Savers cashing in large pension pots are facing substantial, and often unexpected, income tax bills, according to new research. Analysis of official data indicates that individuals withdrawing pension funds exceeding their 25% tax-free lump sum risk being pushed into higher tax brackets and may face limitations on future pension tax relief.
Between October 2024 and March 2025, individuals who cashed in entire pension funds of £100,000 or more paid a collective £87.2 million in income tax. This figure represents a 20% increase compared to the previous year, with some individuals incurring five-figure tax bills after accessing their pensions in a single transaction. The study by Standard Life suggests that many retirees may have paid significantly more tax than anticipated.
While the specific reasons for these large withdrawals are not detailed, Standard Life speculates that upcoming changes to inheritance tax (IHT) that will include pensions could be a contributing factor. The government announced in the autumn 2024 Budget that pensions will be subject to IHT, similar to assets like ISAs and property, starting in spring 2027. This impending change may prompt some savers to consider withdrawing funds earlier, even if it means paying income tax, to avoid potential IHT liabilities later.
Tax Implications of Large Withdrawals
The analysis revealed that 392 individuals who fully cashed out pension pots exceeding £250,000 paid at least £98,700 in tax each. Furthermore, 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 tax on withdrawals from smaller pots or regular, ongoing withdrawals.
The final tax liability for individuals cashing in their pension in one go is dependent on their overall income for the tax year. For example, someone fully withdrawing a pension pot of £174,500 could face a tax bill of approximately £64,700 before considering other income. Similarly, a £500,000 pension withdrawal could incur a tax bill exceeding £150,000, and a £1 million withdrawal could cost around £300,000 in tax.
Pension Tax Traps and Advice
Beyond immediate income tax, savers need to be aware of other pension tax complexities. The 'money purchase annual allowance' (MPAA) limits annual tax relief to £10,000 once an individual starts making taxable withdrawals from a defined contribution pension pot. This is a reduction from the standard annual allowance.
Mike Ambery, retirement savings director at Standard Life, advised caution, stating that decisions about pensions can be difficult to reverse. He highlighted how a single large withdrawal can quickly push individuals into higher tax bands, significantly increasing their tax burden. Spreading withdrawals across different tax years is recommended as a strategy to manage tax liabilities more effectively. He also pointed out that individuals receiving a full state pension may have limited headroom within their personal allowance, meaning additional private pension withdrawals could be taxed from the first pound.
Ambery emphasized that withdrawing an entire pension pot at once is often the most expensive tax option and can lead to a loss of potential investment returns. He suggested that phasing withdrawals, carefully utilizing the 25% tax-free lump sum, and considering guidance or financial advice before making significant decisions can help mitigate unexpected tax bills and preserve long-term financial security. Decisions about pensions can be difficult to reverse, so it is crucial to understand the implications before making a withdrawal. Accessing all of one's pension at once could also restrict future contributions due to the MPAA.