Should you withdraw a lump sum from your pension at 55?

Withdrawing a lump sum from your pension when you turn 55 might seem tempting, but it could lead to unexpected consequences. 

A survey by Legal & General found 27% of people make pension withdrawals without seeking advice, potentially exposing themselves to unexpected tax bills and losing entitlement to means-tested benefits. 

Here, Which? breaks down what you need to know before taking cash from your pension.

What are the rules with withdrawing a lump sum?

You can take a tax-free lump sum from your pension when you turn 55 (rising to 57 in 2028). 

Usually, any income you withdraw from your pension is subject to tax. However, you're allowed to take up to 25% as a tax-free lump sum, up to a maximum of £268,275. 

Every pension scheme you're part of should allow you to take a lump sum, so you could withdraw 25% from each one once you turn 55.

An alternative strategy is to use your tax-free entitlement gradually, by taking 'uncrystallised funds pension lump sums', or UFPLS. 

• Find out more: pension options: what can I do with my pension pot?

4 things to consider first

Legal & General surveyed people over 50 to understand their retirement decisions and plans. 

It found that 46% of people took a pension lump sum ‘because they could’, while a further 32% did so to cover essential expenses. 

Whatever your reason for taking a lump sum, here are four things you should consider before doing so:

1. How much tax you'll need to pay

67% of people surveyed by Legal & General withdrew 25% or less to stay within the tax-free allowance, but 10% withdrew their entire pot. 

Anything over 25% is subject to income tax and could potentially push you into a higher tax bracket. 

For example, if your pot was worth £60,000 and you took it all at once, you would get £15,000 (25% of £60,000) tax-free. The remaining £45,000 would be treated as income and, therefore, subject to income tax.

Alternatively, you could spread the lump sum amounts over more than one tax year, meaning you might pay less tax on them overall.

You can use the Which? pension tax calculator to find out how much tax you'll owe if you take your whole pot, or a chunk of it as a lump sum

The first lump sum you take from your pension often won't be taxed correctly by HMRC, meaning you might initially pay more tax than you need to.

HMRC will eventually repay this, usually at the end of the tax year. However, you can request a refund within 30 days and get your money back. 

• Find out more: HMRC pays back £50m in pension tax

2. Whether it will impact any benefits

24% of those surveyed by Legal & General didn’t realise that taking a lump sum can affect their eligibility for means-tested benefits, with 11% saying it had a direct impact on their entitlement. 

Your pension income is considered when assessing your eligibility for benefits, but how it’s treated depends on your age. 

• If you're below state pension age (currently 66), withdrawals from your pension will be counted as part of the assessment for tax credits or housing benefit. 
• If you're above state pension age, both the lump sum you take and the remaining balance in your pension will be factored into the assessment. 

If you already receive means-tested benefits, they could be reduced or stopped if you don’t withdraw money from your pension that you're entitled to. 

Legal & General has teamed up with financial charity Turn2us, which offers an online benefits calculator where you can check your entitlement and how withdrawing your pension could impact this.

• Find out more: how to take a lump sum from your pension

3. How much money you'll need in retirement

You’ll need to withdraw enough to cover your living costs, but you should also plan carefully to make sure your savings don’t run out too soon.

To make this easier, the Pension and Lifetime Savings Association (PLSA) has developed three ‘retirement living standards’. These reflect the amounts you’d need for what it describes as a 'minimum', 'moderate' and 'comfortable' standard of living in retirement.

For a comfortable standard of living in retirement, the PLSA says single-person households need £43,100 a year, while couples need £59,000.

If you do take part of your pension as a lump sum, you'll need to decide what to do with the rest of it. You could buy an annuity which guarantees an income each year for life, use pension drawdown to keep it invested and take it as you need, or even a mix of both. 

• Find out more: how much do you need to retire?

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4. Whether to take financial advice

If you’re unsure about how to manage your pensions, you may find it useful to speak to a regulated, independent financial adviser. However, cost can be a barrier. 

According to the adviser directory Unbiased, at-retirement advice for a pension pot worth £250,000 typically costs around £3,000, with consolidating pots worth £500,000 costing approximately £5,000.

If you choose to pay for financial advice, comparison sites such Unbiased and Vouched For can help you find quotes from regulated and qualified advisers. Just be sure the advisers are properly accredited.

If you’re 50 or older and have a defined contribution pension, you can access free guidance from Pension Wise, a government-backed service provided by MoneyHelper. While it’s not personalised advice, it offers general information and is available via one-hour face-to-face, phone, or online appointments.

• Find out more: how to get pension advice for your retirement