go into drawdown (a more flexible arrangement that lets you draw out income and lump sums).
Either way, you can take up to a quarter of your pension pot as tax-free cash before you buy the annuity or start drawdown.
Cash during retirement
Once you are in drawdown, the full amount of any lump sums you draw out is taxable.
For example, if you have a pension pot of £100,000, you can take a quarter of it, £25,000, tax-free at the start. If later on, you draw out £25,000 and it is taxed at 20%, you would pay £5,000 tax and receive an after-tax sum of £20,000.
Restriction on the amount you can save
Pension schemes have tax incentives to encourage you to save.
This includes tax relief on contributions up to the greater of £3,600 a year or the value of your UK earnings. There’s also an overall cap, called your annual allowance, of £40,000 a year. For example: if you earn £30,000 a year, you get tax relief on savings up to £30,000; but if you earn £70,000, you get tax relief on savings up to £40,000 a year.
From April 2016 the £40,000 annual allowance is reduced if you have an income of over £150,000 including pension contributions.
If you draw out lump sums using UFPLS or drawdown, your annual allowance is reduced so that the maximum you can pay into any defined contribution schemes becomes just £10,000.
This restriction may be important if you are planning to save extra in future to replace a lump sum that you have drawn out today.
You can save more that this into your pension if you choose but you won't get tax relief on your contributions.
From age 55, if you have a pension pot worth no more than £10,000, you can cash in the whole lot. You can do this with up to three personal pension pots and any number of other pension schemes.
If you are in the sort of workplace pension scheme that promises you a set level of pension (a defined benefit scheme), provided this pension plus any other pension savings come to no more than £30,000, you can swap the whole of the promised pension for cash.
In either case, a quarter will be tax-free and the rest taxable.
When you use these rules, there is no reduction in your annual allowance, which stays at £40,000.
Guidance and advice