Is it utter madness to take your pension tax-free lump sum now?
Clients are worrying about changes to the tax-free pension lump sum and are considering taking it now. However, as one client asked David Goodfellow, Head of Wealth Planning: “Is this mad thinking?”
Quick summary: Why acting on speculation could cost you
Why reacting to pension tax speculation may be premature, with changes unlikely before April 2026.
2. Three important reasons not to panic
The risks of giving away money too early, moving cash into a taxable environment, or not being able to provide for future care options.
3. Act now if you have plans already in progress
Why you should take action if you already have a clear plan underway.
4. Make the most of all current tax rules
How we can help with broader tax planning, including inheritance tax mitigation.
Will Labour scrap the tax-free pension lump sum?
Many clients are feeling apprehensive about potential changes to pensions amid a shifting tax backdrop. Since the Labour Government’s election in mid-2024, uncertainty has persisted - a period that could extend into late 2025 and beyond. The Autumn Budget, now pushed back to 26 November, prolongs this period of uncertainty but provides additional time for clients to plan carefully.
If you’re considering taking your pension tax-free lump sum just because you’re nervous about what the government might do to current pension rules - but have no other specific reason or goal for doing so - here’s why it could be a mistake. We might even call it ‘mad thinking’ depending on your personal circumstances. Acting solely on speculation could have far-reaching consequences for the rest of your life.
Even if the Chancellor proposes some changes at the end of November, we believe they are unlikely to take effect until April 2026 (or later) meaning you still have plenty of opportunity to consider your options with more certainty and insight. At the moment, there are some very strong reasons why we think taking your tax-free pension lump sum right now could be a costly mistake.
In this article, David Goodfellow, Head of Wealth Planning, explains why and how you can use this period to plan with purpose instead.
Three important reasons why you shouldn’t take your tax-free pension lump sum now
Reason one: avoid knee-jerk gifting of your tax-free pension cash at the cost of long-term security
If you weren’t already planning to pass on money to your children imminently, to do so now by taking your tax-free lump sum, could leave you much worse off in the long run.
A tax-free lump sum of £250,000 given away now in your late fifties, for example, could be worth £370,000 ten years later assuming an annualised, compounded 4% return or nearly £450,000 assuming an annualised compound growth of 6%. That’s a lot of potential capital growth you’d be giving up which you might need for later life care, for example.
You’d also be cutting into the income that same fund could provide you to live the life you want. Assuming withdrawals of 4% per annum, this could reduce your income by £15,000 and £18,000 respectively.
That said, gifting income can be an excellent tax mitigation strategy when it’s part of a clearly defined plan. We can help you put a plan together, including a cashflow forecast to see how much money you will need, when it might run out and/or what you could afford to give away if you wanted to.
We can also help you organise your gifting, with a timing plan, trust structure or letters of intent (for example, to protect your intentions in the event of next generation divorce). If you decide you still want to give it away, let us help you do it properly.
Key take away
We’d warn against knee-jerk gifting just because of Budget speculation as it risks leaving a gap in your own finances that will be difficult to unwind.
Reason two: avoid moving your tax-free pension cash into a taxable environment
You might be thinking about taking your tax-free lump sum but have no immediate plans to spend or give it away. You might still be working and earning and not planning to fully retire any time soon.
If you plan to simply reinvest your lump sum, it will now be outside your tax-efficient pension structure and most likely sitting in a general investment account in a taxable environment. In making this decision, it’s important to understand the potential impact on your investment returns and capital growth.
Money left inside a pension grows free of income tax and capital gains tax (CGT), which is why a pension is still such a useful tax mitigation strategy. Meanwhile, for most other general investments (excluding ISAs), the tax-fee capital gains allowance has been cut considerably to only £3,000 per year.
Based on our earlier example, if you leave your £1m pension intact and fully invested, the 25% lump sum equivalent (£250,000) could grow to around £450,000 tax free over the next ten years at 6% annual, compounded growth.
Instead, if you were to take out the £250,000 and reinvest it in a general investment account, any capital growth on this amount would be subject to CGT. This has the impact of reducing the effective rate of return to around 4.5%, leaving your investment worth about £388,000 - a significant £62,000 difference.
Of course, it is different if you have longstanding plans to spend your lump sum and the timing works. But before you act hastily just to avoid a potential tax change and blow it all on a sports car or round-the-world cruise, let us help you forecast the impact of drawing and spending your lump sum.
We can help you put together a plan to make sure you have enough to live your whole retirement as you want, not just the next year. After all, you might live for the next 30-40 years. The same applies if you are considering paying off any outstanding mortgage. We can help you calculate the difference between the interest you’re paying on your mortgage vs. the potential return on your pension - and when might be the best time to clear your debts.
Key take away
Acting prematurely purely because of speculation about Budget changes and moving money outside your pension, only to reinvest it, risks undermining your long-term retirement security.
Reason three: avoid taking your lump sum now when you might need to buy a care annuity later
There are other longer-term considerations, especially if you are thinking about gifting or spending your lump sum which could mean it is a risky strategy for your long-term financial security and peace of mind.
For example, we work with clients and their families who want to buy an annuity which will guarantee the income they need for later life care, whether care home fees or in-home care. With care fees rising all the time and some costing over £10,000 per month,1 you may need a significant amount of capital to buy an annuity in the future.
If you’ve already given the money away, you may no longer have sufficient funds or contingency to do this, limiting your options and choice of care. Instead, let us work with you to explore what this might cost and help you decide how comfortable you feel about your future.
Key take away
Acting purely out of Budget speculation or short-term concerns could leave you exposed when you need your pension most.
Get on with it if you’re already in the middle of planning based on current tax rules
While this article concentrates on the tax-free lump sum, there are many areas where speculation is rife which could lead to knee-jerk reactions, unintended consequences or weaker outcomes. And so, we urge you to think very carefully before taking a new action you are only considering because of Budget concerns and surrounding speculation.
However, if you are already in the process of a transaction, making a gift or reorganising assets, we would recommend ‘getting on with it’. To ensure you’re making the most of the current rules and tax mitigation strategies, we can provide advice and recommendations, act as a sounding board and help with all the paperwork to expedite your plan before the rules change.
Take advantage of all the current tax rules – and don’t forget about inheritance tax
In all the noise about pensions and the tax-free lump sum, it’s easy to forget about other wealth planning strategies which can help mitigate other potential tax liabilities like inheritance tax.
For example, we’ve recently advised business owners who sold their company earlier this year and now hold the sale proceeds personally. As things stand, those funds fall into their estate for inheritance tax (IHT) purposes, but by reinvesting some or all those proceeds into assets that qualify for Business Relief (BR) within three years, they can regain an IHT exemption straight away.
Taking this further, those assets could be placed into a discretionary trust. There are significant tax complexities associated with doing this, but they could benefit from a considerably discounted tax IHT charge when putting their assets into a trust or, if the assets qualify for BR, there would be no IHT to pay on entry.
This is obviously a very specialist wealth planning area, but one where we have considerable expertise. In the same spirit, we are currently working with clients in lots of different situations to review their wealth plans and ensure they have the right strategies in place before the Autumn Budget on 26 November – whatever happens.
This is the kind of forward-looking, advice-led proactiveness we wish to offer our clients to achieve better outcomes – sensible planning grounded in the rules we know today, rather than speculation.
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