DIY pension investors take tax-free cash amid switch to ISAs

Fears of further pension reforms in chancellor Rachel Reeves’s Autumn Budget are fuelling a surge in self-invested personal pension (SIPP) savers withdrawing their money, according to data from one of the UK’s largest investment platforms.

Bestinvest said its DIY pension savers made a third more (33%) demands for their money in September, compared to the previous two-year average.

This was largely driven by those aged 55 and over accessing their 25% tax-free cash lump sum, the investment platform said.

MoneyWeek

Subscribe to MoneyWeek today and get your first six magazine issues absolutely FREE

Get 6 issues free

Sign up to Money Morning

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter

Sign up

The size of the pension income withdrawals from SIPPs, known as a pot for life pension, also jumped in September – by 146% – compared to the two-year average for the same month in 2023 and 2024, as retirees cashed out.

Alice Haine, personal finance analyst at Bestinvest by Evelyn Partners, said: “Saving into a pension is a long-term financial goal that requires commitment from a saver but also a stable and consistent approach from the government.

“Incessant speculation around pension changes can have huge repercussions, as it can discourage savers from topping up their retirement pots at a time when they’re already being criticised for not contributing enough.”

Why are investors switching to ISAs?

Uncertainty around the taxing of pensions is seemingly already prompting fewer people to use the traditional retirement product to save for their golden years. Contributions into SIPPs slowed to increase by just 3% last month, Bestinvest reported.

Meanwhile ISA contributions rose by 38% in September compared to the previous two-year average for the same month on the online investment platform. The move is thought to reflect savers reconsidering their retirement saving habits now unused defined contribution pensions will come under the scope of inheritance tax from April 2027.

Though ISAs are also subject to inheritance tax, unlike pensions, they can be spent at any time.

Looking back over the three months to the end of September, SIPP contributions at Bestinvest are down by 24% compared to the previous two-year average for the same period as opposed to ISA contributions which rose by 10%.

We compare ISAs vs SIPPs in a separate article.

“Ultimately, both ISAs and pensions are valuable tools for those looking to build long-term, tax-efficient savings in the UK though they have different limitations,” said Haine.

“An ISA has a tax-free allowance of £20,000 that cannot be carried forward to the next financial year, but the money held within an ISA is not taxable when it is withdrawn.

“Pensions have a higher annual allowance (AA) and the benefit of carry forward rules where savers can backdate contributions, up to their AA, over the previous three financial years – useful for those who receive a windfall such as an inheritance or the sale of a business.

“But a pension is taxable at the withdrawal stage and will also become subject to IHT – like an ISA – in 18 months’ time.”

Cuts to tax-free cash

One of the biggest concerns centres on rumours the chancellor may reduce the maximum amount pension savers, aged 55 can over, can withdraw tax-free from their retirement pots. Currently savers can access 25% of their pension tax-free, up to a maximum of £268,275 – a ceiling introduced by former Conservative chancellor Jeremy Hunt.

Similar speculation ahead of last year’s Autumn Budget triggered a wave of withdrawals from pensions, with some savers later regretting their decision after realising they did not need the cash immediately, and no changes were made.

This year, rumours of further pension tax changes appear to be having a similar effect, compounded by the fact that pensions minister Torsten Bell had previously advocated reducing tax-free cash while running the Resolution Foundation, a think tank.

Potential changes to gifting rules

With pensions brought under the scope of inheritance tax (IHT) in the chancellor’s maiden fiscal statement last year, many DIY investors have radically changed their approach to pension saving – choosing to withdraw pension funds to spend or gift rather than risk their beneficiaries being hit with a heavy tax bill on their death.

Speculation around potential changes to gifting rules – including the possibility the seven-year rule may be extended, or a lifetime gifting cap introduced – is also driving the significant behavioural shift of more people withdrawing more from their pensions before the Budget to avoid inheritance tax.

Haine said: “At Bestinvest, we’ve seen a surge in tax-free cash requests as we edge closer to the Autumn Budget, echoing the trend seen ahead of the chancellor’s first fiscal statement last year.

“Taking tax-free cash prematurely as a knee-jerk reaction to a possible policy change can undermine retirement plans and prove to be tax inefficient. Moving a large sum out of a tax-protected wrapper, like a pension, into a taxable environment such as a bank or building society savings account can counteract the gain someone makes from making the tax-free withdrawal in the first place.

“From that point, interest, income or capital gains could be liable for tax unless the money falls within an existing tax-free allowance, such as the personal savings allowance, or is transferred into another tax-efficient vehicle such as an ISA.”

Can you reverse tax-free cash withdrawal?

Anyone considering taking large sums from their pension would be wise to take financial advice before they make any decisions. Worryingly, 70% of people do not, according to Financial Conduct Authority data from the 2024/25 tax year.

“Without a clear picture of their retirement funding strategy, they cannot assess whether accessing their tax-free pension lump sum now makes sense – or whether it’s better to leave the money invested for longer or only take a portion of the 25% tax-free element,” said Haine.

Decisions made in haste cannot always be reversed. While some providers previously allowed savers to cancel tax-free lump sum withdrawals within a certain cooling-off timeframe, HMRC and the FCA have recently made clear that providers should not permit savers to reverse their decision. This means once the money is taken, the decision cannot be undone.