When is the best time to take my tax-free cash and what are my retirement income options?

When is the best time to take my tax-free cash and what are my retirement income options? Four key questions to consider.

By Saroj Ekanayake, Wealth Management Consultant

It’s natural to look forward to finally being able to draw from the savings pot you have worked hard all these years to create. But accessing your pension at the wrong time could cost you thousands of pounds in lost growth and tax efficiency. So, how do you time it right?

Seeking financial advice is highly recommended and at Mattioli Woods, we can provide advice on how and when taking a retirement income will properly fit your financial needs. For now, we examine four key questions to consider when planning the right time to start drawing from your pension.

1. Can I keep contributing into my pension once I start to draw money?

The simple answer is yes, but with a much-reduced limit.

The ‘annual allowance’ – the amount that can be contributed across all your defined contribution pension plans each tax year and receive tax relief – is currently £60,000. For those earning less than this, the limit will be the higher of their relevant UK earnings or £3,600. The limit includes any tax relief and employer contributions.

Under a flexi-access arrangement, tax-free cash can be taken as one lump sum, or in segments as and when you choose. You can continue to contribute to your pension; however, as soon as you take taxable pension income from any defined contribution pension your annual allowance is automatically reduced to a maximum of £10,000, subject to the above earnings rule. This limit is called the money purchase annual allowance (MPAA) and if breached, you will be liable for a tax charge on the excess amount.

The same rules apply if you choose to spread your tax-free cash evenly across all your withdrawals, where scheme rules allow; this is known as uncrystallised funds pension lump sum (UFPLS).

2. When is the best time to take my tax-free cash?

While it’s a strong temptation to access your tax-free cash as soon as possible, it’s important to consider the possible long-term implications on your retirement income.

Maybe you have good reason to withdraw the money – you might want to pay off some debt, help your children with a deposit on a house, or just enjoy that special holiday you’ve been dreaming about! But drawing on your retirement funds early without an immediate need can have a significant effect on your future income.

Leaving money in your pension allows it to reap tax-free growth on its earnings, as opposed to placing the money in a bank account where earnings could be subject to tax. It’s also important to note that, for now, bank deposits are included in your estate for Inheritance Tax calculations, whereas money in your pension is currently exempt (although legislation is due to change in April 2027).

One tax-efficient alternative is to invest the money in an Individual Savings Account (ISA) but there are annual limits to how much you can invest.

If the pension scheme rules allow it, and you’re keen on drawing some funds as soon as you can, consider drawing a smaller portion of your tax-free cash. This will leave the rest to grow tax free to better support you in the future.

Market movements can also be a concern. If your pension savings have dropped in value, taking the money would consolidate that loss. If you don’t need the money immediately, consider allowing time for it to recover before you withdraw any funds. Conversely, for large pension pots, an upward swing in performance might take you over the lump sum allowances, which in itself could cause tax implications.

3. What is the possible impact of taking tax-free cash on my retirement income?

Once you reach the minimum pension age (currently 55, rising to 57 on 6 April 2028), most UK workplace and private pension schemes will allow you to take up to 25% of your pension savings free of Income Tax (capped at £268,275 across all pensions unless you have protected allowances). But by drawing from your pension savings, you automatically reduce the pot’s ability to grow through tax-free investment returns – although of course, investment growth is never guaranteed. Age 55 might be a long time before your formal retirement and could equate to a large loss of potential fund growth and consequently the loss of a greater tax-free amount.

For example: a £70,000 pot at age 55 would provide a 25% tax-free lump sum of £17,500. Whereas, allowing that fund to grow until age 65, and assuming a monthly compounding growth rate of 5% after charges (even with no further contributions), you might retire with a pot of almost £115,300, meaning £28,825 of it is available tax free!*

4. What income options do I have after I take my tax-free cash?

The remainder of your pot can be used to provide you with a retirement income and there are various ways you can do this, depending on the individual scheme rules.

Drawdown

This method has grown in popularity over recent years as it allows you to keep your pension pot invested, with the aim of reaping tax-free investment returns, dividends and interest while drawing a flexible income of your choice. The downsides of this method include the unguaranteed nature of investment returns and the risk that you could take too much money early on, leaving yourself with insufficient income in later life.

Annuity

This option guarantees you an income but requires you to hand over the funds to the annuity provider, who will pay an agreed level of income for the rest of your life. The biggest advantage here is that you know what your annual income will be and it will not be affected by changes in investment markets. The downside is that the money no longer belongs to you.

Uncrystallised funds pension lump sum (UFPLS)

Finally, there’s the option to leave your money in your pension pot and take your tax-free lump sum allowance from it as and when you choose. In this scenario, 25% of each withdrawal will be tax free and 75% will be taxed as earnings.

Thankfully, you don’t have to choose just one of these options – you can mix and match these choices to create an approach that works best for you.

Key takeaways

• Taking taxable pension income reduces your future annual contribution allowance from £60,000 to £10,000
• Waiting to access your tax-free cash could result in a significantly larger tax-free amount available
• Money in pensions grows tax free and is exempt from Inheritance Tax until April 2027
• You can mix drawdown, annuities, and UFPLS options to create a tailored retirement income strategy
• Market conditions, your age and your personal circumstances all influence the optimal timing

Whatever your situation, retirement planning is not straightforward. If you’d like expert guidance tailored to your personal situation, the team at Mattioli Woods is here to help you navigate these options and create a retirement income strategy that truly works for you.

*all figures used are for illustrative purposes only and do not constitute financial advice

Important information 

As with all investments, your capital is at risk. The value of your investments and the income from them may fall or rise and there are no guarantees. Past performance is not a guide to future returns. Tax treatment of investments and income depends on an individual’s circumstances and may be subject to change in future. The content of this article is for information only and does not constitute advice.

All content correct at time of writing.