Under new flexible rules introduced in April 2015, you can now use your pension pot to take out cash as and when you need it. However, there are tax implications and a risk that your money could run out.

How it works
You take cash from your pension pot whenever you need it. For each cash withdrawal, the first 25% will be
tax-free and the rest will be taxed at
your highest tax rate by adding it to the rest of your income.

There may be charges each time you make a cash withdrawal and/or limits on how many withdrawals you can make each year.

Unlike with the option called flexi-access drawdown, your pension pot isn’t re-invested into funds that are actively managed to pay a regular income – this means there’s more risk that its value could fall.

Things to think about
Your pension pot reduces with each cash withdrawal. The earlier you start taking money out of your pot, the greater the risk your money could run out. What’s left in your pension pot might not grow enough to give you the income you need to last you into old age – most people underestimate how long their retirement will be.

The administration charges for each withdrawal could eat into your remaining pot. The funds where your existing pot is invested could fall in value and you could run out of money.

Because your pot hasn’t been reinvested to produce an income, its investments could fall in value – so you’ll need to have it reviewed regularly. Charges will apply and you may need to move or reinvest your pot at a later date.

Once you take money out of your pension pot, any growth in its value is taxable, whereas it will grow tax-free inside the pot – once you take it out, you can’t put it back.

Taking cash lump sums could also reduce your entitlement to benefits now or as you grow older.

Tax you will pay
Three quarters of each cash withdrawal counts as taxable income. This is added to the rest of your income, and depending on how much your total income for the tax year is, you could find yourself pushed into a higher tax band. So if you take lots of large cash sums, or even a single cash sum, you could end up paying a higher rate of tax than you normally do.

Your pension scheme or provider will pay the cash through a payslip and take off tax in advance – called ‘PAYE’ (Pay As You Earn). This means you may pay too much tax and have to claim the money back – or you may owe more tax if you have other sources of income.

Extra tax charges or restrictions may apply if your pension savings exceed the lifetime allowance (currently £1.25m), or if you have less lifetime allowance available than the amount you want to withdraw.

Tax relief on future pension savings
If the value of your pension pot is £10,000 or more, once you start to take income, the amount of Defined Contribution pension savings on which you can get tax relief each year is reduced from £40,000 (the ‘annual allowance’) to £10,000 (called the ‘Money Purchase Annual Allowance’ or ‘MPAA’). If you want to carry on building up your pension pot, this option may not be suitable.

What happens when you die?
• If you die before the age of 75, any
untouched part of your pension pot will pass tax-free to your nominated beneficiary or estate
• If you die after the age of 75 or over and your nominated
beneficiary takes the money as income, they will pay tax on it in the normal way. If they take the money as
a lump sum before 6 April 2016, they’ll pay 45% tax on it – any lump sum taken on or after this date will be added to their income and taxed in the normal way

The lifetime allowance charge
If the value of all of your pension savings is above £1.25m when you die, further tax charges may apply.

Your other retirement income options
Taking cash sums is just one of several options you have for using your pension pot to provide a retirement income. Because of the risk of running out of money, we don’t recommend using this method to fund your retirement income.