A rising number of Britons are paying a hefty price for accessing their pension savings early, with tax bills soaring as high as £98,700 for those withdrawing large sums.
A new analysis of Financial Conduct Authority (FCA) figures show that from October 2023 to March 2024, 292 people cashed in pension pots of £250,000 or more, resulting in significant tax liabilities.
This marks a 31.5 per cent increase compared to the previous year and raises concerns about the tax implications for those looking to tap into their retirement funds.
For many, the decision to withdraw their pension pots is prompted by the desire for easy access to cash, but experts warn that the tax hit can often overshadow the benefits of keeping sums invested to grow.
According to the analysis by Standard Life, in the six month-period up to March last year, 292 people withdrew pension pots worth more than £250,000, up from 222 in the previous year.
These high withdrawals are leading to tax bills in the region of £98,700 per person, or more, depending on other income sources, according to the figures.
Additionally, 1,593 people fully withdrew pots between £100,000 and £249,000 – a group facing a minimum tax bill of £27,400 each.
For those taking amounts closer to the £174,500 midpoint of that range, the tax burden is even steeper – a minimum of £64,700.
The figures only take pensions into account, as those with other sources of income at the time of withdrawal would pay more tax.
People can usually take up to 25 per cent of the amount built up in any pension as a tax-free lump sum. The most you can take is £268,275.
Mike Ambery, retirement savings director at Standard Life, part of the Phoenix Group, said the trend was concerning. “A huge number of people are paying a disproportionate amount of tax to access their pension,” he added.
“It’s impossible to know whether their individual circumstances warranted them taking such a big tax hit, but for the vast majority of people, it’s something they’ll want to avoid.”
The impact of new tax rules
The increase in tax bills can be attributed in part to the Government’s decision to lower the additional rate tax threshold – those paying 45 per cent – from £150,000 to £125,140 in April 2023.
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This shift means that those encashing larger pots are now subject to a higher tax burden.
For example, those withdrawing a pension pot of £250,000 now face an additional £1,200 in taxes compared to the previous year, and the tax paid on larger pots in the 2023/24 period is substantially higher than in 2022/23.
Mr Ambery said: “This change in the tax threshold has had a significant impact on those withdrawing larger pots, especially those in the higher income brackets.Pension pots are treated as income by HMRC once the 25 per cent tax-free cash is taken, so those with substantial pots could face a tax hit that wipes out years of hard-earned savings.”
Strategies to avoid excessive tax payments
While the tax consequences of fully encashing a pension can be severe, there are ways to manage withdrawals to reduce the overall tax bill. Standard Life has outlined several strategies that pension holders can use.
One of the easiest ways to minimise tax payments is to work within your annual personal allowance, which for the 2025/26 tax year stands at £12,570. Mr Ambery said: “The simplest way to avoid paying too much tax is to only take out what you need.
“Taking your pension in small, regular chunks can keep your tax bill low. You only pay income tax on any amount above your personal allowance, so if your pension is your only source of income, you could withdraw £12,570 each year tax-free.” However, he cautioned that withdrawing large lump sums all at once could push you into a higher tax bracket, resulting in a much larger tax bill.
2. Combine tax-free and taxable withdrawals
Another way to keep taxes under control is by combining taxable and tax-free portions of your pension pot. You don’t have to take all of your tax-free lump sum in one go – you can usually take it in chunks over a number of months or years.
This strategy, known as tailored drawdown, allows individuals to withdraw from both the taxable and tax-free parts of their pension in a way that keeps them under the personal allowance. For example, you could withdraw £1,000 from the taxable portion and £1,000 from the tax-free portion, ensuring that the total withdrawal stays tax-free.
Those with ISAs should consider tapping into these funds first before touching their pension pot. Unlike pensions, ISAs are not taxed when withdrawals are made. By using ISA savings in the early years of retirement, individuals can avoid drawing on their pension and incurring a tax hit.
4. Consult a pension provider or financial adviser
While these strategies can help reduce tax liabilities, Mr Ambery stressed the importance of seeking expert guidance when making pension withdrawal decisions. He said: “It’s worth speaking to your pension provider about your options, and ideally, seeking professional advice before taking your pension. Not all providers will offer the same withdrawal options, so it’s important to shop around.”
HM Treasury spokesperson said: “This Government is on the side of pensioners and savers. That’s why we encourage pension saving by providing around £70bn a year in pension tax relief to help ensure that people have an income, or funds on which they can draw, throughout retirement.
“For the majority of savers, pension contributions made from income during working life are totally tax-free. It’s also why last month we raised the state pension, which is worth around £1,900 over the next five years.”
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