Sarah Coles, head of personal finance at AJ Bell, comments: “The tax-free lump sum is everyone’s favourite part of the pension. People with little or no interest in pensions overall hit the age of 55 and realise they can get their hands on tens of thousands of pounds overnight. They can suddenly buy things they have always wanted, from cars to holidays and home improvements. However, there’s a risk some of them are doing so without considering the impact on their overall retirement income.
“Once you reach the age of 55 (rising to 57 in 2028), in the vast majority of cases, 25% of the pension can be taken free of tax. It’s technically known as the Pension Commencement Lump Sum, but it’s known to most people as tax-free cash. The vast majority of people take this money, but this research rings alarm bells over how they’re doing it, and what they’re spending the money on.
1. People are taking it while they’re still working
“Overall, 26% of people said they took the first payment from their pension while they were still working. This will include some people who are phasing retirement, and continuing to do some work to supplement their pension income. However, when we narrowed it down to people who weren’t doing any work in retirement, 23% had drawn money from their pension before they stopped work.
2. They’re taking it early
“76% of people aged 55-64 say they have already taken the lump sum from their pension. Taking the cash early comes with two downsides – it restricts the total they can take tax-free, and it hampers the future growth of their pot. If they have invested it outside a pension they may be exposed to tax, if they have saved the money in cash they have cut its growth potential, and if they have spent it they have drastically reduced the money they have to live on in retirement.
3. They’re spending it
“Of those who say they have taken a lump sum from a pension, only 30% used the first pension payment to cover living costs. Meanwhile, 26% paid for home improvements, 21% spent it on a holiday, 19% paid off debt and 16% bought a new car. “This isn’t a fundamentally bad idea. They may have factored this into their plans while saving for a pension, and decided to pay their mortgage off at this point. They may have plenty of money set aside, so can afford to take the holiday of a lifetime or make changes to their home so it suits them in retirement.
“However, there’s a real risk many of them haven’t considered the implications. They may be mentally accounting for this pot of cash completely separately from the part of their pension they want to draw an income from, so they haven’t weighed up what they stand to lose from that income if they spend the cash on something else. “The fact that almost as many people say they have managed their pot badly as say they have managed it well is a worrying sign that people are making decisions with their lump sum, and pension withdrawals in general, that they come to regret later.
The Budget risk
“There’s a risk that all of this could be exacerbated in the run up to the Budget. The last two Budgets sparked speculation over a potential raid on pensions tax-free cash. AJ Bell analysis of the latest Financial Conduct Authority data from 2025/26 found that people took an estimated £14 billion more from their pension than they would have done without this speculation – that’s on the back of £10 billion a year earlier.
“It constitutes a horrible pensions raid which could seriously damage retirement incomes. The Pensions Commission found that 14.6 million people aren’t saving enough for retirement, but that this rises by 2 million if people take their tax-free cash and spend it. It’s why AJ Bell has called on Chancellor John Healey to commit to a Pension Tax Lock to avoid this damaging trend continuing.”
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