Nicole García Mérida
After cost-of-living struggles in recent years and the prospect of higher tax bills, older workers may feel tempted to cash in their pension early to access some extra money.
The rate of inflation may have slowed from the double digits of early 2024, but interest rates remain relatively high at 4.75%, making it expensive to borrow compared with recent years.
Meanwhile, household costs such as council tax and energy bills have risen, and frozen tax thresholds – as well as higher capital gains tax rates introduced in the Autumn Budget – continue to put pressure on people's finances.
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Retirement costs have soared in recent years, meaning many people are already facing the risk of pension shortfall. Accessing your pension pot early could exacerbate this risk – particularly with people living longer than ever before.
The cost of a comfortable retirement has now hit £43,100 per year for a single-person household, or £59,000 for a two-person household, according to the Pension and Lifetime Savings Association.
When can I take my pension?
If you have a private pension, you don’t need to wait until state pension age to access it, but you should think carefully about what approach is right for you before making any irreversible decisions.
Currently, you can start drawing on your private pension after you turn 55 – although this will increase to 57 in 2028. At this point, you can withdraw up to 25% of your pension pot tax-free, either as a lump sum or in instalments.
The amount of tax-free cash you can withdraw under the 25% rule is capped at £268,275.
When it comes to the other 75% of your pension pot, you have a range of different options:
Annuities
You could use your pension savings to buy an annuity. This will provide you with a regular guaranteed income for the rest of your life or for a set number of years, depending on the type of annuity you purchase.
For a long time, annuities were an unattractive option due to low interest rates, but they have surged in recent years after the Bank of England hiked the base rate 14 times between December 2021 and August 2023.
A total of 82,061 annuities were sold in 2023/24, up 39% compared to a year earlier, according to the Financial Conduct Authority (FCA). This reflects the better value for money they now offer.
However, buying an annuity is an irreversible decision, so you should conduct thorough research before making a decision and consider taking financial advice.
For example, not all annuities can be passed on to your partner if you die, unless you opt for a dual-life annuity. The rates on dual-life annuities are often lower than those on single-life products.
It is also important to shop around to secure a competitive rate.
Pension drawdown
Pension drawdown is where you leave some money invested in the hope it will grow, and take a regular income directly from the fund. This approach gives you more flexibility compared to buying an annuity, which is an irreversible decision.
The drawback is that it offers less certainty, as you don’t know which direction markets will move in, meaning the value of your pension pot could go down at times as well as up.
With drawdown, you also need to consider how much cash you want to take out and at what intervals. You will need to make an assessment about your own longevity to reduce the risk of depleting your pot prematurely.
A combination of drawdown and annuity
It is possible to do a combination of the two approaches, using some of your pension pot to buy an annuity and leaving the remainder in drawdown. This can offer a good balance for some retirees.
Leave it invested
Another option is not to release your cash at all and instead let it increase in value until you decide you want to dip into it.
If you are still working beyond age 55 or have sufficient savings tucked away elsewhere to fund the start of your retirement, it might make sense to draw on other money first.
Under current rules, pension pots sit outside of your taxable estate for inheritance tax purposes, but this is set to change from April 2027 after changes announced in the Autumn Budget.
Historically, this IHT perk has made pension pots a tax-efficient way to pass on wealth after you die, but we could see a change in pension behaviour in light of the changes.
Watch out for retirement regret
Accessing your pot too early could mean running out of money later in your retirement.
Around one in 10 retirees aged 55 and older who withdraw money from their pension before leaving full-time work regret it, according to research by retirement specialist Just Group.
Its survey of more than 1,000 people found that 28% had withdrawn pension cash between the age of 55 and when they finished working full time, either as a lump sum or through income drawdown. Almost half said they received no financial advice or guidance.
Meanwhile, the FCA’s latest retirement income market data shows that, in 2023/24, the number of people accessing their pension plan for the first time increased by 19.7% compared to the previous year.
“This substantial increase indicates that more individuals are turning to their pensions to manage their financial needs, likely influenced by the cost-of-living crisis forcing people to dip into their pension pots to supplement other forms of income,” says Jon Greer, head of retirement policy at wealth management company Quilter.
He adds: “As more people access their pension savings earlier, it becomes increasingly important for individuals to consider the long-term impact of their decisions, particularly as the number of people opting out of advice continues to rise. Many retirees may struggle to ensure their income lasts throughout retirement.”
Worryingly, the FCA’s data shows that the number of people taking advice is actually falling. Only 30.9% of those who accessed their plan for the first time in 2023/24 took advice, according to the industry watchdog, down from 32.9% the year before.
Can I cash in my pension early?
If you want to cash in your pension before you hit 55, it gets a bit more complicated and is almost always inadvisable.
“There are only a few instances where savers can release their pension before the age of 55, such as extreme ill health or terminal illness,” says online pension service PensionBee. “If none of these circumstances apply, HMRC may view the early pension release as unauthorised, imposing a 55% tax charge on the amount withdrawn. No reputable pension provider will approve an early withdrawal unless these conditions are met.”
In other words, while it might be tempting to look at your pension pot as a way to boost your income throughout the cost-of-living crisis, the fact is you would almost certainly be losing out.
Because of the hefty HMRC charges, most pension providers won’t help you release your pension early. Instead you would have to turn to a third party who could charge up to 30% to do so.
There is an increased risk with this too – most of the firms that arrange early pension release aren’t FCA authorised and so your money isn’t secure, says PensionBee.
In other words, trying to cash in your pension before you hit 55 is almost always a bad idea. Not only will it expose you to significant risk, it will also result in you giving up a large sum of your hard-earned money in exchange for a small fraction now.
Be wary of pension scams
“There are numerous pension scams which claim to help savers access their pension before the age of 55 by exploiting loopholes in the system,” warns PensionBee.
“Unless a saver meets some of the above criteria or has been explicitly informed by a provider that they qualify for early pension release, savers should never trust a third party to withdraw their pension on their behalf.”
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