Individuals who withdraw large sums from their pension pots may be facing unexpectedly high income tax bills, according to new research. Analysis of official data indicates that savers cashing in pension funds worth over £100,000 collectively paid £87.2 million in income tax between October 2024 and March 2025, an increase of 20% from the previous year. Some individuals have reportedly been subjected to five-figure tax liabilities after accessing their entire pension in one go.

Standard Life, which conducted the analysis, suggests that upcoming changes to inheritance tax (IHT) could be a factor influencing some savers' decisions to withdraw funds. From spring 2027, pensions are set to become liable for IHT, similar to other assets like ISAs and property.

Tax Implications of Large Withdrawals

The firm's findings, based on Financial Conduct Authority figures, show that 392 individuals who fully cashed in pots exceeding £250,000 each paid at least £98,700 in tax. Additionally, 1,772 individuals who withdrew entire pots valued between £100,000 and £249,000 paid at least £27,400 each. These figures do not account for taxes on smaller pots or regular withdrawals. Standard Life emphasizes that the final tax bill can be higher depending on an individual's total income for the year.

Withdrawals exceeding the 25% tax-free lump sum are typically treated as income. This can quickly push individuals into higher or additional tax brackets. For example, a full withdrawal of a £174,500 pension pot could result in a tax bill of around £64,700 before considering other income. Larger sums, such as £500,000, could incur over £150,000 in tax, and a £1 million withdrawal could cost over £300,000.

Other Pension Tax Considerations

Savers also need to be aware of the 'money purchase annual allowance' (MPAA). Once taxable income is taken from a defined contribution pension pot, the amount that can be contributed annually while still qualifying for tax relief is reduced to £10,000. While HMRC ended emergency tax for regular withdrawals in April 2025, some individuals making one-off withdrawals may still need to reclaim overpaid tax.

Mike Ambery, retirement savings director at Standard Life, advised caution. "Life doesn’t always follow a set path, and when people reach the point of accessing their pension, there are often a lot of competing priorities," Ambery said. "For some, taking a larger amount upfront will feel like the simplest option, but it can come with a sting in its tail in the form of a higher tax bill than many expect."

He added, "What catches people out is how quickly a single withdrawal can push them into higher tax bands. Taking a bit of time to understand how withdrawals are taxed, and spreading them more carefully, can make a real difference over time."

Strategies to Mitigate Tax Liabilities

Standard Life suggests several strategies to help manage pension withdrawals and minimize tax bills:

  • Monitor Tax Thresholds: Be aware of the higher and additional rate income tax thresholds (which are above £50,270 and £125,140, respectively, excluding Scotland) and how a single withdrawal might push income over these limits. Spreading withdrawals across tax years can help manage this.
  • Factor in State Pension: The full state pension utilizes a significant portion of the personal allowance, meaning additional private pension withdrawals could be taxed from the first pound.
  • Gradual Withdrawals: Cashing out an entire pension pot at once is often the most tax-expensive option. Taking gradual withdrawals can reduce the total tax paid and offer greater flexibility.
  • Strategic Use of Tax-Free Cash: While up to 25% of a pension can be taken tax-free, this does not all need to be taken at once. Phasing tax-free cash alongside taxable withdrawals can help smooth out tax positions.
  • Seek Guidance: Given that pension decisions are difficult to reverse, seeking guidance or professional financial advice before making significant withdrawals is recommended. Fully withdrawing funds may also restrict future pension contributions due to the MPAA.