Withdrawing your pension

When and how you choose to withdraw money from your pension is a big decision. Whether you’re planning to enter into a pension drawdown arrangement, buy an annuity or take the whole amount as a lump sum, there are various factors you’ll need to consider.

In this article, you’ll learn more about taking money out of your pension, including when you make a withdrawal, how it works and the potential tax implications. We also look at some of the other ways you can boost your retirement income, such as by opening a high-interest savings account.

If you’re a member of a defined pension contribution scheme – you may also have heard this called a ‘money purchase’ pension – you can normally start making withdrawals after your 55th birthday. This type of scheme might be a personal pension that you’ve set up yourself, or a workplace pension arranged by your employer.

The minimum age for making withdrawals from a defined benefit pension or ‘final salary’ scheme is typically 60 or 65, although this can vary depending on your particular scheme.

While you might currently be able to withdraw from your pension as early as age 55, that doesn’t necessarily mean you should. The earlier you start making withdrawals from your pension, the longer your pension pot will need to last and the less money you’ll have to fund your retirement years. 

It’s also worth noting that the government intends to increase the normal minimum pension age from 55 to 57 in 2028. From this point onwards, the age at which you can start making pension withdrawals will be 10 years below the state pension age.

While most people can’t access their pension before the age of 55, there are some circumstances in which it may be possible to withdraw your pension early. For example, you might be able to start taking money out of your pension if you’re forced to retire early due to ill health. 

Your pension provider will have their own definition of ill health. You may also be able to get an ill health pension if you can’t continue to carry out your job because of your illness, whether it’s physical or mental.

If you’re aged under 75 and are diagnosed with a terminal illness that means you aren’t expected to live for more than a year, you may be able to withdraw your entire pension as a tax-free lump sum. It might also be possible to withdraw your pension early if you have a lower than normal retirement age, for example, because you’re an elite sportsperson.

If you have a defined contribution scheme, you can withdraw up to 25% of your pension tax-free after your 55th birthday. You can choose to take this as one lump sum or break it down into smaller instalments. Everyone – no matter how big or small their pension pot is – is entitled to withdraw a quarter of their savings without paying tax.

The remaining 75% of your pension pot is subject to income tax, so you’ll need to think carefully about what you do with it. You could, in theory, withdraw the whole amount as a single lump sum, but this will usually result in a very large tax bill. 

You’ll also need to consider how you’ll use your lump sum to fund your retirement, especially if it’s your only pension. For this reason, most pension providers will normally advise you against withdrawing the whole amount as one lump sum. Not all pension schemes give you the option to withdraw your entire pension in one go, so you may need to switch to a different provider if you do choose to take this route.

Once you’ve accessed the 25% tax-free cash portion of your pension, you’ll need to decide how you plan to turn the remaining 75% into a retirement income. If you have a defined contribution pension, your main options are:

• Withdraw the whole amount as a cash lump sum, although this could result in a hefty tax bill.
• Buy a product known as an annuity. This will provide you with a fixed income that’s guaranteed for the whole of your retirement. If you choose this option, it’s important to shop around to find the best product for your needs.
• Make regular withdrawals as and when you need to while leaving the rest of the money invested in the pension (commonly known as income drawdown or flexi-access drawdown). 
• A mix of the above.

There are pros and cons to each option, and the most suitable strategy will depend on your individual circumstances. If you’re unsure which path is best for you, speak to an independent financial adviser. 

If you’re a member of a defined benefit pension scheme, you’ll be paid an income for life. The amount you’ll receive will depend on whether you have a final salary or career average pension. Some schemes will also give you the option of taking a tax-free lump sum alongside this.

How can I avoid paying too much tax?

You can help to minimise the amount of tax you pay on your pension withdrawals by only taking out as much as you need in any given tax year.

If you do want to take out a large amount, it might be better to stagger your withdrawal over several years to avoid paying too much tax. An independent financial adviser can help you devise a tax-efficient pension withdrawal strategy that works for you.

Withdrawing money from your pension is an important and irreversible decision, so you’ll need to think carefully before taking action. Ask yourself the following questions:

If you choose to withdraw a lump sum, it will normally take about four to five weeks to receive the funds following your request. This can vary, so it’s a good idea to check with your pension provider for details of their specific timescales.

The tax you pay on your pension income depends on how and when you choose to withdraw your money, so it’s important to avoid rushing into any decisions before you fully understand the repercussions.

As we’ve already explained, under the current pension withdrawal rules you can access 25% of your pension tax-free. After this, the remaining 75% will be subject to tax at your normal rate of income tax. As a rule of thumb, the money you receive from your pension is treated in the same way as the other income you earn.

So if you’re a basic rate taxpayer, you’ll pay 20% on pension income over the personal allowance (£12,570 in 2024). Higher rate taxpayers pay income tax at 40%, while additional rate taxpayers are subject to tax at 45%. Bear in mind that withdrawing a large lump sum could push you into a higher tax bracket, meaning you’ll be taxed at a higher rate.
The rate of tax you’ll pay on pension savings over your lifetime allowance will depend on how the money is paid out.

Of course, taking money out of your pension isn’t the only way to boost your retirement income. Many people choose to continue working part-time to supplement their income and preserve their pension pot.

You might also want to consider individual savings accounts (ISAs), which provide a tax-free way to save. You can save up to a maximum of £20,000 per tax year (traditionally 6th April to 5th April), and you can choose from different types of ISA.

Another way to increase your income is to put money into a high-interest savings account, such as a fixed rate bond. They tend to pay higher interest rates than other types of savings accounts in exchange for you locking your money away for a set period–typically between six months and five years. Plus deposits made into savings accounts provided by UK-regulated banks are protected under the Financial Services Compensation Scheme (FSCS), so there’s no risk of you losing your money.

However you choose to boost your retirement income, it’s important to start saving as soon as you can. To view competitive savings accounts from a range of partner banks, simply register for a Raisin UK Account and apply for free online today.