Ruth Jackson-Kirby
Tim Leonard
As you approach retirement, you will need to think about how to cash in your pension. Once you turn 55 you can access the money you’ve worked so hard to save, but what are your choices for cashing in and how best can you provide for your retirement?
New rules introduced in 2015 gave retirees more freedom over how a pension could be accessed. They apply to any defined contribution personal pension you may have had through work or set up yourself, but don’t cover defined benefit pensions like final salary schemes which pay you an income automatically when you retire.
How can I cash in my pension?
When you reach age 55 – or age 57 from 2028 – your key options for cashing in your pension and generating an income from a defined contribution pension are to:
Take your pension as cash
The first option is to take some or all of your pension as cash, to do with as you want. Up to 25% of your pot can be withdrawn tax-free – this is called the pension tax-free lump sum.
However, if you take anything more it will count towards your income for the year and be taxed as earnings at your marginal rate of 20%, 40% or 45%, depending on your total annual income.
Care is therefore required to avoid a significant tax bill, but there’s also the risk of leaving yourself financially short in later life if you’re not careful with the cash you take and have no other retirement income to fall back on.
Go into income drawdown
Alternatively, you can leave your pension invested and take a regular income from it, often switching into investments that focus on paying dividends.
Known as going into drawdown, this option means you can choose how much income you need and when you need it and leave the rest of your pot invested to hopefully carry on growing. Although this option offers maximum flexibility over your pension savings and can help with tax planning, there is a risk that your money could run out if you take too much too early or your investments underperform.
» MORE: Pension drawdown explained
Buy an annuity
The final option is to use some or all of your pension to buy an annuity. This is an insurance policy that guarantees you an income for the rest of your life – no matter how long you live, or for a fixed period of time as is the case with fixed term annuities.
An annuity can offer peace of mind that you’ll always have a certain level of income to rely on which won’t be affected by what happens in the stock market. The potential drawbacks are that you’re tied into the first annuity that you buy and if you die early you might not realise the full financial benefit of your pension savings.
» MORE: Learn more about annuities
Adopt a pick and mix approach
If none of the options are entirely suitable on their own, it might be possible to split the pension pot that you have, and opt for a combination of an annuity, drawdown and cash.
For example, you may decide to take some cash to pay for home improvements, take out an annuity to ensure your regular bills are paid, and also leave some money invested for further growth.
However, making any decision over accessing your pension should never be taken lightly, and seeking pension advice will almost always be worth your while.
Can I cash in my pension early?
In general, you cannot access your pension before you turn 55. However, there are a few exceptions.
You may be able to access your pension early if:
- You can’t work because you’re too ill.
- You’re expected to live for less than a year.
- You work in a profession with a lower than normal retirement age, such as an athlete.
If you access your pension early without meeting the above criteria you could face a tax charge of up to 55% of the amount you withdraw. On top of that you may face fees from your pension provider.
If someone contacts you out of the blue saying they can help you access your pension early it is likely to be a pension scam.
Can I sell my pension?
No, you cannot simply sell your pension. Your options for a defined contribution pension are to purchase an annuity, enter drawdown or access the cash it holds.
You cannot sell a defined benefit pension either.
If you’re contacted by someone who suggests they know a way you can sell your pension, this will almost certainly be a scam.
How are pensions taxed?
When accessing your pension you can take 25% of the pension you’ve built up as a tax-free lump sum. One option is to take the entire tax-free lump sum in one go. Any income you receive either through an annuity or withdrawals you make via drawdown is then subject to income tax at your marginal rate.
Alternatively, if you don’t want to start taking an income from your pension, and so cannot access the tax-free lump sum, you can leave your pension fund invested as it is, but take lump sums when you want to. If you make partial withdrawals in this way – under so-called ‘uncrystallised funds pension lump sum’ rules – 25% of each payment is tax-free, and the rest will be taxed as income, taking any other income you receive into account as well.
The table below shows the income tax bands and rates for the 2023/24 tax year in England, Wales and Northern Ireland (the bands are different if you live in Scotland).
| Total annual income | Tax band | Income tax rate |
|---|---|---|
| Under £12,570 | Personal Allowance | 0% |
| £12,571 to £50,270 | Basic Rate | 20% |
| £50,271 to £125,140 | Higher Rate | 40% |
| Over £125,140 | Additional Rate | 45% |
Other sources of pension income
When you start thinking about accessing your pension, remember to factor any other potential sources of retirement income into the equation as well. In particular, you may have other savings or investments that can deliver an income. You may also be entitled to a state pension and, if you are on a low income, pension credit.
» MORE: Can I get a loan in retirement?
Where to get financial advice about cashing in your pension
Choosing what to do with your pension is one of the most important financial decisions you will make. Because of this it is a good idea to get professional advice or guidance to help you make the best decision for your circumstances.
Everyone aged over 50 with a pension is entitled to a free pension consultation with the government’s Pension Wise service – however, this just provides guidance rather than advice tailored to your individual circumstances.
If you’re willing to pay for bespoke advice from an independent financial adviser, you’ll be getting the best help in making your retirement income decisions.
» MORE: How to get pension advice
Dive even deeper
Pension Annuity: Retire with a Guaranteed Income
Buying a pension annuity with some or all of your pension pot means you can rely on a certain level of retirement income. There are different types of annuity that can provide for your loved ones after you die, pay a higher income if you’re in ill health or smoke, and keep pace with inflation.
Pension Drawdown: How to Take a Flexible Retirement Income
Using pension drawdown to access the money in your pension can provide you with a flexible retirement income. Your pension funds can stay invested to hopefully grow further after you retire. How pension drawdown works means retirement income decisions are firmly in your hands.
The Pension Tax-Free Lump Sum Explained
Pension tax-free lump sum is the name given to the amount of your pension pot that you can withdraw when you access your pension without needing to pay income tax. It might also be referred to as your pension commencement lump sum.